U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
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Commission File No.0-21472
AMERICAN RESOURCES OFFSHORE, INC.
(Name of small business issuer in its charter)
DELAWARE 86-0713506
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
160 MORGAN STREET, P. O. BOX 87
VERSAILLES, KENTUCKY 40383
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: 606-873-5455
Securities registered pursuant to Section 12(b) of the Exchange
Act: NONE
Securities registered pursuant to Section 12(g) of the Exchange
Act:
PREFERRED STOCK, PAR VALUE $12.00 PER SHARE
(Title of Class)
COMMON STOCK, PAR VALUE $.00001 PER SHARE
(Title of Class)
WARRANTS TO PURCHASE COMMON STOCK
(Title of Class)
Check whether the issuer (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the
past 12 months (or for such shorter period that the registrant
was required to filed such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES xx NO
------ ------
X Indicate by check mark if disclosure of delinquent filers in
response to Item 405 of Regulation S-K (229.405 of this Chapter)
is not contained herein, and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-
K or any amendment to this Form 10-K.
The aggregate market value of the voting stock held by non-
affiliates of the Registrant was approximately $3,606,766 as of
March 15, 1999, based upon the closing sale price of the Common
Stock on the NASDAQ SmallCap Market on March 15, 1999 of $0.469
per share. As of March 15, 1999, Registrant had 10,261,074
shares of Common Stock, par value $.00001 per share, and 230,516
shares of Series 1993 Preferred Stock, par value $12.00 per
share, outstanding.
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PAST FIVE YEARS
Check whether the issuer has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Exchange
Act after the distribution of securities under a plan confirmed
by a court.
YES xx NO
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DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference in
this report in the Part(s) indicated: None.
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ii
TABLE OF CONTENTS
Page
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PART I
Item 1. Business 1
Item 2. Description of Property 13
Item 3. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of
Security Holders 20
PART II
Item 5. Market for Common Equity and Related
Stockholder Matters 21
Item 6. Management's Discussion and Analysis of
Financial Condition and Results of Operations 22
Item 7. Financial Statements 33
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 33
PART III
Item 9. Directors and Executive Officers, Promoters
and Control Persons; Compliance with
Section 16(a) of the Exchange Act 34
Item 10. Executive Compensation 39
Item 11. Security Ownership of Certain Beneficial
Owners and Management 47
Item 12. Certain Relationships and Related Transactions 49
PART IV
Item 13. Exhibits and Reports on Form 8-K 52
Signatures 109
Exhibit Index 110
iii
PART I
ITEM 1. DESCRIPTION OF BUSINESS:
OVERVIEW:
American Resources Offshore, Inc. ("ARO") is the surviving
company of the October 29, 1998 merger between American Resources
of Delaware, Inc. and its wholly-owned subsidiary, American
Resources Offshore, Inc., the merged company having assumed the
name of ARO. ARO is an independent oil and gas company engaged
in the acquisition, exploration, development, and production of
oil and gas properties offshore Louisiana and offshore Texas (the
"Gulf Coast Region") and in southeastern Kentucky ("Appalachia"
or the "Appalachian Region"). ARO also gathers and markets its
natural gas in Appalachia. Southern Gas Co. of Delaware, Inc.
("Southern Gas") is ARO's only wholly-owned subsidiary. When
used herein, the word "ARO" refers to both ARO and Southern Gas
unless otherwise indicated.
ARO's acquisition, exploration and development activities
have resulted in substantial increases in reserves, production
and cash flow from oil and gas operations since year-end 1993.
As the result of successful drilling activities and acquisitions,
ARO has grown proved reserves more than 700% since year-end 1993,
resulting in 1998 earnings before interest, taxes,
depreciation/depletion and amortization and impairment on assets
("EBITDA") of $13.6 million. However, for the year ended
December 31, 1998, ARO had a net loss of $46.2 million which
included a non-cash impairment in the amount of $36.7 (See Item
7, "Financial Statements," to this Report on Form 10-K). At
December 31, 1998, ARO's estimated net proved reserves were 49.2
billion cubic feet ("Bcf") of natural gas and .85 million barrels
("MMBbls") of oil, or 54.3 Bcf equivalent with estimated future
net cash flows discounted using a rate of 10% ("PV-10 Value") of
approximately $51.4 million. 76% of these reserves were
classified as proved developed.
ARO saw its production volumes increase 18.5% in 1998 as
compared with 1997; and with the acquisition of additional
prospects in the Gulf Coast Region during 1998, ARO has adequate
inventory with which to continue exploration.
ARO's first direct involvement in the Gulf Coast Region
began in 1995 when it acquired an interest in and drilled two
successful wells on the offshore Louisiana lease block known as
Ship Shoal 150. In 1996 and 1997, ARO made great progress in
expanding its Gulf Coast Region operations by acquiring working
interests in existing oil and gas wells together with exploration
rights on the offshore Louisiana lease blocks known as South
Timbalier 148, Ship Shoal 222, Ship Shoal 225 and West Cameron
368. In order to assist with the change in ARO's primary focus
from the Appalachian Region to the Gulf Coast Region and to
support additional growth in the Gulf Coast Region, in November
1997, ARO formed a wholly-owned subsidiary named American
Resources Offshore, Inc. and staffed it with an experienced
technical team.
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During the first quarter of 1998, ARO significantly expanded
its holdings in the Gulf Coast Region by acquiring properties
from TECO Oil & Gas, Inc. ("TECO") for $57.7 million (see Item 1,
"Description of Business--Acquisition Activities," of this Report
on Form 10-K). $16.5 million of the purchase price was paid from
funds borrowed under bridge loans provided by DNB Energy Assets,
Inc. ("DNB"), successor to Den norske Bank AS ("Den norske"), and
$18.5 million was paid in the form of a promissory note in favor
of TECO ("TECO Note"). At the time of the acquisition, ARO
planned to raise additional capital and obtain permanent debt
financing in order to i) refinance the bridge loans and the TECO
Note, and ii) provide funding necessary to actively develop the
properties and significantly increase its reserve base. However,
in the months that followed, ARO was faced with several difficult
challenges which have placed it in an uncertain financial
position.
Simultaneously with the acquisition of properties from TECO,
ARO hired an investment banking firm to assist it in completing a
combination high yield debt offering and preferred stock
offering, and the two worked on this project diligently
throughout the spring and summer months. Unfortunately, due to
the softening of the debt and equity markets, these attempts were
unsuccessful and no funds were raised. ARO believes that a
contributing factor to the failure to raise outside funding was
the simultaneous decline in oil and gas prices to their lowest
levels in recent history. To further compound the situation,
production from ARO's two largest producing fields, South
Timbalier 211 and 148, declined approximately 60% over the six-
month period from March to September 1998. Finally, throughout
the summer months, ARO incurred trade payables of approximately
$16 million as a result of the capital requirements for the
development of additional wells. However, subsequent to year end
1998, ARO settled approximately $12 million of the trade payables
by surrendering its interest in Grand Isle Block 55, which is
reflected in the December 31, 1998 financial statements.
Due to the events described above, as of December 31, 1998,
ARO's financial situation was such that it was not in compliance
with its primary credit facility and the bridge loans, as
amended, from DNB in the approximate amounts of $48 million and
$15.6 million, respectively; TECO had declared ARO in default of
the TECO Note which matured on October 1, 1998; and ARO had
current liabilities in excess of current assets of approximately
$6.3 million (excluding current portion of long-term debt).
ARO is taking measures in an attempt to remedy the above
deficiencies, as more particularly described in Item 6,
"Management's Discussion and Analysis of Financial Condition and
Results of Operation--Liquidity and Capital Resources," of this
Report on Form 10-K. In the event ARO is successful in its
restructuring efforts, it plans to actively develop its existing
Gulf Coast Region properties during 1999 and beyond.
2
STRATEGY:
ARO's primary goal is to increase reserves, production and
cash flow through the exploration and development of its oil and
gas properties. ARO emphasizes the following elements in
achieving this strategy:
ENHANCE GULF COAST REGION PRESENCE. ARO plans to expand its
production and reserve position in the Gulf Coast Region, a
region which represented approximately 74% of ARO's PV-10 Value
for proved reserves at December 31, 1998. ARO believes it has
been successful in its exploration and development activities in
this region and believes that there remains significant
undiscovered reserve potential attainable through active
drilling.
BALANCE EXPLORATION AND DEVELOPMENT ACTIVITIES. ARO plans
to utilize a balanced approach to grow its reserves, production
and cash flow. ARO's acquisitions during 1998 were consistent
with this strategy and consisted of a balanced portfolio of
production and proved undeveloped properties, as well as higher
impact exploratory projects which have been identified using 3-D
seismic technology. ARO anticipates that substantially all of
its 1999 drilling budget will be allocated toward lower risk
development drilling projects.
EXPAND PROSPECT GENERATION PROGRAM. ARO's participation in
partnerships such as Louisiana Offshore Ventures and Texas 3D
Ventures increases its exposure to a greater number and variety
of high quality drilling opportunities, while diversifying its
risk. ARO currently owns interests in substantially undeveloped
leasehold inventory in the Gulf Coast Region encompassing
approximately 225,000 gross acres and 49 lease blocks. Ten of
the 49 lease blocks are currently producing from 26 wells. ARO
believes that its internal exploration team, acting in
cooperation with an external network of geoscientists, will
accelerate ARO's growth through development and exploratory
drilling of its own acreage and additional undeveloped acreage
acquired through farm-ins and other joint venture arrangements.
USE ADVANCED TECHNOLOGIES. ARO utilizes 3-D seismic and
other advanced technologies to evaluate its development and
exploratory projects in the Gulf Coast Region, to provide more
accurate geological data and to improve the likelihood of
drilling success. During 1998, ARO gained access to 14
geoscientists, in addition to its own staff of four, and over
13,500 square miles of 3-D seismic data.
ACQUISITION ACTIVITIES:
In the past, ARO actively pursued the acquisition of
producing oil and gas properties in its core areas of operations.
From inception, ARO has acquired interests in approximately 508
wells in the Gulf Coast Region and Appalachia (net of
dispositions), as well as several hundred undeveloped leases in
these areas. ARO also increased its
3
leasing activities in the Gulf Coast Region and at December 31,
1998, had invested approximately $48.2 million for the
acquisition of unproved leases in the area.
Set forth below is a brief description of the major property
acquisitions by ARO during the last five years.
MARCH 1998 - TECO OIL & GAS - $57.7 million - ARO purchased
interests in 41 leaseblocks in the Gulf of Mexico from TECO. The
properties consisted of an average 30% interest in approximately
198,300 acres and 5 producing wells, interests in two joint
ventures and access to approximately 12,500 square miles of 3-D
seismic data. ARO believes that these properties provide ample
opportunity to increase reserves, production and cash flow from
development and exploration activities. ARO has participated in
the drilling and completion of 6 wells on the properties since
they were acquired and has identified numerous other drilling
locations thereon.
DECEMBER 1997 - K. E. RESOURCES - $2.5 million - ARO
acquired interests in three producing leases and one undeveloped
lease covering a combined 15,000 acres in the Federal Outer
Continental Shelf ("OCS") offshore Louisiana (Ship Shoal Blocks
222 and 225 and West Cameron 368) from K.E. Resources, Ltd. The
properties include 6 platforms servicing the existing wells which
contain an estimated 3.5 Bcf equivalent of proved oil and gas
reserves net to ARO. Management believes there are several
desirable locations for additional exploration as well as
additional development opportunities on the property.
SEPTEMBER 1997 - PRIMA - $2.8 million - ARO acquired
additional interests in several producing and non-producing oil
and gas properties in the Gulf Coast Region from Prima Capital,
LLC ("Prima").
JUNE 1997 - DAUGHERTY - $0.5 million - ARO acquired
interests in 26 natural gas wells in Appalachia from Daugherty
Petroleum, Inc. The properties were attractive to ARO because
they were located in or adjacent to existing facilities owned by
ARO.
JULY 1996 - CENTURY - $15.6 million - ARO acquired working
interests in proved developed and undeveloped oil and gas
properties in the Federal OCS offshore Louisiana (South Timbalier
148 containing proved reserves of approximately 12.0 Bcf of gas
and 465,000 barrels of oil) from Century Offshore Management
Corporation ("Century"). The purchase price consisted of $8
million in cash, the cancellation of a $6.5 million promissory
note from Century to ARO and the assumption of existing liens of
$1.1 million.
DECEMBER 1995 - AKS - $4.2 million - ARO acquired properties
in Appalachia from AKS Energy Company ("AKS"). ARO acquired more
than 100 miles of gathering pipelines and related equipment,
ownership in approximately 155 producing wells located
4
in or adjacent to ARO's existing Kentucky facilities and net
proved reserves of approximately 7.7 Bcf.
FEBRUARY 1994 - SOUTHERN GAS COMPANY - $16.8 million - ARO
acquired the oil and gas properties, pipeline and equipment, and
accounts receivable of Southern Gas Company, Inc. ("SGC"), an
independent Kentucky-based natural gas production, pipeline and
gas marketing company.
FEBRUARY 1994 - SOUTHERN GAS HOLDING CO. - $2.1 million -
ARO acquired from Southern Gas Holding Co. ("SGH"), the parent
company of SGC, its interests in gas wells owned by SGH and
441,176 shares of common stock in National American Life
Insurance Company of Pennsylvania, Inc. ("NALICO") owned by SGH.
Based upon an independent appraisal of the investment, a final
purchase price of $869,000 was allocated to the NALICO stock.
During 1995, Management obtained an independent appraisal of
ARO's investment value of NALICO. As result of the appraisal,
ARO reduced the investment's value to zero and recognized the
reduction as a charge against income in 1995.
1994 - MISCELLANEOUS - Throughout 1994, ARO actively
acquired numerous natural gas properties in Kentucky to enhance
the properties acquired from SGC.
TECHNOLOGY:
ARO intends to utilize 3-D seismic surveys and its access to
18 geoscientists and 13 state of the art 3-D seismic workstations
to evaluate its exploratory prospects in the Gulf Coast Region
prior to drilling thereon. The availability of 3-D data at
reasonable cost makes it an attractive risk management tool for
the shallow waters of the Gulf of Mexico. The use of 3-D seismic
technology will provide ARO with substantially more accurate and
comprehensive geological data for the evaluation of drilling
prospects than 2-D seismic technology and traditional evaluation
methods. ARO believes that its use of 3-D seismic technology
improves its likelihood of drilling success and provides it with
an advantage over those companies that do not regularly utilize
similar technology.
MARKETING AND CUSTOMERS:
ARO sells substantially all of its current Gulf Coast Region
gas production through H&N Gas, Ltd. and Superior Natural Gas
Corporation. ARO utilizes forward sales contracts for a
significant portion of its Gulf Coast Region gas production to
achieve more predictable cash flows and to reduce the effect of
fluctuations in gas prices. During 1998, ARO's Gulf Coast Region
production averaged 28.8 million cubic feet equivalent per day
("MMcfe/d"). At March 15, 1999, ARO had forward sales
arrangements with respect to 20 MMcfe/d at an average price of
$1.86 per thousand cubic feet ("Mcf"). During 1998, ARO sold
call options for 20 MMcfe/d at a call price of $2.70 per Mcf,
which expire in March 2000. In exchange for establishing a
ceiling of
5
$2.70 per Mcf over the option term, ARO received an average
option premium of $0.14 per Mcf on the volumes contracted for
under the call option agreement. These contracts were terminated
in January 1999 at a profit of $680,114. ARO continuously
reevaluates its sales contracts in light of market conditions,
commodity price forecasts, capital spending plans and debt
service requirements.
ARO sells more than 10% of its Gulf Coast oil production to
Citgo Petroleum Corporation, Texon Corporation, Conoco and
through contracts administered by I.P. Petroleum Company.
In Appalachia, ARO markets substantially all of the gas
production from company-operated properties as well as gas
production purchased from other sources. During 1998, ARO's
Appalachia production averaged 3 MMcfe/d. As of December 31,
1998, ARO sold approximately 7.5 MMcfe/d of its own and third
party Appalachia production at an average price of $2.84 per Mcf.
ARO, through its marketing operation, purchased 4.5 MMcfe/d at an
average cost of $2.83 per Mcf at such date.
During 1996, 1997 and 1998, Osram Sylvania purchased in
excess of 10% of the natural gas sold by ARO, and Southern
Resources, Inc. purchased approximately 69%, 48% and 0%,
respectively, of the natural gas sold by ARO under a contract
which was terminated in May 1997, the majority of which was sold
on a spot market basis. The remaining Appalachia production is
sold to industrial end-users in Kentucky and surrounding states.
ARO has a number of customers for its Appalachian gas, most
of which are industrial end-users located in Kentucky. However,
other end-users of ARO's gas are located in Ohio, Tennessee and
West Virginia. Its largest customers currently include Osram
Sylvania, Williams Energy and PG&E. The industrial end-users are
serviced through a variety of gas companies, including Columbia
Gas of Kentucky, Inc., Texas Eastern Pipeline and Delta Natural
Gas Company.
Most of ARO's Appalachian production is transported through
its approximately 300 miles of gas gathering systems running
through Southeastern Kentucky to transmission pipelines which are
not owned by ARO. Transportation space on these transmission
pipelines may be occasionally limited and at times unavailable
due to repairs or improvements being made to the facilities.
ARO's access to transportation options could also be affected by
regulation of intrastate and interstate gas transportation. In
an attempt to promote competition, the Federal Energy Regulatory
Commission ("FERC") has issued a series of orders which have
altered significantly the marketing and transportation of natural
gas (See "Regulation: Federal Regulation of Sales and
Transportation of Natural Gas"). The effect of these orders to
date has been to enable producers such as ARO to market their
natural gas production to purchasers other than the interstate
pipelines located in the vicinity of their producing properties.
While ARO has not experienced any inability to market its
production, if transportation
6
space becomes restricted or is unavailable, ARO's cash flow could
be adversely affected. However, in order to guard against
curtailment of deliveries due to normal capacity limitations, ARO
maintains firm or priority transportation capacity where
available on key transmission pipelines. (See "Regulations--
Federal Regulation of Sales and Transportation of Natural Gas.")
COMPETITION:
The oil and gas industry is highly competitive, particularly
with respect to the acquisition of producing properties and
proved undeveloped acreage. Major and independent oil and gas
companies actively bid for desirable oil and gas properties, as
well as for the equipment and labor required to operate and
develop such properties. Many of ARO's competitors have
financial and personnel resources and exploration and development
budgets that are substantially greater than those of ARO, which
may affect ARO's ability to compete with these companies.
REGULATIONS:
ENVIRONMENTAL. Activities of ARO with respect to (1)
exploration, development, and production of oil and natural gas
and (2) the operation and construction of pipelines, plants, and
other facilities for the transportation and treatment of natural
gas and natural gas liquids are subject to stringent
environmental regulation by local, state and federal authorities,
including the U.S. Environmental Protection Agency ("EPA"). Such
regulation has increased the cost of planning, designing,
drilling, operating and in some instances, abandoning wells.
Similarly, such regulation has also increased the cost of design,
construction, and operation of natural gas pipelines and
treatment facilities. In most instances, the regulatory
requirements relate to the handling and disposal of drilling
production waste and waste created by water and air pollution
control procedures or equipment. Although ARO believes that
compliance with existing environmental regulations will not have
a material adverse effect on operations or earnings, the risks of
substantial costs and liabilities are inherent in oil and gas
operations, and there can be no assurance that significant costs
and liabilities, including civil and criminal penalties, will not
be incurred. Moreover, it is possible that other developments,
such as stricter environmental laws and regulations, and claims
for damages to property or persons resulting from ARO's
operations could result in substantial costs and liabilities to
ARO.
The Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA"), also known as the "Superfund" law,
imposes liability, without regard to fault or the legality of the
original conduct, on certain classes of persons with respect to
the release of a "hazardous substance" into the environment.
These persons include the owner or operator of the disposal site
or sites where the release occurred and companies that disposed
or arranged for the disposal of the hazardous substances found at
the site. Persons who are or were responsible for releases of
hazardous substances under CERCLA may be subject to joint and
several liability for the costs of cleaning up the
7
hazardous substances that have been released into the environment
and for damages to natural resources, and it is not uncommon for
neighboring landowners and other third parties to file claims for
personal injury or property damages allegedly caused by the
hazardous substances released into the environment. At least two
federal courts have held that certain wastes associated with the
production of crude oil may be classified as hazardous substances
under CERCLA. At this time, neither ARO nor its predecessors has
been designated as a potentially responsible party under CERCLA.
ARO generates or has generated in the past wastes, including
hazardous wastes, that are subject to the federal Resource
Conservation and Recovery Act ("RCRA") and comparable state
statutes. EPA and various state agencies have promulgated
regulations that limit the disposal options for certain hazardous
and nonhazardous wastes. Furthermore, it is possible that
certain wastes generated by ARO's oil and gas operations that are
currently exempt from treatment as "hazardous wastes" may in the
future be designated as "hazardous wastes" under RCRA or other
applicable statutes and therefor be subject to more rigorous and
costly operating and disposal requirements.
ARO currently owns or leases, or has in the past owned or
leased, numerous properties that for many years have been either
used for the exploration and production of oil and gas or used to
store and maintain equipment that was regularly used in these
operations. Although ARO utilized operating and disposal
practices that were standard for the industry at the time,
hydrocarbons or other wastes may have been disposed of or
released on or under the properties owned or leased by ARO or on
or under other locations where such wastes have been taken for
disposal. In addition, many of these properties have from time
to time been operated by third parties whose treatment and
disposal or release of hydrocarbons or other wastes was not under
ARO's control. These properties and the waste disposed thereon
may be subject to CERCLA, RCRA, and analogous state laws. Under
such laws, ARO could be required to remove or remediate
previously disposed wastes (including wastes disposed of or
released by prior owners or operators) or property contamination
(including groundwater contamination) or to perform remedial
plugging operations to prevent future contamination.
The Oil Pollution Act ("OPA") amends certain provisions of
the Federal Water Pollution Control Act of 1972, commonly
referred to as the Clean Water Act ("CWA") and other statutes as
they pertain to the prevention of and response to oil spills into
the navigable waters of the United States. OPA subjects owners
and operators of facilities to strict joint and several liability
for all containment and cleanup costs and certain other public
and private damages arising from a spill, including, but not
limited to, the costs of responding to a release of oil to
surface waters. OPA establishes a liability limit for onshore
facilities of $350 million and for offshore facilities of all
removal costs plus $75 million, however a party cannot take
advantage of the liability limits if the spill is caused by gross
negligence or willful misconduct or resulted from a violation of
a federal safety, construction, or operating regulation. If a
party fails to report a spill or cooperate in the cleanup,
liability limits likewise do not apply. OPA also imposes ongoing
requirements
8
on responsible parties, including proof of financial
responsibility for potential oil spills. OPA originally required
owners and operators of offshore oil and gas facilities to
establish $150 million in financial responsibility. Under the
rule, the responsible party can establish financial
responsibility through insurance, guaranty, indemnity, surety
bond, letter of credit, qualification as a self-insurer, or a
combination thereof. On September 30, 1996, Congress passed
legislation lowering the minimum financial responsibility
requirement for offshore facilities in United States waters under
OPA to $35 million, subject to increases up to a maximum of $150
million if the risk posed by a potential oil spill indicates the
increase is warranted. The United States Department of the
Interior Minerals Management Service ("MMS") has proposed a final
rule to implement these financial assurance requirements. See 62
Fed. Reg. 14,052 (March 25, 1997). MMS has not yet issued the
final financial responsibility rule. While the financial
assurance requirements under OPA may impose additional costs on
ARO, the impact of the rule is not expected to be any more
burdensome to ARO than it will be to other similarly situated
owners and operators with operations within or adjacent to the
waters of the United States.
The CWA provides penalties for any discharges of petroleum
product in reportable quantities and imposes substantial
liability for the costs of removing a spill. State laws for the
control of water pollution also provide varying civil and
criminal penalties and liabilities in the case of releases of
petroleum or is derivatives into surface waters or in the ground.
Federal regulations under the CWA and OPA require certain owners
or operators of facilities that store or otherwise handle oil,
such as ARO, to prepare and implement spill prevention, control
and countermeasure plans and facility response plans relating to
the possible discharge of oil into surface waters. In addition,
the CWA and analogous state laws require permits to authorize
discharges into surface waters or to construct facilities in
wetland areas. With respect to certain of its operations, ARO is
required to maintain such permits or meet general permit
requirements. In 1992, EPA adopted regulations concerning the
discharge of stormwater runoff. This program requires that
covered facilities obtain individual permits, participate in a
group permit, or seek coverage under an EPA general permit. ARO
believes that it is in substantial compliance with the
requirements of the CWA and OPA and that any non-compliance would
not have a material adverse effect on ARO.
FEDERAL REGULATION OF SALES AND TRANSPORTATION OF NATURAL
GAS: Historically, the transportation and sale for resale of
natural gas in interstate commerce have been regulated pursuant
to the Natural Gas Act of 1938 (the "NGA"), the Natural Gas
Policy Act of 1978 (the "NGPA") and the regulations promulgated
thereunder by the FERC. Maximum selling prices of certain
categories of natural gas sold in "first sales," whether sold in
interstate or intrastate commerce, were regulated pursuant to the
NGPA. On July 29, 1989, the Natural Gas Wellhead Decontrol Act
(the "Decontrol Act") was enacted, which removed, as of January
1, 1993, all remaining federal price controls from natural gas
sold in "first sales",such as sales by ARO of its own production.
The FERC's jurisdiction over natural gas transportation was
unaffected by the Decontrol Act.
9
ARO's sales of natural gas are affected by the availability,
terms and cost of transportation. The price and terms for access
to pipeline transportation remain subject to extensive federal
and state regulation. Several major regulatory changes have been
implemented by Congress and the FERC from 1985 to the present
that affect the economics of natural gas production,
transportation and sales. In addition, the FERC continues to
promulgate revisions to various aspects of the rules and
regulations affecting those segments of the natural gas industry,
most notably interstate natural gas transmission companies, that
remain subject to the FERC's jurisdiction. These initiatives may
also affect the intrastate transportation of gas under certain
circumstances. The stated purpose of many of these regulatory
changes is to promote competition among the various sectors of
the natural gas industry and these initiatives generally reflect
more light-handed regulation of the natural gas industry. The
ultimate impact of the complex rules and regulations issued by
the FERC since 1985 cannot be predicted. In addition, many
aspects of these regulatory developments have not become final
but are still pending judicial and FERC final decisions. ARO
cannot predict what further action the FERC will take on these
matters; however, the Company does not believe that it will be
affected by any action taken materially differently than other
natural gas producers and marketers with which it competes.
The Outer Continental Shelf Lands Act (the "OCSLA") requires
that all pipelines operating on or across the OCS provide open-
access, non-discriminatory service. Although the FERC has opted
not to impose the regulations of Order No. 509, in which the FERC
implemented the OCSLA, on gatherers and other non-jurisdictional
entities, the FERC has retained the authority to exercise
jurisdiction over those entities if necessary to permit non-
discriminatory access to service on the OCS. While ARO does not
currently own or operate any gathering lines on the OCS, the
expansion of its business into the Gulf of Mexico may be impacted
by the OCSLA.
ARO owns certain natural gas pipeline facilities that it
believes meet the traditional tests the FERC has used to
establish a pipeline's status as a gatherer not subject to FERC
jurisdiction. Whether on state or federal land or in offshore
waters subject to the OCSLA, natural gas gathering may receive
greater regulatory scrutiny in the future.
Additional proposals and proceedings that might affect the
natural gas industry are pending before Congress, the FERC and
the courts. The natural gas industry historically has been very
heavily regulated; therefore, there is no assurance that the less
stringent regulatory approach recently pursued by the FERC and
Congress will continue.
FEDERAL LEASES: Certain of ARO's operations are located on
federal oil and gas leases, which are administered by the MMS.
Such leases are issued through competitive bidding, contain
relatively standardized terms and require compliance with
detailed MMS regulations and orders pursuant to the OCSLA (which
are subject to change by the MMS). For offshore operations,
lessees must obtain MMS approval for exploration
10
plans and development and production plans prior to the
commencement of such operations. In addition to permits required
from other agencies (such as the Coast Guard, the Army Corps of
Engineers and the Environmental Protection Agency), lessees must
obtain a permit from the MMS prior to the commencement of
drilling. The MMS has promulgated regulations requiring offshore
production facilities located on the OCS to meet stringent
engineering and construction specifications. The MMS also has
regulations restricting the flaring or venting of natural gas and
has recently proposed to amend such regulations to prohibit the
flaring of liquid hydrocarbons and oil without prior
authorization. Similarly, the MMS has promulgated other
regulations governing the plugging and abandonment of wells
located offshore and the removal of all production facilities.
To cover the various obligations of lessees on the OCS, the MMS
generally requires that lessees post substantial bonds or other
acceptable assurances that such obligations will be met. The
cost of such bonds or other surety can be substantial, and there
is no assurance that bonds or other surety can be obtained in all
cases. Under certain circumstances, the MMS may require any of
ARO's operations on federal leases to be suspended or terminated;
and the MMS has recently proposed, but not yet enacted,
regulations that would allow it to expel unsafe operators from
existing OCS platforms and bar them from obtaining future leases.
Any such suspension, termination or bar could materially and
adversely affect ARO's financial condition and operations. The
MMS also intends to adopt financial responsibility regulations
under the OPA, as described below.
The MMS issued a notice of proposed rulemaking in which it
proposes to amend its regulations governing the calculation of
royalties and the valuation of crude oil produced from federal
leases. This proposed rule would modify the valuation procedures
for both arm's length and non-arm's length crude oil transactions
to decrease reliance on oil posted prices and assign a value to
crude oil that better reflects market value, establishing a new
MMS form for collecting value differential data, and amend the
valuation procedure for the sale of federal royalty oil. ARO
cannot predict what action the MMS will take on this matter, nor
can it predict at this stage of the rulemaking proceeding how ARO
might be affected by this amendment to the MMS' regulations.
In April 1997, after two years of study, the MMS withdrew
proposed changes to the way it values natural gas for royalty
payments. These proposed changes would have established an
alternative market-based method to calculate royalties on certain
natural gas sold to affiliates or pursuant to non-arm's length
contracts. Informed discussions among MMS and industry officials
are continuing, although it is uncertain whether and what changes
may be proposed regarding gas royalty valuation. In addition,
MMS announced its intention to issue a proposed rule that would
require all but the smallest producers to be capable of reporting
production information electronically.
Recently, the MMS has issued a final rule to clarify the
types of costs that are deductible transportation costs for
purposes of royalty valuation of production sold off the lease.
In particular, under the rule, the MMS will not allow deduction
of costs
11
associated with marketer fees, cash out and other pipeline
imbalance penalties, or long-term storage fees. ARO cannot
predict what, if any effect the new rule will have on its
operations.
STATE AND LOCAL REGULATION OF DRILLING AND PRODUCTION:
Production of oil and gas by ARO is also affected by state
regulations. ARO conducts operations in Kentucky, Mississippi
and in Louisiana state waters in the Gulf of Mexico. State
regulations are generally intended to prevent waste of oil and
gas and to protect correlative rights to produce oil and gas
between owners of a common reservoir. Such regulations include
requiring permits for the drilling of wells, maintaining bonding
requirements in order to drill or operate wells, and regulating
the location of wells, the method of drilling and casing wells,
the surface use and restoration of properties upon which wells
are drilled, the plugging and abandoning of wells, and the
disposal of fluids used in connection with operations. ARO's
operations are also subject to various conservation laws and
regulations including the regulation of the size of drilling
spacing units or proration units, the density of wells that may
be drilled, and the unitization or pooling of oil and gas
properties. In addition, state conservation laws establish
maximum rates of production from oil and natural gas wells,
generally prohibit the venting or flaring of natural gas, and
impose certain requirements regarding the ratability of
production. The effect of these regulations may limit the amount
of oil and natural gas that ARO can produce from its wells and
may limit the number of wells or the locations at which ARO can
drill. To the extent any of ARO's natural gas gathering
facilities are subject to state regulations, regulation of
gathering facilities generally includes various safety,
environmental, and in some circumstances nondiscriminatory take
requirements, but does not generally entail rate regulation.
Inasmuch as such laws and regulations are periodically expanded,
amended and reinterpreted, ARO is unable to predict the future
cost or impact of complying with such regulations; however, ARO
does not believe it will be affected by these laws and
regulations materially differently than the other oil and natural
gas producers with which it competes.
OIL PRICE CONTROLS AND TRANSPORTATION RATES: Sales of crude
oil, condensate and gas liquids by ARO are not currently
regulated and are made at market prices. Commencing in October
1993, the FERC issued a series of rules (Order Nos. 561 and 561-
A) establishing an indexing system under which oil pipelines will
be able to change their transportation rates, subject to
prescribed ceiling levels. The indexing system, which allows or
may require pipelines to make rate changes to track changes in
the Producer Price Index for Finished Goods, minus one percent,
became effective January 1, 1995. In certain circumstances,
these rules permit oil pipelines to establish rates using
traditional cost of service or other methods of rate making. The
effect that these rules may have on the cost of moving ARO's
product to market is uncertain.
12
OPERATING HAZARDS AND INSURANCE:
The oil and gas business involves a variety of operating
risks, including the risk of fire, explosions, blow-outs, pipe
failure, casing collapse, abnormally pressured formations and
environmental hazards such as oil spills, gas leaks, ruptures and
discharges of toxic gases, the occurrence of any of which could
result in substantial losses to ARO due to injury or loss of
life, severe damage to or destruction of property, natural
resources and equipment, pollution or other environmental damage,
clean-up responsibilities, regulatory investigation and penalties
and suspension of operations. In addition to the foregoing,
certain of ARO's operations are currently offshore and subject to
the additional hazards of marine operations, such as capsizing,
collision and adverse weather and sea conditions.
In accordance with customary industry practice, ARO
maintains insurance against some, but not all, of the risks
described above. ARO maintains insurance to cover business
interruption and loss of revenues on its proved producing
properties in the Gulf Coast Region; however, ARO's insurance
does not cover business interruption or protect against loss of
revenues for properties in the Appalachian Region. There can be
no assurance that any insurance obtained by ARO will be adequate
to cover any losses or liabilities. ARO cannot predict the
continued availability of insurance or the availability of
insurance at premium levels that justify its purchase. The
occurrence of a significant event not fully insured or
indemnified against could materially and adversely affect ARO's
financial condition and operations.
EMPLOYEES:
On March 5, 1999, ARO, including its subsidiary, had 24 full
time employees, none of whom are covered by a collective
bargaining agreement. From time to time, ARO utilizes a series
of independent consultants and contractors to perform various
professional services, particularly in the areas of geology and
environmental assessment. ARO considers its relationship with
its employees to be satisfactory.
ITEM 2. DESCRIPTION OF PROPERTY:
ARO's oil and gas properties are concentrated in the Gulf
Coast Region and Appalachia, representing approximately 74% and
26%, respectively, of ARO's PV-10 Value for proved reserves as of
December 31, 1998. These regions are well established oil and
gas producing basins with a substantial history of exploration
and development activity.
ARO's interests in the wells it operates represented
approximately 26% of its PV-10 Value for proved reserves as of
December 31, 1998. ARO has established a preliminary budget of
$12 million of capital expenditures for exploration and
development in the Gulf Coast Region in 1999 (see Item 6,
"Management's Discussion
13
and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources" of this Report on Form 10-K).
The following table provides proved reserve information for
ARO's major fields as of December 31, 1998:
% of
Gas Proved
Oil Gas Equivalent PV-10
Core Area/Field (MBbl*) (MMcf*) (MMcfe*) Value
- - --------------- ------- ------- ------- -----
GULF COAST REGION:
- - -----------------
West Cameron 172 71 7,030 7,456 21.40%
South Timbalier 211 34 6,788 6,992 19.50%
South Timbalier 148 389 7,872 10,206 13.74%
West Cameron 368 4 2,235 2,260 5.19%
Ship Shoal 150 292 437 2,189 3.87%
Ship Shoal 97 53 4,218 4,536 3.40%
Galveston 213 6 800 836 1.80%
Galveston 394/395 -- 1,689 1,689 5.00%
APPALACHIA:
- - ----------
Gausdale -- 10,960 10,960 16.00%
Other -- 7,201 7,201 10.10%
Total net proved 849 49,230 54,325 100.00%
reserves
*(MBbl - thousand barrels; MMcf - million cubic feet; MMcfe -
million cubic feet equivalent.)
GULF COAST REGION:
As of December 31, 1998, ARO owned interest in 49 leases in
the offshore Gulf of Mexico. These leases cover a total of
225,000 acres, and ARO owns working interests ranging from 59% to
15% with an average working interest of 29.8%. Of the leases
located in Federal OCS waters, 26 are offshore Louisiana and 21
are offshore Texas. One lease is in the state waters of offshore
Louisiana, and one lease is in the state waters of offshore
Texas. Ten of the leases are currently producing and the
remainder are in prospect inventory and scheduled for
development. Those leases not producing are under primary term.
Of the expirations of primary terms for currently undeveloped
leases, one occurs in 1999, 12 in 2000, 18 in 2001, 7 in 2002,
and 1 in 2003.
14
WEST CAMERON 172
West Cameron Block 172 is located 25 miles offshore
Louisiana in an average water depth of 40 feet. ARO owns a 27%
working interest in the lease which covers 5,000 acres. Interest
in this lease was obtained as a part of the TECO acquisition. At
the time of the acquisition, there were no producing wells on the
lease; however, during the course of 1998, three successful wells
were drilled on the lease, and a production platform was
installed. Production from the platform commenced in December
1998. I.P. Petroleum Company, Inc. is the operator of the lease.
Additional exploratory opportunities exist on the lease.
SOUTH TIMBALIER 211
South Timbalier Block 211 is located 42 miles offshore
Louisiana in an average water depth of 140 feet. ARO owns a
29.997% working interest in the lease which covers 5,000 acres.
Interest in this lease was obtained as a part of the TECO
acquisition, and I.P. Petroleum is the operator of the lease.
Both of the currently producing wells on the lease were producing
at the time of the acquisition. There are developmental and
exploratory opportunities on the lease.
SOUTH TIMBALIER 148.
South Timbalier Block 148 is located 30 miles offshore
Louisiana in an average water depth of 100 feet and is operated
by Newfield Exploration Company. ARO owns an interest in the
west half of the block. ARO acquired its interest in the lease
from Century. The lease covers 2,500 acres and is situated on
the northern extension of the South Timbalier 176 Field salt dome
which has produced more than 64 million barrels of oil and 818
Bcf of gas from upper to middle Pliocene sands. Oil and gas
accumulations occur in 22 different sands in the upper and middle
Pliocene. As of December 31, 1998, there were 9 producing wells
on 4 production platforms on the lease. ARO's working interest
in the wells ranges from 10% to 45%.
WEST CAMERON 368.
West Cameron Block 368 is located 58 miles offshore
Louisiana in an average water depth of 80 feet. ARO owns an
interest covering 5,000 acres. ARO acquired its interest from
K.E. Resources, Ltd. during the fourth quarter of 1997. The
property is operated by Century, and one well is currently
producing in which ARO owns a 29.4% working interest. In 1998,
ARO entered into a transaction with the operator of the lease
which provided ARO with a 95% working interest on an 1,100 acre
portion of the lease where ARO has an exploratory prospect.
15
SHIP SHOAL 150.
Ship Shoal Block 150 is located 31 miles offshore Louisiana
in an average water depth of 53 feet and is operated by Century.
The lease is situated on the northwest flank of the Ship Shoal
Block 154 Field salt dome which has produced 69 million barrels
of oil and 81 Bcf of gas from upper to middle Pliocene sands.
ARO acquired a 50% working interest from Century in 1995 and
successfully drilled 2 wells that year, both of which are
currently producing. Additional exploratory drilling
opportunities exist on the lease and are currently being
evaluated utilizing 3-D seismic.
GALVESTON 213.
Galveston Block 213 is located 10 miles offshore Texas in an
average water depth of 40 feet. ARO owns a 33.33% working
interest in the lease which covers 5,760 acres. Interest in the
lease was obtained as a part of the TECO acquisition, and Basin
Exploration, Inc. is the operator of the lease. The well which
is currently producing on the lease was drilled during 1998 after
ARO's acquisition of interest. An additional developmental
opportunity exists on the lease.
APPALACHIAN REGION:
The majority of the wells that ARO owns in the Appalachian
Region are located in the Gausdale gas field in Southeastern
Kentucky and were acquired in various transactions since 1993.
Gausdale is located on the eastern edge of the Cincinnati Arch to
the Appalachian Basin. The field is also located some eight miles
from Pine Mountain. The Newman, Waverly and Devonian formations
have all been successfully stimulated, resulting in increases of
more than 500% of the wells' natural productivity in certain
instances. ARO's working interest in the wells ranges from 5% to
100%. ARO operates all of its Kentucky wells through its
subsidiary, Southern Gas.
OIL AND GAS OPERATIONS:
OIL AND GAS RESERVES.
Estimated net quantities and the related costs and present
values of the oil and gas reserves of ARO are set out in "Oil and
Gas Producing Activities (Unaudited)" to the Financial Statements
included in Item 7 to this Report on Form 10-K. No estimates of
ARO's total, proved net oil or gas reserves have been filed with,
or included in, reports to any other federal authority or agency
since the beginning of the last fiscal year.
16
PRODUCTION.
The following tables set forth for each of the last three
fiscal years by the primary geographic areas in which ARO owns
production, which are identified as Kentucky and the Gulf Coast
Region, the average sale price and production cost per barrel of
oil or Mcf of gas produced by wells owned by ARO. The amounts
include only marketable production of oil or gas (on an "as sold"
basis) and produced to its interest, less royalties and
production due others. ARO does not own any oil properties in
Kentucky.
KENTUCKY (GAS ONLY)*
Average Sales Average Production
Fiscal Price Per Unit Cost Per Unit
Year Gas (Mcf) Gas (Mcf)
---- --------- ---------
1998 $2.19 $0.49
1997 $2.24 $0.79
1996 $2.12 $0.59
*For the years 1998, 1997 and 1996, the Average Sales Price and
Production Cost per Unit were calculated using the weighted
average method, comparing volumes delivered with the price for
each category previously reported.
GULF COAST REGION (OIL AND GAS)
Average Sales Average Production
Fiscal Price Per Unit Cost Per Unit
Year Oil (per bbl) Gas (per Mcf) Oil (per bbl) Gas (per Mcf)
---- ------------- ------------- ------------- -------------
1998 $12.59 $2.47* $2.16 $0.41
1997 $18.08 $2.64* $1.56 $0.27
1996 $20.71 $2.96 $2.10 $0.35
*Includes effect of hedging activities.
PRODUCTIVE WELLS AND ACREAGE AS OF DECEMBER 31, 1998.
The following tables set forth as of December 31, 1998, the
total gross and net productive wells in which ARO had an interest
(expressed separately for oil and gas), and the total gross and
net developed acres in which ARO had an interest by geographic
area. Productive wells are producing wells and wells capable of
production, including gas wells awaiting pipeline connections and
oil wells awaiting connection to production facilities. Wells
that are completed in more than one producing horizon are counted
as one well.
17
KENTUCKY (GAS ONLY)
Total Gross Total Net Total Gross Total Net
Productive Productive Developed Developed
Wells Wells Acres Acres
----- ----- ----- -----
482 313 33,740 21,931
GULF COAST REGION (GAS AND OIL PRODUCED FROM EACH WELL)
Total Gross Total Net Total Gross Total Net
Productive Productive Developed Developed
Wells Wells Acres Acres
----- ----- ----- -----
26 7.75 47,753 13,504
UNDEVELOPED ACREAGE AS OF DECEMBER 31, 1998.
The following table sets forth as of December 31, 1998, the
amount of undeveloped gross and net leasehold acreage in which
ARO had an interest.
KENTUCKY
Gross Net
Undeveloped Undeveloped Acreage Remaining
Acres Acres Concentration Term
----- ----- ------------- -----
2,000 1,750 * **
*Approximately seventy acre spacing.
**Depending on the lease, the remaining term varies from 1 year
to as long as oil or gas is produced from the lease.
During 1995, ARO made a determination to focus its drilling
efforts on the Gulf Coast Region and to concentrate on the
acquisition of proved producing properties in the Appalachian
Region such as the AKS acquisition (see Item 1, "Acquisition
Activities," of this Report on Form 10-K). Therefore, ARO has
made a conscious effort to limit its undeveloped acres in
Appalachia to more desirable locations, thereby also reducing its
lease expenses. ARO also controls the majority of the capacity
in the major pipeline through which the gas must flow to be
delivered to market, thereby giving it the competitive advantage
to obtain desired drilling acreage on an "as needed" basis.
Additionally, recently enacted legislation providing for
significant taxes on unmined minerals reduces the incentive to
maintain large undeveloped acreage blocks as has been done in
past years.
18
GULF COAST REGION
Gross Net
Undeveloped Undeveloped Acreage Remaining
Acres Acres Concentration Term
----- ----- ------------- ----
178,034 48,090 * **
*Not less than the legal spacing required by applicable
authorities.
**The remaining term of the leases varies.
DRILLING ACTIVITIES.
The following table describes the drilling activity of ARO
for the last three fiscal years.
Net Net
Productive Net Dry Productive Net Dry
Exploratory Exploratory Developmental Developmental
Fiscal Wells Wells Wells Wells
Year Drilled Drilled Drilled Drilled
---- ------- ------- ------- -------
1998 1.2(1) 2.1(2) 8.3(1) 0
1997 .6(3) 1.7(4) 1(3) 0
1996 0 0 4(5) 0
(1) ARO owns working interests ranging between 26.95% and 33.33%
in 4 exploratory wells drilled in the Gulf Coast Region,
100% working interest in 6 developmental wells drilled in
the Kentucky region, together with working interests ranging
between 27% and 100% in 3 developmental wells drilled in the
Gulf Coast Region.
(2) ARO drilled 6 dry exploratory wells in which it had working
interests ranging between 16.2% and 100%. All of these
wells were located in the Gulf Coast Region.
(3) ARO owns a 100% working interest in 1 developmental well
drilled in Kentucky, together with working interests ranging
between 6% and 23% in 5 exploratory wells drilled in the
Gulf Coast Region.
(4) ARO drilled 7 dry exploratory wells in which it had working
interests ranging between 3.5% and 48%. All of the wells
were located in the Gulf Coast Region.
(5) ARO owns a 50% working interest in 8 developmental wells it
drilled in the Kentucky Region and a 45% working interest in
1 developmental well drilled in the Gulf Coast Region in
1996.
ITEM 3. LEGAL PROCEEDINGS:
ARO has been named as a defendant in lawsuits arising in the
ordinary course of business. ARO believes, based on experience
to date, that the ultimate resolution of
19
such items, individually or in the aggregate, will not have a
material adverse impact on ARO's financial position or results of
operations.
During 1997, the Kentucky Revenue Cabinet assessed Southern
Gas for outstanding sales tax of approximately $1.5 million, plus
penalties and interest, allegedly owed to the Commonwealth of
Kentucky by SGC, a dissolved company, prior to Southern Gas'
acquisition of the assets of SGC. In January 1999, ARO received
notification from the Kentucky Revenue Cabinet that the Cabinet
had accepted ARO's Offer in Settlement in the amount of $47,499
for any and all outstanding sales and tangible property taxes.
In January 1999, ARO was named as a defendant in a lawsuit
initiated by a trade creditor seeking approximately $8.6 million
for work performed on Grand Isle Block 55. Additionally, other
trade creditors filed liens against Grand Isle Block 55. ARO had
previously reported the amounts it owed the trade creditors for
work performed on Grand Isle Block 55 in its Report on Form 10-Q
for the Quarter Ended September 30, 1998. On March 10, 1999, ARO
finalized an agreement (the "Compromise and Release Agreement")
with Huber Oil & Gas, Inc. ("Huber") agreeing to the termination
of the participation agreement with Huber (the "Participation
Agreement") affecting the Property and relinquishing any and all
rights ARO had to the Property. Huber acquired all of the trade
creditors' lien claims on the Property, and the Compromise and
Release Agreement provides for a full release of ARO from all
trade creditor claims and for all obligations of ARO under the
Participation Agreement. The litigation initiated by the trade
creditor is in the process of being dismissed with prejudice. As
a result of the relinquishment of ARO's rights in the Property,
ARO took a net writedown of approximately $1.4 million in the
fourth quarter of 1998.
In the first quarter of 1999, ARO was also named a co-
defendant in litigation filed by the operator of High Island
Block 105 seeking approximately $600,000 for expenses incurred in
the drilling of a well. On March 10, 1999, ARO settled this
litigation by agreeing to convey its interest in the #19 well
located on West Cameron Block 172 to the co-defendant in exchange
for approximately $600,000 and a 25% reversionary interest after
payout. Those proceeds were utilized by ARO to settle this
litigation. At the time of this settlement, ARO was in default on
its obligation to advance an additional $733,752 for completion
cost of the #19 well and did not have the capital to make this
advance. As ARO would have been caused to non-consent this
operation, it agreed to convey its interest to the co-defendant,
who paid the completion costs.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
There were no matters submitted to a vote of security
holders during the fourth quarter of 1998.
20
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS:
MARKET INFORMATION:
On September 30, 1993, ARO's Common Stock began trading
under the symbol "GASS" on the small cap section of the NASDAQ.
The following table sets forth the closing high and low sales
prices of the Common Stock for the periods indicated, as reported
by NASDAQ. These prices are believed to be representative inter-
dealer quotations, without retail mark-up, mark-down or
commissions and may not represent prices at which actual
transactions occurred.
1998 1997
Sales Sales
----- -----
High Low High Low
---- --- ---- ---
First Quarter $3.44 $2.25 $3.88 $2.22
Second Quarter $3.22 $2.25 $3.06 $1.88
Third Quarter $2.59 $0.81 $3.03 $2.06
Fourth Quarter $1.41 $0.22 $3.88 $2.06
On January 4, 1999, ARO received notification from NASDAQ
that unless the shares of ARO's common stock report a closing bid
of $1.00 or greater for ten consecutive trading days prior to
April 5, 1999, ARO's securities will be subject to delisting. As
of the date of the filing of this Report on Form 10-K, ARO's
stock has not reported a closing bid of $1.00 or greater for ten
consecutive trading days. ARO has requested an oral hearing
before the NASDAQ Qualifications Board with regard to this
matter. This hearing is scheduled for May 13, 1999 and provides
ARO with a stay of action to that date.
HOLDERS:
On March 15, 1999, the last sale price of ARO's Common Stock
as reported on the NASDAQ SmallCap Market was $0.47; and there
were 401 holders of record of ARO's Common Stock and 14 holders
of record of ARO's Series 1993 Preferred Stock.
21
DIVIDENDS:
Holders of shares of ARO's $12.00 par value Series 1993
Preferred Stock are entitled to receive, when declared,
cumulative dividends at the rate of 8% per share based upon the
total number of shares outstanding. Such dividends are payable
semi-annually to holders of record on the 15th day of January and
July of each year. All dividends payable on ARO's capital stock
are payable in cash or common stock, at ARO's election.
ARO has not in the past nor does it intend to pay cash or
common stock dividends on its Common Stock or cash dividends on
its Series 1993 Preferred Stock in the foreseeable future. ARO
intends to retain earnings, if any, for the future operation and
development of its business. In addition, the payment of cash
dividends on any share of any class of its capital stock is
prohibited by the terms of ARO's credit facility. See Note 14 to
Notes to Financial Statements included in Item 7 of this Report
on Form 10-K.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS:
The following discussion is intended to assist in an
understanding of ARO's financial position and results of
operations for each year of the three-year period ended December
31, 1998. ARO's consolidated financial statements and the notes
thereto which follow contain detailed information that should be
referred to in conjunction with the following discussion.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995:
Statements, other than historical facts, contained in this
Report on Form 10-K, including statements of estimated oil and
gas production and reserves, drilling plans, future cash flows,
anticipated capital expenditures and Management's strategies,
plans and objectives, are "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as
amended. Although ARO believes that its forward looking
statements are based on reasonable assumptions, it cautions that
such statements are subject to a wide range of risks and
uncertainties incident to the exploration for, acquisition,
development and marketing of oil and gas; and it can give no
assurance that its estimates and expectations will be realized.
Important factors that would cause actual results to differ
materially from the forward looking statements include, but are
not limited to, changes in production volumes, worldwide demand,
and commodity prices for petroleum natural resources; the timing
and extent of ARO's success in discovering, acquiring, developing
and producing oil and gas reserves; risks incident to the
drilling and operation of oil and gas wells; future production
and development costs; the effect of existing and future laws,
governmental regulations and the political and economic climate
of the United States
22
and foreign countries in which ARO operates, if any; the effect
of hedging activities; and conditions in the capital markets.
Other risk factors are discussed elsewhere in this Form 10-K and
in the Form 8-K which ARO filed with the Securities and Exchange
Commission on July 25, 1997.
GENERAL:
American Resources Offshore, Inc. ("ARO") is an independent
oil and gas company engaged in the acquisition, exploration,
development, and production of oil and gas properties offshore
Louisiana and offshore Texas, and in southeastern Kentucky. ARO
also gathers and markets its gas in Appalachia.
ARO was formed in August 1992, to acquire the assets and
assume specific liabilities of Standard Oil and Exploration of
Delaware, Inc. ("Standard Oil"). Since the consummation of the
Standard Oil transaction in April 1993, ARO has grown, primarily
through acquisition and development activities. ARO's
acquisition expenditures for 1996 through 1998 are listed below
by major areas. As a result of acquisitions and dispositions of
oil and gas properties, operating results may not be comparable
from period to period.
Year ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
(000) (000) (000)
Gulf of Mexico
Offshore $60,864 $3,793 $ 3,026
Onshore 146 3,179 16,088
Kentucky 1,114 536 2,251
------ ----- ------
Total Acquisitions $62,124 $7,508 $21,365
====== ===== ======
ARO's revenue, profitability and cash flow are substantially
dependent upon prevailing prices for oil and gas and the volumes
of oil and gas it produces. In addition, ARO's proved reserves
and oil and gas production will decline as oil and gas are
produced unless ARO conducts successful exploration and
development drilling activities.
ARO follows the successful efforts method of accounting for
its oil and gas properties. Under this method of accounting, all
property acquisition costs and costs of exploratory and
development wells are capitalized when incurred, pending
determination of whether the well has found proved reserves. If
an exploratory well has not found proved reserves, the costs of
drilling the well are charged to expense. The costs of
development wells are capitalized whether productive or
nonproductive.
23
ARO utilizes forward sales contracts for gas production to
achieve more predictable cash flows and to reduce its exposure to
fluctuations in gas prices. These arrangements are settled on a
monthly basis. ARO continuously re-evaluates its sales contracts
in light of market conditions, commodity price forecasts, capital
spending plans and debt service requirements. As of March 15,
1999, approximately 90% of ARO's estimated natural gas production
for the period of March 1999 through August 1999 was committed to
forward sales contracts at an average price of $1.86 per Mcf.
See Item 1, "Description of Business -- Marketing and Customers."
RESULTS OF OPERATIONS:
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER
31, 1997
REVENUES. Total revenues for ARO decreased 4.9% to $36.1
million for 1998 from $38 million for the comparable period in
1997. Marketing revenues decreased approximately $9.6 million,
or 62%, primarily due to the termination of the gas sales
contract with Southern Resources, Inc., resulting from ARO's
decision to focus on exploration and development activities.
However, due to the small profit margins and administrative
expenses associated with the Southern Resources gas sales
contract, the termination had no significant adverse effect on
ARO's net income as reflected by a corresponding $9.5 million
reduction in marketing expense.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue increased 37.3% to $26.7 million in 1998, due primarily
to production attributable to wells acquired and drilled on
acreage acquired from TECO Oil & Gas, Inc. ("TECO").
The following table summarizes production volumes, average
sales prices and period to period comparisons for ARO's oil and
gas operations for the periods indicated:
YEAR ENDED
DECEMBER 31,
------------ % INCREASE
1998 1997 (DECREASE)
---- ---- ---------
Production volumes:
Natural gas (MMcf) 9,428 4,579 106
Oil (MBbls) 374 426 (12)
Total (MMcfe) 11,671 7,134 64
Average sale prices:*
Natural gas (per Mcf) $ 2.44 $2.57 (5)
Oil (per Bbl) $12.59 $18.08 (32)
Per Mcfe $ 2.30 $2.73 (16)
Expenses (per Mcfe):
Lease operating (including
production taxes) $ 0.43 $0.36 19
Depreciation, depletion
and amortization $ 1.55 $1.21 28
Administrative $ 0.39 $0.47 (17)
*Includes effect of hedging.
24
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense increased 92% to $5 million in 1998 due primarily to
operating costs associated with increased production. Oil and
gas production expense was $0.43 per Mcfe for 1998 compared with
$0.36 for the same period in 1997, an increase of 19%.
EXPLORATION COSTS. During 1998, costs of approximately $5
million were attributable to dry hole expense and the purchase of
seismic data, analysis of such data and other directly allocable
geological and geophysical costs which must be expensed under
ARO's accounting method. Exploration costs for 1997 were
approximately $785,000.
IMPAIRMENT OF ASSETS. As of January 1, 1996, ARO began
assessing the impairment of capitalized costs of proved oil and
gas properties and other long-lived assets in accordance with
Statement of Financial Accounting Standards No. 121 (SFAS No.
121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." SFAS No. 121 requires that
an impairment loss be recognized whenever the carrying amount of
an asset exceeds the sum of the estimated future undiscounted
cash flows of the asset. For each asset determined to be
impaired, an impairment loss equal to the difference between the
carrying value and the fair value of the asset was recognized.
With respect to ARO's oil and gas properties, fair value was
estimated to be the present value of expected future cash flows
computed by applying estimated future natural gas and oil prices,
as determined by Management, to estimated future production of
oil and gas reserves over the economic lives of the reserves.
During 1998, ARO recorded an impairment of oil and gas properties
of $34.7 million compared with $5 million during 1997. The
impairment includes a $8.2 million write down of ARO's
Appalachian properties based on its current efforts to sell the
Kentucky division of ARO. The Appalachian impairment allowance
is included in ARO's accumulated depreciation, depletion and
amortization. ARO also recognized a $22.5 million impairment on
the TECO properties. The write down was primarily the result of
a significant decline in the production on several of the TECO
wells coupled with a substantial decline in oil and gas prices in
1998. An additional $4 million impairment was recognized on
other oil and gas properties. ARO also recognized a $2 million
impairment on its holding of Century stock.
ADMINISTRATIVE EXPENSE. Administrative expense increased
37.5% to $4.6 million in 1998, and was $0.39 per Mcfe, a decrease
of 17% from the prior year. The per unit decrease occurred as
the result of increased production volumes, principally
attributable to new Gulf Coast Region wells. In 1998, ARO
expanded its Gulf Coast operations by staffing its Louisiana
office with technical personnel experienced in Gulf Coast Region
exploration and development activities.
DEPRECIATION, DEPLETION AND AMORTIZATION (DD&A) EXPENSE.
DD&A expense increased 110% to $18 million in 1998 and was $1.55
per Mcfe, an increase of 28% from the prior year. The increase
resulted primarily from the TECO acquisition and increased
25
depletion attributable to the acquisition costs and successful
drilling activities. Given the impairment of oil and gas
properties and adjustments to reserve volumes recognized during
1998, ARO expects its DD&A expense per unit to decrease during
1999.
INTEREST EXPENSE. Interest expense increased 171% to $7.4
million in 1998 due to additional borrowings to fund the TECO
acquisition and expanded exploration and development activities.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $46.2 million for the year ended December
31, 1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER
31, 1996
REVENUES. Total revenues for ARO increased 15% to $38
million for 1997 from $33 million for the comparable period in
1996 primarily due to an increase in production.
OIL AND GAS PRODUCTION REVENUE. Oil and gas production
revenue increased 128% to $19 million in 1997, due primarily to
the acquisition of South Timbalier 148 in late 1996 and
subsequent production of 11 wells thereon.
The following table summarizes production volumes, average
sales prices and period to period comparisons for ARO's oil and
gas operations for the periods indicated:
YEAR ENDED
DECEMBER 31,
------------ % INCREASE
1997 1996 (DECREASE)
---- ---- ---------
Production volumes:
Natural gas (MMcf) 4,579 1,830 150
Oil (MBbls) 426 200 113
Total (MMcfe) 7,134 3,031 135
Average sale prices:
Natural gas (per Mcf) $ 2.57 $ 2.40 7
Oil (per Bbl) $18.08 $20.71 (13)
Per Mcfe $ 2.73 $ 2.82 (3)
Expenses (per Mcfe):
Lease operating (including
production taxes) $ 0.36 $ 0.46 (22)
Depreciation, depletion
and amortization $ 1.21 $ 1.09 11
Administrative $ 0.47 $ 0.77 (39)
OIL AND GAS PRODUCTION EXPENSE. Oil and gas production
expense increased 84% to $2.6 million in 1997 due primarily to
operating costs associated with increased production. Oil and gas
production expense was $0.36 per Mcfe for 1997 compared to $0.46
for the same period in 1996, an increase of 22%.
26
EXPLORATION COSTS. During 1997, costs of approximately
$785,000 were attributable to dry hole expense and the purchase
of seismic data, analysis of such data and other directly
allocable geological and geophysical costs which must be expensed
under ARO's accounting method. There were no such costs for
1996.
IMPAIRMENT OF ASSETS. As of January 1, 1996, ARO began
assessing the impairment of capitalized costs of proved oil and
gas properties and other long-lived assets in accordance with
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of." SFAS No. 121
requires that an impairment loss be recognized whenever the
carrying amount of an asset exceeds the sum of the estimated
future undiscounted cash flows of the asset. For each asset
determined to be impaired, an impairment loss equal to the
difference between the carrying value and the fair value of the
asset was recognized. With respect to ARO's oil and gas
properties, fair value was estimated to be the present value of
expected future cash flows computed by applying estimated future
natural gas and oil prices, as determined by Management, to
estimated future production of oil and gas reserves over the
economic lives of the reserves. During 1997, ARO recorded an
impairment of oil and gas properties of $5 million. There were
no impairments for 1996.
ADMINISTRATIVE EXPENSE. Administrative expense increased
43% to $3.3 million in 1997, and was $.47 per Mcfe, a decrease of
39% from the prior year. The per unit decrease occurred as the
result of increased production volumes, principally attributable
to new Gulf Coast Region wells. This expense increased
principally due to the establishment of a Louisiana office in
1996 and the expanded staffing of that office during the fourth
quarter of 1997.
DEPRECIATION, DEPLETION AND AMORTIZATION (DD&A) EXPENSE.
DD&A expense increased 160% to $8.6 million in 1997 and was $1.21
per Mcfe, an increase of 11% from the prior year. The increase
resulted primarily from the increased production on South
Timbalier 148 and Ship Shoal 150 and the establishment of a
reserve for future plugging and abandonment costs.
INTEREST EXPENSE. Interest expense increased 13% to $2.75
million in 1997 due to additional borrowings to fund acquisition
and expanded exploration and development activities.
NET INCOME. Due to the factors described above, ARO
recognized a loss of $1.8 million for the year ended December 31,
1997.
LIQUIDITY AND CAPITAL RESOURCES:
As of December 31, 1998, ARO had cash and cash equivalents
of approximately $255,000 compared with approximately $1.2
million for 1997.
27
Funding for ARO's business activities has historically been
provided by operating cash flow, bank borrowings and equity
capital from private placements. ARO's principal uses of capital
have been for the acquisition, exploration and development of oil
and gas properties. ARO has no present agreement, commitment or
understanding with respect to any acquisitions of oil and gas
properties and plans to use all available resources, if any, for
the development of its existing Gulf Coast Region properties.
During 1998, ARO expended approximately $8.6 million in its
exploration and development program. ARO has established a
preliminary budget of $12 million for exploration and development
in 1999; however, this budget is subject to revision during the
year to reflect drilling results and new opportunities.
Additionally, these expenditures are substantially at the
discretion of ARO; and ARO does not currently have sufficient
cash to fully fund the proposed program. There are no assurances
that the funds can be obtained or that they can be obtained under
terms acceptable to ARO. In the event ARO is unable to obtain
sufficient funds under acceptable terms, it will be necessary for
ARO to adjust the level of the development and exploratory
program.
As of December 31, 1998, ARO had current liabilities in
excess of current assets of approximately $6.3 million (excluding
current portion of long-term debt), was not in compliance with
its primary credit facility and bridge loans with DNB Energy
Assets, Inc. ("DNB"), successor to Den norske Bank, AS ("Den
norske"), of approximately $48 million and $15.6 million,
respectively, and was in default under its $18.5 million loan
with TECO. As more particularly described in Item 1,
"Description of Business--Overview," of this Report on Form 10-K,
this situation is primarily the result of: i) the lack of
available outside funding to complete the scheduled refinancing
of the interim loans and capital expenditures associated with the
acquisition and development of properties from TECO; ii) the
marked decline in oil and gas prices; iii) the more than 60%
decline of production in ARO's two largest producing fields; and
iv) the approximately $16 million in trade payables incurred in
association with the capital requirements for the development of
additional wells; however, subsequent to year-end 1998, ARO
settled approximately $12 million of the trade payables by
surrendering its interest in Grand Isle Block 55, which is
reflected in the December 31, 1998 financial statements.
It is important to note that DNB has not yet demanded
payment nor has it agreed to extend the term of the bridge loans;
and TECO is a party to an agreement between ARO and DNB which
substantially limits TECO's remedies against ARO unless the Bank
is paid in full or declares a default and takes affirmative
action against ARO. Additionally, pursuant to the terms of a
warrant agreement entered into between the parties relative to
the TECO Note, TECO has been vested with the rights to acquire
600,000 shares of ARO's common stock at $2.67 per share, plus
additional common stock in ARO equal to fifteen (15%) percent of
ARO's issued and outstanding common stock and options or rights
to purchase common stock for $0.00001 per share, together with
the right to appoint two members to ARO's Board of Directors.
TECO has not taken
28
any action to exercise its warrant rights or make any
appointments to ARO's Board at this time; however, TECO has not
waived any of its rights. TECO has filed a Schedule 13-D and
Form 3 with the Securities and Exchange Commission ("SEC")
regarding such rights. TECO's rights to acquire fifteen (15%)
percent of ARO's issued and outstanding common stock and options
or rights to purchase common stock will increase to twenty (20%)
percent if the TECO Note is not paid in full by April 1, 1999.
ARO has taken the following measures in an attempt to remedy
the above deficiencies:
On October 29, 1998, ARO's wholly-owned subsidiary, American
Resources Offshore, Inc., was merged into ARO for the
purpose of reducing administrative expenses.
During the fourth quarter of 1998, the Board of Directors
authorized and ARO entered into discussions with third
parties for the sale of its Appalachian properties. In the
event ARO sells these properties, the proceeds will be used
to reduce its outstanding indebtedness to DNB, which would
also result in a substantial reduction of interest expenses.
Further, the sale of these properties would result in an
additional reduction of ARO's administrative expenses.
During the first quarter of 1999, ARO settled approximately
$12 million of trade payables incurred as a result of the
capital requirements for the development of additional wells
by surrendering its interest in its Grand Isle Block 55
wells to the operator of the wells.
ARO's Management continues to explore all possible
alternatives for the restructuring of the company, including
the refinancing of debt and possible business combinations
with third parties.
NET CASH PROVIDED BY OPERATING ACTIVITIES. Net cash
provided by operating activities was $22 million, $9.4 million
and $6.1 million for 1998, 1997 and 1996, respectively. Cash
flows increased due to increases in oil and gas production and
revenues resulting principally from acquisition and development
activities between the three years.
NET CASH USED IN INVESTING ACTIVITIES. Net cash used in
investing activities by ARO was $56.3 million, $12.7 million and
$18.9 million for 1998, 1997 and 1996, respectively. Acquisition
and development of oil and gas properties were the primary uses
of funds.
The following table sets forth capital expenditures,
including acquisitions, made by ARO during the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Oil and gas expenditures
Development $ 9,834 $1,357 $ 3,315
Exploration - 929
Acquisitions 62,124 7,509 21,365
------ ----- ------
Total $71,958 $9,795 $24,680
====== ===== ======
For 1999, ARO has budgeted approximately $12 million for oil and
gas development and exploration (see "Liquidity and Capital
Resources," above).
NET CASH PROVIDED BY FINANCING ACTIVITIES. Cash provided by
ARO's financing activities was $33.4 million, $4.1 million and
$12.3 million for 1998, 1997 and 1996, respectively. Most of
this cash was provided by borrowing activities except for $7
million in stock issuances in 1996.
CREDIT FACILITY. At December 31, 1998, an aggregate of
$48.2 million was outstanding under the Credit Facility with DNB.
The Credit Facility provides for a $75 million revolving
commitment which will be payable in full on or before February 1,
2002. The amount of credit available at any time under the
Credit Facility may not exceed the borrowing base which was $48.2
million at December 31, 1998, and will be redetermined
semiannually. The borrowing base was increased to $50 million in
March 1998 in connection with the TECO acquisition. Advances
under the Credit Facility bear interest at either a Prime rate or
LIBO (London Interbank Offer) rate (plus 2.5%) of interest, at
ARO's option. The Credit Facility contains customary covenants
(see the First Amended and Restated Credit Facility Agreement
attached as Exhibit 10.86 to the Form 8-K filed with the
Securities and Exchange Commission on November 19, 1997).
Under the Credit Facility with DNB, ARO is required to
maintain certain ratios relating to debt coverage ratio, current
ratio, tangible net worth, general and administrative expenses
and quarterly interest ratio. Under the covenants, the financial
amounts used to compute the requirements are specifically defined
in the credit facility. The following lists the specific
requirements and the actual amounts as calculated under the terms
of the credit facility at December 31, 1998:
30
Required Actual
-------- ------
Debt coverage ratio 1.2 to 1.0 .7 to 1.0
Current ratio 1.0 to 1.0 .6 to 1.0
Tangible net worth $17,540,000 ($22,878,473)
General and administrative expenses
(not to exceed in current year) $8,586,930 $4,568,868
Quarterly interest ratio 2.25 to 1.0 1.74 to 1.0
Under the required calculation of the current ratio, ARO is
allowed to deduct from current liabilities current amounts of
principal and interest due under the credit facility. At
December 31, 1998, ARO was not in compliance with all of the
required financial ratios; however, DNB agreed to temporarily
waive the requirements at year-end 1998. As stated earlier, DNB
has not yet demanded payment nor has it agreed to extend the
terms of ARO's bridge loans.
BRIDGE FINANCING. In order to complete the acquisition of
the TECO properties in March 1998, in addition to increasing
ARO's borrowing base to $50.0 million to provide an additional
$22 million under the Credit Facility, DNB provided additional
bridge financing of $16.5 million. The balance due DNB at
December 31, 1998 for these loans was $15.6 million. The
financing, as amended, matured on December 31, 1998. As partial
consideration for the TECO properties, ARO also executed the TECO
Note in the amount of $18.5 million. This loan matured on
October 1, 1998. (See Item 1, "Description of Business -
Overview" and "Liquidity and Capital Resources," above.)
EQUITY SECURITIES. In order to assist in its continued
growth and expansion, ARO completed the following private
placements during 1998 and 1997.
See the discussion in "Liquidity and Capital Resources,"
above, regarding the warrant agreement entered into between
ARO and TECO.
In July 1997, pursuant to a Securities Purchase Agreement,
ARO's primary lender, Den norske, purchased 500,000 shares
of common stock of ARO for a price of $2.66 per share, for a
total of $1,330,000 ($1,132,911 net of placement costs).
ARO and Den norske also entered into a Registration Rights
Agreement wherein Den norske was granted certain demand and
piggyback registration rights with respect to the shares
purchased.
In late 1996, ARO privately placed 4% convertible securities
in the aggregate principal amount of $6,000,000 ($4,997,554
net of placement costs) with a maturity date one year from
date of issuance. The securities were convertible at the
option of the holders into shares of common stock valued at
the lesser of (1) the closing bid price of the common stock
as reported on NASDAQ on the date of issuance of the
security, or (2) 75% of the average closing bid prices of
the
31
common stock as reported on NASDAQ for the five trading days
prior to the date of conversion. As of June 9, 1997,
securities totaling $5,538,483 had been converted into
3,101,864 shares of common stock inclusive of the 4%
dividend shares paid as of the date of conversion, and the
remaining securities totaling $461,517 had been redeemed by
ARO pursuant to its rights under the security documents.
ARO was not required to pay any liquidated damages or
additional interest as a result of the conversion or
redemption of the securities.
YEAR 2000 ISSUE. The year 2000 issue relates to the
inability of certain computers and software applications to
correctly recognize and process date sensitive information for
the Year 2000 and beyond. Without correction, the computers and
software applications could fail or create erroneous information.
Since this problem could affect ARO's systems, as well as the
systems of its business partners, ARO is presently analyzing its
internal and external systems, focusing on minimizing disruptions
of ARO's operations as a result of the millennium change.
ARO uses a PC based network system to process, record and
analyze financial information. A majority of the equipment and
support software has been purchased in recent years, and its
suppliers have informed ARO that it is year 2000 compliant.
ARO's primary oil and gas software is not year 2000 compliant at
this time. In conjunction with an ongoing review of year 2000
issues, ARO has been in contact with the oil and gas software
provider. The software provider is currently working towards
making its system year 2000 compliant and expects to achieve this
by mid-1999.
ARO is assessing the readiness of business partners,
including industrial end-users, joint interest operators, and
outside-operated pipeline and processing facilities as well as
suppliers of goods and services. Interruptions in these services
could disrupt production and delivery of oil and gas. ARO
intends to contact these parties in order to determine their
efforts in becoming year 2000 compliant and ability to deliver
services.
ARO will develop contingency plans to provide business
continuity and to address operations, safety and environmental
concerns. This effort began in the first quarter of 1999 and
should be completed by the third quarter of 1999.
ARO estimates that the costs incurred to address the Year
2000 issue with respect to its financial, administrative and
operational systems will be less than $100,000.
ARO expects to have all internal systems and computer
equipment Year 2000 compliant by the millennium change. ARO is
relying on its business partners and suppliers to be year 2000
compliant as well. Failure of significant third parties to
complete their Year 2000 compliance projects could interrupt the
supply of materials and services needed for oil and gas
operations. Disruptions to the oil and gas transportation
networks controlled by third party carriers could result in
reduced production volumes delivered to market. Such occurrences
could have a material adverse effect on ARO's
32
business, results of operations and financial condition. The
analysis of present internal and external systems for year 2000
compliance is expected to significantly reduce ARO's level of
uncertainty about the Year 2000 issue.
ITEM 7. FINANCIAL STATEMENTS:
The information required hereunder is included in this
report as set forth in the "Index to Financial Statements" on
page F1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE:
On January 6, 1999, ARO engaged Ernst & Young LLP as its
independent accountants to audit ARO's financial statements for
the year ended December 31, 1998. This appointment followed the
resignation of KPMG LLP ("KPMG") as the principal accountant for
ARO, the acceptance of such resignation having been recommended
by the Audit Committee of and approved by the Board of Directors
of ARO. KPMG's report on ARO's financial statements for the
years ended December 31, 1997 and December 31, 1996 did not
contain an adverse opinion or a disclaimer of opinion, and such
reports were not qualified as to uncertainty, audit scope or
accounting principles. ARO had no disagreements with KPMG during
the fiscal years ended December 31, 1997 or December 31, 1996 on
any matter of accounting principles or practice, of financial
statement disclosure or of auditing scope or procedure. On
January 11, 1999, ARO filed a Report on Form 8-K reporting the
change in its certified accountant.
33
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE
ACT:
DIRECTORS AND EXECUTIVE OFFICERS:
Information concerning the names, ages, positions and
business experience of the current directors and executive
officers of ARO is set forth below.
Name Age Position
---- --- --------
Rick G. Avare(1)(5) 37 Director, President
and Chief Executive Officer
Douglas L. Hawthorne(2)(5)(6) 57 Chairman of the Board
Leonard K. Nave(3)(5) 63 Director
David Fox, Jr.(6)(7) 78 Director
Len Aldridge(7) 61 Director
Robert L. McIntyre(6) 52 Director
Joseph P. Shields(7) 41 Director
Ralph A. Currie(4) 44 Vice President of
Finance, Chief Financial
Officer and Treasurer
William M. Gray 44 Director, President
and Chief Operating Officer
of former wholly-owned
subsidiary through October
1998
David J. Stetson(8) 42 Vice President,
General Counsel and
Assistant Corporate
Secretary
Karen M. Underwood(9) 42 Vice President of
Corporate Compliance and
Corporate Secretary
34
(1) Also serves as a director, Executive Vice President and
Chief Operating Officer of ARO's wholly owned subsidiary,
Southern Gas Co. of Delaware, Inc. ("Southern Gas").
(2) Also serves as a director of Southern Gas.
(3) Also serves as Chairman of the Board, President and Chief
Executive Officer of Southern Gas.
(4) Also serves as Chief Financial Officer and Treasurer of
Southern Gas.
(5) Member of Executive Committee.
(6) Member of Compensation Committee.
(7) Member of Audit Committee.
(8) Also serves in the same capacity for Southern Gas.
(9) Also serves as a director, Vice President of Administration
and Corporate Secretary of Southern Gas.
Directors of ARO are elected to hold office for terms of one
to three years, respectively, or until their respective
successors are duly elected and qualified. Officers of ARO are
elected annually by the Board of Directors and hold office until
their successors are duly elected and qualified. ARO anticipates
holding its 1999 annual meeting in the second quarter of 1999.
RICK G. AVARE, age 37, has served as President and Chief
Executive Officer of ARO since May 1996, and as a director of ARO
since September 1994, having also served in that position in
March and April 1993. Mr. Avare has served on the Executive
Committee of ARO's Board since its establishment in April 1997.
He has also held various executive and director positions with
ARO's wholly-owned subsidiaries since 1994 and with Southern Gas
Company, Inc. ("SGC") from 1985 until its dissolution in February
1995. Mr. Avare served as Chief Operating Officer and Executive
Vice President of ARO from August 1995 until May 1996, and he
served as Chief Financial Officer of ARO from September 1994
through December 1995. Mr. Avare also serves as Administrative
Member of Prima Capital, LLC and MAP, LLC and acts as an outside
consultant to the Boston Celtics limited partnership from time to
time. Mr. Avare is a certified public accountant. See "Certain
Relationships and Related Transactions."
DOUGLAS L. HAWTHORNE, age 57, has served as a director and
Chairman of the Board of ARO since March 1993 and has been a
director of Southern Gas since February 1994, having also served
in this position in March and April, 1993. Mr. Hawthorne has
served on the Executive Committee of ARO's Board since its
establishment in April 1997 and has served on the Board's
Compensation Committee since August 1996. Mr. Hawthorne also
served on the Audit Committee of ARO's Board from August 1996
until July 1997. Mr. Hawthorne has served as a director of
Bullet Sports International, Inc. since 1995. Mr. Hawthorne has
been a principal of Carillon Capital, Inc., a Dayton, Ohio
investment banking firm, since 1992. From 1991 to 1994, Mr.
Hawthorne was a principal in SPECTRA Group, Inc., a management
consulting firm also based in Dayton, Ohio.
35
LEONARD K. NAVE, age 63, has served as Chairman of the
Board, Chief Executive Officer, and President of Southern Gas
since February 1994. He has served as a director of ARO since
September 1994 and also served in that position in March and
April 1993. Mr. Nave has served on the Executive Committee of
ARO's Board since its establishment in April 1997. Mr. Nave has
served as a director for Bullet Sports International, Inc. since
1995. Mr. Nave served as the President, Chief Executive Officer
and a director of SGC from its inception in March 1983 until its
dissolution in February 1995. Since October 1988, Mr. Nave has
served as the President and a director of Southern Gas Holding
Company. In addition, Mr. Nave currently holds the position of
President and a director of Woodway Farms, Inc. (since August
1983). In February 1996, Mr. Nave filed for reorganization and
protection under Chapter 11 of the United States Bankruptcy Code.
This action was initiated primarily because of the attempted
enforcement of certain guaranties which Mr. Nave had signed on
behalf of an unrelated corporation. Mr. Nave's discharge from
Chapter 11 was effective March 18, 1998. Mr. Nave is an active
member of the Kentucky Bar Association. See "Certain
Relationships and Related Transactions."
DAVID FOX, JR., age 78, has served as a director of ARO
since August 1996. Mr. Fox has served on the Compensation
Committee of the Board of ARO since August 1996 and on the
Board's Audit Committee since September 1997, having previously
served on the Board's Audit Committee from August 1996 until July
1997. Mr. Fox has served as Vice Chairman and Secretary-
Treasurer of McJunkin Appalachian Oil Field Supply Company since
1989. He also serves as President of Appalachian Production Co.,
an oil and gas producing company, President and Chairman of the
Board of FGO, Inc., a West Virginia residential real estate
development company, and as a Director of River Cities
Association; Bank One, West Virginia, Charleston; the Marshall
University Foundation and the Huntington Museum of Art. During
the past five years, Mr. Fox also served as a Director of KYOWVA
Container Corporation and Bank One, West Virginia, as well as
President of the Marshall Foundation.
LEN ALDRIDGE, age 61, has served as a director of ARO since
July 1997 and has also served on the Audit Committee of the Board
of ARO since that time. He has served as Vice President of
Limited Partners of Lexington, a Kentucky corporation engaged in
the development and management of real estate, since March 1994.
Mr. Aldridge also currently holds the following positions:
Partner of Poole & Aldridge (since 1975), Vice President of Poole
Enterprises, Inc. (since 1988), Director of Rafferty's Inc.
(since 1991), Vice President/Treasurer of Mason Headley
Development (since 1994) and Director of First Security Bank of
Lexington (since 1997). Mr. Aldridge is a certified public
accountant.
ROBERT L. MCINTYRE, age 52, has served as a director of ARO
since July 1997 and has also served on the Compensation Committee
of the Board of ARO since that time. From April 1992 through
September 1996, he was a partner with the law firm of Breeding,
McIntyre & Cunningham, PSC, Lexington, Kentucky, managing the
firm's
36
energy, corporate, transactional and international practice. He
has been Of Counsel to the law firm of Breeding, Cunningham,
Dance and Cress, PLC, Lexington, Kentucky, since October 1996.
He is an active member of the State Bar Associations of Kentucky
and Texas.
JOSEPH P. SHIELDS, age 41, has been a director of ARO since
June 1998 and has also served on the Audit Committee of the Board
of ARO since that time. He has been employed by New Jersey
Natural Gas Company since 1983 where he served as Manager to Gas
Supply Operations from 1990 to 1995, as Director of Gas Supply
from 1995 to 1996, as Vice President of Gas Supply from January
1996 to January 1997, and as Senior Vice President, Energy
Services, since January 1997.
RALPH A. CURRIE, age 44, has served as Vice President,
Treasurer and Chief Financial Officer of ARO since 1997. He has
also held various executive and director positions with ARO's
wholly-owned subsidiaries since 1997. Mr. Currie has served as
Chief Financial Officer of American Rehabilitation Group, P.S.C.,
a Kentucky-wide physical therapy company, since 1994. From 1991
to 1994, he was a partner with the regional business and
financial planning firm of Cramer, Currie & Company, Lexington,
Kentucky. Mr. Currie is a certified public accountant.
WILLIAM M. GRAY, age 44, served as President, Chief
Operating Officer and a director of a wholly-owned subsidiary of
ARO from its inception in 1997 until it was merged into ARO in
October 1998. He served as President and Chief Executive Officer
of Gulfstream Resources, Inc. from 1992 to 1996.
DAVID J. STETSON, age 42, has served as Vice President of
ARO since June 1998, and as General Counsel and Assistant
Corporate Secretary since January 1997. Mr. Stetson was engaged
in the private practice of law from 1982 to 1997.
KAREN M. UNDERWOOD, age 42, has served as Corporate
Secretary of ARO since January 1996 and as Vice President-
Corporate Compliance of ARO since July 1997. She also has served
as a director, Vice President-Administration and Corporate
Secretary of Southern Gas since February 1994. She served in
those positions for SGC at various times from 1983 to February
1995.
MEETINGS AND COMPENSATION:
During the year ended December 31, 1998, the Board of
Directors of ARO met on eleven occasions, either in person or
telephonically. Each of ARO's directors attended at least 75% of
the meetings of the Board of Directors except for Robert L.
McIntyre and Joseph P. Shields who attended 64% and 63%,
respectively, of the meetings.
37
During 1998, ARO's non-employee directors, Messrs. Fox,
Aldridge, McIntyre and Shields, received $750 for each regular
meeting of the Board of Directors as compensation for their
services to ARO; and they were reimbursed for reasonable travel
expenses incurred, if any, in connection with their attendance at
the meetings. The Chairman of the Board, Douglas L. Hawthorne,
received a total of $25,500 for his services to ARO during 1998
and was also reimbursed for reasonable travel expenses incurred
by him during the year. In addition, non-employee directors are
eligible for stock options granted under ARO's 1994 Compensatory
Stock Option Plan.
EXECUTIVE COMMITTEE. The Executive Committee is composed of
Messrs. Hawthorne, Nave and Avare. The Committee has all of the
powers and authority of the Board of Directors in the management
of the business, including the declaration of dividends on
preferred stock and the sale and issuance of shares of common and
preferred stock; provided, however, that the Committee does not
have the power or authority to approve, adopt or recommend to the
stockholders any action or matter expressly required by the
Delaware General Corporation Laws to be submitted to stockholders
for approval, or to adopt, amend or repeal any by-law of ARO.
The Executive Committee met six times during 1998.
AUDIT COMMITTEE. The Audit Committee is composed of Messrs.
Aldridge, Fox and Shields. The Audit Committee's duties include
(1) recommending the selection of independent auditors, (2)
reviewing the scope and results of the audit made by ARO's
auditors, (3) ensuring that disagreements, if any, as to the
application of generally accepted accounting principles are
resolved to the satisfaction of ARO and (4) reviewing ARO's
financial reporting activities and the accounting standards and
principles follows. The Audit Committee met one time during
1998.
COMPENSATION COMMITTEE. The Compensation Committee consists
of Messrs. Hawthorne, Fox and McIntyre. The Compensation
Committee makes recommendations to the full Board of Directors
regarding salaries and benefits provided to executive officers
and the establishment of various employee benefit plans. The
Compensation Committee met two times during 1998.
FAMILY RELATIONSHIPS:
There are no family relationships among directors, executive
officers or persons nominated or chosen to become directors or
executive officers of ARO.
LEGAL PROCEEDINGS:
During the past five years, no directors or executive
officers or persons nominated or chosen to become directors or
executive officers of ARO were general partners or executive
officers of any business either at the time a bankruptcy petition
was filed by or against such business or within two years prior
to that time.
38
During the past five years, no directors or executive
officers or persons nominated or chosen to become directors or
executive officers of ARO were (i) convicted in any criminal
proceeding or the subject of any criminal proceeding (other than
traffic violations and other minor offenses), (ii) subject to any
order, judgment or decree, not subsequently reversed, suspended
or vacated, of any court of competent jurisdiction, permanently
or temporarily enjoining, barring, suspending or otherwise
limiting his involvement in any type of business, securities or
banking activities, or (iii) found by a court of competent
jurisdiction in a civil proceeding, the Securities and Exchange
Commission ("SEC") or the Commodities Trading Commission, to have
violated a federal or state securities or commodities law, and
the judgment has not been reversed, suspended or vacated.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT:
Section 16(a) of the Securities Exchange Act of 1934
requires ARO's officers and directors and persons who own more
than 10% of a registered class of ARO's equity securities to file
reports of ownership and changes in ownership with the SEC.
Officers, directors and greater than 10% stockholders are
required by SEC regulation to furnish ARO with copies of all
Section 16(a) forms they file.
Based solely upon a review of the copies of such forms
furnished to ARO or written representations that no other reports
were required, ARO believes that during the 1997 fiscal year, all
filing requirements applicable to its officers, directors and
greater than 10% beneficial owners were complied with except that
Leonard K. Nave inadvertently filed his Form 4 for the month of
July 1998 two weeks late. The report contained one transaction
wherein stock was transferred in payment of a loan.
ITEM 10. EXECUTIVE COMPENSATION:
The table below sets forth information concerning the annual
and long-term compensation for services to ARO and its
subsidiary, Southern Gas, for the fiscal years ended December 31,
1998, 1997 and 1996 of those persons who were, at December 31,
1998 (i) the chief executive officer and (ii) the other four most
highly compensated executive officers of ARO (the "Named
Officers"):
39
<TABLE>
SUMMARY COMPENSATION TABLE
Annual Long-Term
Compensation Compensation
------------ ------------
Securities
Name and Other Underlying All
Principal Annual Stock LTIP Other
Position(1) Year Salary Bonus Compensation Options Payouts Compensation
----------- ---- ------ ----- ------------ ------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Rick G. Avare 1998 $183,429 - $11,269(3) 493,204 - $10,000(2)
President and 1997 166,455 $140,000 12,615(3) 493,204 - 8,000(2)
Chief Executive 1996 137,684 50,000 17,400(4) 493,204 - 6,846(2)
Officer
Douglas L. Hawthorne 1998 - - $26,006 354,315 - -
Chairman of 1997 - - 40,000 354,315 - -
the Board 1996 - - 60,000 354,315 - -
Leonard K. Nave 1998 $175,781 - $ 5,976 271,603 - $8,757(2)
Chairman of the 1997 175,000 - 4,655 271,603 - 8,000(2)
Board, President & 1996 175,761 - 3,281 246,603 - 8,750(2)
Chief Executive
Officer,
Southern Gas
William M. Gray 1998 $168,261 - $ 8,966 - - $4,189(2)
President and 1997 N/A N/A N/A N/A N/A N/A
Chief Operating 1996 N/A N/A N/A N/A N/A N/A
Officer of former
wholly-owned
subsidiary
through
October 1998
Jack G. Bryant 1998 $150,761 - $ 1,433 20,000 - -
Geologist 1997 N/A N/A N/A N/A - -
1996 N/A N/A N/A N/A - -
Jonathan C. Garrett 1998 $120,761 - $ 8,835 20,000 - $5,202(2
Engineer 1997 N/A - N/A N/A - N/A
1996 N/A - N/A N/A - N/A
Ralph A. Currie 1998 $92,704 - $ 7,558(5) - - $ 6,556(2)
Vice President & 1997 68,138 $ 32,000 7,200(5) - - -
Chief Financial 1996 N/A N/A N/A N/A N/A N/A
Officer
</TABLE>
(1) The disclosures in this table for Messrs. Hawthorne and
Currie have been provided for informational purposes only
and in light of their status as significant employees of
ARO. SEC rules require only the disclosure of the four most
highly compensated executive officers whose total annual
salary and bonus exceeds $100,000.
(2) Represents contribution made on behalf of the Named Officer
to a 401(K) plan.
(3) Includes car allowance of $8,937.
(4) Includes car allowance of $11,907.
(5) Includes car allowance of $7,200.
The table below contains information on grants of stock
options during 1998 to the Named Officers. No stock appreciation
rights were granted during 1998.
40
OPTION GRANTS IN LAST FISCAL YEAR
(INDIVIDUAL GRANTS)
Percent of
Total Options
Securities Granted to
Underlying Employees Exercise
Options in Price Expiration
Name Granted (#) 1998 ($/share) Date
---- ----------- ---- --------- ----
Rick G. Avare None
Douglas L. Hawthorne None
Leonard K. Nave None
William M. Gray None
Jack G. Bryant None
Jonathan C. Garrett 20,000 100% $3.00 6/30/03
Ralph A. Currie None
Shown below is information with respect to all unexercised
options to purchase ARO's Common Stock granted to the Named
Officers through the end of fiscal year 1998. No options were
exercised by the Named Officers during 1998. No stock
appreciation rights have been granted.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
<TABLE>
Number of
Securities Value of
Underlying Unexercised
Shares Unexercised in-the-Money
Acquired Options Options at
on Value at FY-End FY-End ($)
Exercise Realized Exercisable/ Exercisable/
Name (#) ($) Unexercisable Unexercisable
---- --- --- ------------- -------------
<S> <C> <C> <C> <C>
Rick G. Avare - - 493,204/0
Douglas L. Hawthorne - - 354,315/0 0/0
Leonard K. Nave - - 271,603/0 0/0
William M. Gray - - 0/0 0/0
Jack G. Bryant - - 20,000/85,000 0/0
Jonathan C. Garrett - - 20,000/85,000 0/0
Ralph A. Currie - - 0/0 0/0
</TABLE>
On April 14, 1994, the Board of Directors adopted two formal
stock plans: (i) the CSO Plan, and (ii) the 1994 Employee Stock
Compensation Plan ("Employee Plan"). The CSO Plan is a
compensatory (non-statutory) stock option plan covering 2,000,000
(post-reverse stock split) shares of ARO's common stock, which is
not a qualified plan
41
under Section 422 of the Internal Revenue Code of 1986. The
number of shares authorized for issuance under the CSO was
originally 750,000; however, this amount was increased to
2,000,000 on June 22, 1995, by approval of the shareholders.
The Employee Plan is an employee stock compensation plan
covering 650,000 (post-reverse stock split) shares of ARO's
Common Stock. The Employee Plan is not qualified under section
401(a) of the Internal Revenue Code of 1986. As of December 31,
1998, 321,000 shares have been issued under the Employee Plan.
From March 19, 1994, and at various dates until February 2,
1995, ARO entered into separate Compensatory Stock Option
Agreements with the following individuals: (i) Douglas L.
Hawthorne, Chairman of the Board; (ii) Donald Schellpfeffer,
former Director; (iii) Leonard K. Nave, Director of ARO and
President, Chief Executive Officer and a Director of Southern
Gas; and (iv) Rick G. Avare, Director and President and Chief
Executive Officer of ARO and Director, Vice President of Finance
and Chief Operating Officer of Southern Gas. Pursuant to the
terms of these agreements, Messrs. Hawthorne, Schellpfeffer, Nave
and Avare were granted options to purchase 307,712, 150,000,
200,000 and 175,000 shares of Common Stock, respectively, at
exercise prices of between $6.00 and $8.00 per share and
expiring between March 18, 2003, and February 1, 2005. Effective
March 4, 1996, the Board of Directors of ARO approved a
Resolution wherein all options previously granted under the CSO
Plan may be amended, at the election of the optionee, to provide
that the option price be reduced to $4.50 per share and the term
be reduced to 5 years from March 4, 1996.
On November 12, 1996, ARO's Board of Directors adopted an
Incentive Bonus Plan (the "Bonus Plan"). The Bonus Plan provides
that in each Contribution Period, as hereinafter defined, (the
"Bonus Period") ARO will make a Bonus Contribution to the Bonus
Plan. One-half of the Bonus Contribution will be an amount equal
to two and one-half cents ($.025) per thousand cubic feet
equivalent of the net increase in ARO's proved producing reserves
during the Bonus Period; and the other one-half of the Bonus
Contribution will be an amount equal to two percent (2%) of ARO's
net income before taxes during the Bonus Period as determined in
accordance with generally accepted accounting principles,
excluding extraordinary items such as net gain or loss resulting
from the sale, exchange or other disposition of capital assets
(other than in the ordinary course of business), and, to the
extent deducted in arriving at net income, interest,
depreciation, depletion and amortization expenses. However, the
Bonus Contribution made during any Bonus Period cannot exceed the
sum of $500,000.
The initial contribution period began January 1, 1997, and
calendar year 1997 and each successive calendar year thereafter
constitutes a Contribution Period until such time as the Bonus
Plan is modified or terminated by the Board of Directors.
Within 60 days after the end of each Bonus Period, the
President of ARO is required to recommend the manner in which the
Bonus Contribution is to be distributed
42
among ARO's Chief Executive Officer, Chief Financial Officer,
Senior Vice Presidents, General Counsel, Corporate Secretary and
other key personnel. All distributions are subject to approval by
the Compensation Committee of the Board of Directors and by the
Board of Directors. For 1998, 1997 and 1996, the total bonus
pool was $0, $225,000 and $125,000, respectively.
EXECUTIVE OFFICER EMPLOYMENT AGREEMENTS:
On March 19, 1993, ARO executed a five-year employment
agreement with Mr. Hawthorne, its Chairman of the Board,
providing for such compensation as the Board of Directors deems
appropriate and the grant of an option to purchase 392,541 shares
of ARO's common stock (which number was subsequently adjusted to
32,712 following ARO's reverse stock splits). Pursuant to the
terms of a separate registration rights agreement, Mr. Hawthorne
also was granted piggy-back registration rights with respect to
the securities underlying the options granted under his
employment agreement; however, on July 15, 1994, the Board of
Directors cancelled the previously issued options and granted
replacement options to Mr. Hawthorne on the same terms as the
previous options but with a new exercise price. These
replacement options were issued under ARO's 1994 CSO. Mr.
Hawthorne's employment agreement, which did not require that he
devote his full time to ARO, expired March 18, 1998; however, ARO
is currently paying Mr. Hawthorne $1,250 per month on a month-to-
month basis.
In April 1993, SGC executed a five-year employment agreement
with Mr. Nave providing for such compensation as the Board of
Directors deems appropriate and providing for severance pay to
Mr. Nave under certain conditions. ARO assumed this agreement as
a result of the purchase transaction with SGC in February 1994.
Mr. Nave's employment agreement expired March 31, 1998; however,
ARO is currently paying Mr. Nave approximately $14,600 per month
on a month-to-month basis.
On November 12, 1996, ARO entered into an Employment
Agreement with Rick G. Avare, ARO's President and Chief Executive
Officer, to serve in such capacity for a period of five years. If
written notice of intent to terminate the agreement is not given
by either party at least six months prior to the third
anniversary of the agreement, after the fifth anniversary of the
agreement it is automatically extended from year to year unless
either party gives written notice of intent to terminate at least
six months prior to the next anniversary date, at which time the
agreement will terminate. As consideration for Mr. Avare's
agreement to serve as President and Chief Executive Officer, ARO
agreed to pay him a salary of $160,000 per year plus benefits
customarily paid to executives holding similar positions. Mr.
Avare's salary is subject to annual review by the Board of
Directors. It can be increased by the Board of Directors, but it
cannot be decreased. Effective March 17, 1998, the Board of
Directors approved an increase in Mr. Avare's base salary to
$185,000 per year.
43
On the same date, ARO entered into a Change of Control
Agreement with Mr. Avare. The agreement is for a term of five
years. If written notice of intent to terminate the agreement is
not given by either party at least six months prior to the third
anniversary of the agreement, it is automatically extended from
year to year after the fifth anniversary of the agreement unless
either party gives written notice of intent to terminate at least
six months prior to the next anniversary date, at which time the
agreement will terminate. However, ARO is prohibited from giving
notice of intent to terminate if within one year prior to the
termination date ARO has received notice of or has reason to
believe that a change of control may occur.
The agreement provides that if a change of control occurs
and Mr. Avare's employment subsequently terminates for any
reason, ARO will pay to Mr. Avare an amount of monies equal to
the sum of (i) any monies due him under the remaining term of his
employment contract, (ii) any monies received by him from the
sale of ARO's common stock acquired as the result of the exercise
of stock options, (iii) 2.99 times the bonus awarded to him for
the prior year under ARO's Incentive Bonus Plan or $300,000,
whichever is greater, and (iv) all legal fees and expenses
incurred by him as a result of such termination and in seeking to
obtain or enforce any right under the agreement. In addition, ARO
is obligated to permit Mr. Avare to participate, for a period of
three years after termination, in ARO's insurance programs at no
cost to Mr. Avare.
Under the agreement, a change of control is deemed to occur
if (i) any person or group of persons, other than a group of
persons consisting of ARO's officers and directors as of the date
of the agreement, acting in concert, acquires beneficial
ownership of ARO's then outstanding capital stock representing
20% or more of the voting power of all of such shares, (ii) ARO
or any of its subsidiaries sell, assign or transfer assets for
consideration greater than 50% of the book value of ARO's then
consolidated assets as determined under generally accepted
accounting principles, (iii) ARO or any of its subsidiaries
merge, consolidate or otherwise reorganize and ARO's officers and
directors as of the date of the agreement receive less than 35%
of the voting power of the capital stock of the surviving or
resulting entity, (iv) ARO adopts a plan of liquidation or
dissolution, (v) the commencement of a tender offer for ARO's
common stock, which, if successful, would result in a deemed
change of control as defined in the agreement, (vi) a
determination by the Board of Directors of ARO in view of then
current circumstances or impending events, that a deemed change
of control as defined in the agreement has occurred or is
imminent, (vii) the persons who were directors of ARO immediately
prior to any merger, consolidation, sale of assets or contested
election, or any combination of the foregoing, cease to
constitute a majority of ARO's Board of Directors, and (viii) the
persons who were directors immediately prior to a tender offer or
exchange offer for ARO's voting stock (other than by ARO or any
of its subsidiaries) cease to constitute a majority of ARO's
Board of Directors within two years after such tender or exchange
offer.
44
On April 1, 1997, ARO entered into an Employment Agreement
with Ralph A. Currie, ARO's Chief Financial Officer, to serve in
such capacity for a period of three years. If written notice of
intent to terminate the agreement is not given by either party at
least three months prior to the second anniversary of the
agreement, it is automatically extended from year to year after
the third anniversary of the agreement unless either party gives
written notice of intent to terminate at least three months prior
to the next anniversary date, at which time the agreement will
terminate. As consideration for Mr. Currie's agreement to serve
as Chief Financial Officer, ARO agreed to pay him a salary of
$85,000 for the first year, $95,000 for the second year, $105,000
for the third year and not less than $105,000 for each year
thereafter, plus benefits customarily paid to executives holding
similar positions.
On November 21, 1997, ARO entered into an Employment
Agreement with William M. Gray to serve as President and Chief
Operating Officer of ARO's former wholly-owned subsidiary for a
period of three years. In the event Mr. Gray's Employment
Agreement expires without renewal prior to January 1, 2001, or
his employment is terminated by ARO for any reason other than his
death, physical or mental disability, or for cause as described
therein, he shall be entitled to receive a lump sum payment equal
to two times his current annual salary. As consideration for Mr.
Gray to serve in such capacity, ARO agreed to pay him a salary of
$167,500 per year plus such increases in salary as the Board of
Directors may from time to time deem appropriate; however, in no
event is Mr. Gray's annual salary increase to be less than an
amount equal to the cost of living increase for the previous
year. Mr. Gray is also to receive benefits customarily paid to
executives holding similar positions.
On December 22, 1997, ARO entered into an Employment
Agreement with Jack G. Bryant to serve as Vice President of
Exploration and Development of ARO's former wholly-owned
subsidiary for a period of two years. As consideration for Mr.
Bryant to serve in such capacity, ARO agreed to pay him a salary
of $150,000 per year plus such increases in salary as the Board
of Directors may from time to time deem appropriate; however, in
no event is Mr. Bryant's annual salary increase to be less than
an amount equal to the cost of living increase for the previous
year. Mr. Bryant is also to receive benefits customarily paid to
executives holding similar positions.
On January 2, 1998, ARO entered into an Employment Agreement
with Jonathan C. Garrett to serve as Vice President of
Engineering of ARO's former wholly-owned subsidiary for a period
of two years. As consideration for Mr. Garrett to serve in such
capacity, ARO agreed to pay him a salary of $130,000 per year
plus such increases in salary as the Board of Directors may from
time to time deem appropriate; however, in no event is Mr.
Garrett's annual salary increase to be less than an amount equal
to the cost of living increase for the previous year. Mr.
Garrett is also to receive benefits customarily paid to
executives holding similar positions.
45
Effective April 13, 1998, ARO entered into an Employment
Agreement with Daniel O. Hall to serve as an employee of ARO's
former wholly-owned subsidiary for an unspecified period of time.
In the event Mr. Hall's employment is terminated by ARO for any
reason other than for cause, he shall be entitled to receive one
year of his full salary plus health insurance coverage for six
months from the date of termination. As consideration for Mr.
Hall to serve as an employee of ARO, ARO agreed to pay him a
salary of $130,000 per year with a minimum salary increase in an
amount equal to the cost of living increase for the previous
year. Mr. Hall is also to receive benefits customarily paid to
employees holding similar positions.
On January 1, 1997, ARO entered into an Employment
Agreement, as amended, with David J. Stetson to serve as General
Counsel and Assistant Secretary of ARO for a period of five
years. If written notice of intent to terminate the agreement is
not given by either party at least three months prior to the
third anniversary of the agreement, it is automatically extended
from year to year after the fifth anniversary of the agreement
unless either party gives written notice of intent to terminate
at least three months prior to the next anniversary date, at
which time the agreement will terminate. As consideration for
Mr. Stetson to serve in such capacity, ARO agreed to pay him a
salary of $124,000 for the first year, $112,000 for the second
year, $170,000 for the third year, and not less than $120,000 for
each year thereafter, plus benefits customarily paid to
executives holding similar positions.
On March 1, 1998, ARO entered into an Employment Agreement,
as amended, with Karen M. Underwood to serve as Vice President of
Corporate Compliance and Corporate Secretary of ARO for a period
of three years. If written notice of intent to terminate the
agreement is not given by either party at least three months
prior to the second anniversary of the agreement, it is
automatically extended from year to year after the third
anniversary of the agreement unless either party gives written
notice of intent to terminate at least three months prior to the
next anniversary date, at which time the agreement will
terminate. As consideration for Ms. Underwood to serve in such
capacity, ARO agreed to pay her a salary of $65,100 for the first
year, $67,100 for the second year, $69,100 for the third year,
and not less than $69,100 for each year thereafter, plus benefits
customarily paid to executives holding similar positions.
ARO also maintains Indemnity Agreements with Rick G. Avare,
in his capacity as President and Chief Executive Officer; Ralph
A. Currie, its Chief Financial Officer, Vice President of Finance
and Treasurer; Karen M. Underwood, its Vice President of
Corporate Compliance and Corporate Secretary; and Douglas L.
Hawthorne, Leonard K. Nave, Rick G. Avare, David Fox, Jr., Len
Aldridge, Robert L. McIntyre and Joseph P. Shields, its Board of
Directors.
46
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT:
The following table reflects certain information regarding
the beneficial ownership of the outstanding equity securities of
ARO as of March 15, 1999, to the extent known to ARO's Board of
Directors. Such information is included for (i) persons who own
5% or more of such equity securities, (ii) directors, (iii) the
executive officers identified in the discussion under the heading
"Executive Compensation" (the "Named Executives"), and (iv)
officers and directors of ARO as a group. Unless otherwise
indicated, ARO believes that each person named below has the sole
power to vote and dispose of the equity securities beneficially
owned by such person.
<TABLE>
Shares Percent
Beneficial Owner Title Beneficially Of
Name/Address Of Class Owned(1) Class(2)
------------ -------- -------- --------
<S> <C> <C> <C>
Douglas L. Hawthorne 8% Preferred 3,334 1.45%
4325 Delco Dell Road Common Stock 561,896 5.29%
Kettering, OH 45429
Southern Gas Holding Common Stock 443,623 4.32%
Co., Inc.
160 Morgan Street
Versailles, KY 40383
Leonard K. Nave(3)(6) Common Stock 719,262 6.83%
160 Morgan Street
Versailles, KY 40383
Leonard K. Nave, Common Stock 443,623 4.32%
Trustee(3)(4)
160 Morgan Street
Versailles, KY 40383
Rick G. Avare(5) 8% Preferred 187,500 81.34%
160 Morgan Street Common Stock 2,109,750 19.28%
Versailles, KY 40383
Prima Capital, LLC Common Stock 645,588 6.29%
1532 Lake Wood Drive
Lexington, KY 40502
David J. Fox, Jr. Common Stock 53,834 *
Appalachian Production Company
940 Fourth Avenue, Ste. 225
Huntington, WV 25701
Len Aldridge Common Stock 151,000 1.47%
1999 Richmond Road
Suite 2-A
Lexington, KY 40502
Ralph A. Currie Common Stock 289,500 2.82%
160 Morgan Street
Versailles, KY 40383
William M. Gray Common Stock 2,500 *
3850 N. Causeway Blvd.
Suite 830
Metairie, LA 70002
</TABLE>
47
<TABLE>
Shares Percent
Beneficial Owner Title Beneficially Of
Name/Address Of Class Owned(1) Class(2)
------------ -------- -------- --------
<S> <S> <C> <C>
Andrew J. Kacic(8) Common Stock 711,540 6.50%
6119 N. Black Bear Loop
Tucson, AZ 85715
TECO Oil & Gas, Inc. Common Stock 2,637,006 20.40%
702 N. Franklin Street
Tampa, FL 33602
Directors and Executive All classes 4,075,380 34.75%
Officers
as a group (9 persons)
</TABLE>
* Represents less than 1% of ARO's outstanding stock for the
indicated class.
(1) Share information reflects the 1-for-4 reverse stock split
of ARO's common stock effected on June 8, 1994. 8%
Preferred Stock is convertible into common stock at the rate
of one share of common stock for each share of Preferred
Stock.
(2) Percentage assumes full exercise of outstanding options and
warrants to purchase shares of ARO's common stock and
conversion of 8% Preferred Stock into common stock.
(3) Includes 443,623 shares of common stock owned by Southern
Gas Holding Company, Inc. ("SGH"). SGH is owned 7.5% by
Leonard K. Nave, individually, and 32.5% by Leonard K. Nave,
as Trustee (See Note 4). Mr. Nave, individually and as
trustee, disclaims the beneficial ownership of such shares
of ARO's common stock to the extent they exceed his
percentage ownership of SGH.
(4) Leonard K. Nave is both the grantor and trustee of a trust
which owns 325 shares (32.5%) of SGH. The Trust Agreement
provides that 75 shares (7.5%) shall be distributed to each
of his three children and 100 shares (10%) shall be
distributed to his wife not later than April 30, 2000.
Neither Mr. Nave's wife nor children have a right to vote
the shares or to cause the trust to sell or otherwise
dispose of them.
(5) Includes 680,704 shares subject to options and conversion
rights exercisable within 60 days and 645,588 shares owned
by Prima Capital, LLC ("Prima") in which Mr. Avare owns a
20% interest. Mr. Avare disclaims beneficial ownership of
80% of the shares of ARO's common stock owned by Prima.
(6) Includes 271,603 shares subject to options exercisable
within 60 days.
(7) Includes 357,649 shares subject to options and conversion
rights exercisable within 60 days, 181,400 shares held in
Mr. Hawthorne's retirement plan and 1,792 shares
48
to which Mr. Hawthorne is entitled as a 1/3 beneficiary of
the Frances R. Hawthorne Trust.
(8) Includes 690,590 shares subject to options exercisable
within 60 days, 6,750 shares owned by the Andrew J. Kacic
Profit Sharing Plan, 6,390 shares held by Advisory Services
and 7,810 shares held by Andrew J. Kacic & Associates.
(9) Shares subject to warrants exercisable within 60 days. In
conjunction with the purchase of properties from TECO Oil &
Gas, Inc. ("TECO"), the parties entered into a warrant
agreement ("TECO Warrant Agreement") granting TECO warrants
to acquire 600,000 shares of common stock of ARO ("First
Warrants") at a price of $2.67 per share if the note between
ARO and TECO in the amount of $18.5 million (the "TECO
Note") was not paid in full by October 1, 1998.
Additionally, the TECO Warrant Agreement granted TECO
warrants to acquire common stock equal to 10% of ARO's
outstanding common stock and options if the TECO Note was
not paid in full by October 1, 1998, increasing by an
additional 5% if the TECO Note was not paid in full by
January 1, 1999, and by an additional 5% if the TECO Note is
not paid in full by April 1, 1999 (collectively, the
"Secondary Warrants"). The price per share of common stock
evidenced by the Secondary Warrants is $0.00001. On October
2, 1998, TECO declared ARO to be in default under the terms
of the TECO Note. Therefore, TECO is currently vested with
the rights to acquire the First Warrants and 15% of ARO's
outstanding common stock and options. TECO's rights to
acquire such common stock will expire on July 1, 1999. The
exercise by TECO of such rights would constitute a change of
control as defined in the Change of Control Agreement
between ARO and Rick G. Avare (see Item 9, "Directors,
Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act--Executive
Officer Employment Agreements" in the Report on Form 10-K).
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
BANKRUPTCY PROCEEDINGS:
In 1996, Leonard K. Nave, a director of ARO, a director and
executive officer of Southern Gas and a beneficial owner of more
than 5% of ARO's Common Stock, filed for reorganization and
protection under Chapter 11 of the United States Bankruptcy Code.
This action was initiated primarily because of the attempted
enforcement of certain guaranties which Mr. Nave signed on behalf
of an unaffiliated corporation. Mr. Nave's plan of
reorganization was confirmed by the Court on February 20, 1998,
and his discharge from Chapter 11 was effective March 18, 1998.
49
SOUTHERN GAS, SGC AND SGH:
Mr. Nave, in his capacity as Trustee of a Trust for the
benefit of his family, an executive officer of Southern Gas and
director of ARO, is the principal stockholder, director and
executive officer of SGH. Mr. Avare, in his capacity as an
executive officer of Southern Gas and an executive officer and
director of ARO, was a stockholder, director and officer of SGH
from October 1988 until February 1998. SGH was the parent
company of SGC, a Kentucky corporation; and as part of the
dissolution of SGC, SGH received 993,623 shares of common stock
of ARO. From March 29, 1993, to April 27, 1993, Messrs. Nave and
Avare served as directors of ARO and have served as directors
continuously since September 1994. Mr. Avare resigned as
president and director of SGH in February 1998 and divested
himself of his ownership of stock in SGH in exchange for 350,000
shares of the common stock of ARO. During 1994 and 1995, ARO
engaged in various transactions involving SGH and SGC and other
third parties regarding the acquisition of oil and gas properties
and interests therein, including the acquisition of substantially
all of the assets and specific liabilities of SGC in February
1994. At the time such transactions were negotiated and
consummated, Messrs. Nave and Avare were neither directors nor
officers or stockholders of ARO.
At December 31, 1998, ARO has made advances to SGH totaling
$464,106 which the principal of SGH intends to secure with
143,000 shares of ARO's common stock held by SGH. Due to a
significant decrease in the value of the collateral, ARO has
fully reserved the receivable from SGH as of December 31, 1998.
OFFICE LEASE:
In connection with the acquisition of the assets of SGC, ARO
assumed the obligations of a certain lease dated June 1, 1986,
between Nave Properties, a sole proprietorship, and SGC relating
to certain office space located in Versailles, Kentucky. This
office serves as the principal headquarters of Southern Gas
(formerly the principal headquarters of SGC); and effective
January 31, 1996, ARO's Scottsdale, Arizona, office was closed
and operations were consolidated in the Kentucky office. Nave
Properties, which is owned by Leonard K. Nave, is an affiliate of
ARO. The lease provides for monthly lease payments of $3,100
($37,200 annually). The lease is currently being renegotiated
for renewal and is operating on a month-to-month basis.
PRIMA TRANSACTIONS:
On September 15, 1997, ARO entered into a Letter of Intent
with Prima, a limited liability company in which Rick G. Avare
owns a 20% interest, providing for the acquisition of an interest
in producing and non-producing oil and gas properties (the
"Properties") located in Mississippi. The purchase price for the
Properties was $2,800,000 payable $1,300,000 on or before closing
which occurred October 10, 1997, and the balance of $1,500,000 in
an interest bearing note with recourse only to the
50
Properties. ARO already owned up to 3.5% interest in the
Properties; and after reviewing an independent geologist's report
on the Properties, the Letter of Intent was approved by a
majority of the disinterested directors of ARO at a special
meeting of the Board of Directors held on September 15, 1997. At
December 31, 1998, the balance due on the note to Prima was
$987,160.
EXECUTIVE OFFICERS:
Effective December 31, 1995, ARO entered into a severance
agreement with Andrew J. Kacic, its former President, Chief
Executive Officer and founder, who resigned effective December
31, 1995. Under the agreement, Mr. Kacic was paid $85,000 and
received the sum of $10,000 per month through March 31, 1998. In
addition, the executive surrendered 515,590 CSO common stock
options which had exercise prices of between $6.00 and $8.00 per
share and expired between March 18, 2003, and February 1, 2005.
In return, Mr. Kacic received 643,987 common stock options under
a Severance Plan, at an exercise price of $4.00 per share and
which expire on November 29, 2000. He also retained 46,203 CSO
common stock options immediately exercisable, previously issued
to him at $3.50 per share and which expire on October 11, 2002.
ARO also agreed to provide for payment of an office lease through
October 1996, and assigned a one percent (1%) gross overriding
royalty interest in certain oil and gas properties. As a result
of the agreement, ARO recognized a charge against income of
$371,346 and accrued a severance liability at December 31, 1995,
of $286,346 based on an eight percent (8%) discount factor. As
of December 31, 1998, this amount had been reduced to $0.
51
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a)(1) and (a)(2) Financial Statements and Financial Statement
Schedules.
See "Index to Financial Statements" set forth on page F-
1.
(a)(3) Exhibits:
The following Exhibits are either attached hereto or
incorporated herein by reference:
EXHIBIT
NUMBER DESCRIPTION
3.9 By-Laws of ARO, as amended (incorporated by
reference to Exhibit 3.2 to ARO's Form 10-SB).
3.10 Restated Certificate of Incorporation filed with
the Delaware Secretary of State (incorporated by
reference to Exhibit 3.10 to ARO's Form 8-K filed
December 12, 1996).
3.11 Copy of the Certificate eliminating the Series B
Preferred Stock (incorporated by reference to Exhibit
3.11 to ARO's Form 8-K filed on April 24, 1997).
3.12 Certificate of Amendment of Restated Certificate
of Incorporation filed with the Delaware Secretary of
State on July 11, 1997 (incorporated by reference to
Exhibit 3.12 to ARO's Form 8-K filed on July 25, 1997).
4.1 Specimen Common Stock Certificate (incorporated by
reference to Exhibit 4.1 to the ARO's Form 10-SB).
4.2 Specimen Preferred Stock Certificate (incorporated
by reference to Exhibit 4.2 to ARO's Form 10-SB).
4.3 Specimen Warrant Certificate and Agreement
(incorporated by reference to Exhibit 4.3 to ARO's Form
10-SB).
4.5 Warrant Agreement dated as of October 6, 1994
between American Resources of Delaware, Inc. and GFL
Ultra Fund, Ltd. (incorporated by reference to Exhibit
4.1 to ARO's September 1994, Form 10-QSB).
52
4.6 Warrant Agreement dated as of November 10, 1994
between American Resources of Delaware, Inc. and GFL
Ultra Fund, Ltd. (incorporated by reference to Exhibit
4.6 to ARO's Form 10-KSB for the fiscal year ended
December 31, 1994 [the "1994 Form 10-KSB"]).
4.9 Specimen copy of the Convertible Debenture
Purchase Agreement, with exhibits. (incorporated by
reference to Exhibit 4.9 to ARO's Form 8-K filed
December 12, 1996).
4.10 Specimen copy of a Stock Option Agreement between
American Resources of Delaware, Inc., and Corporate
Relations Group, Inc. (incorporated by reference to
Exhibit 4.10 to ARO's Form 8-K filed December 12,
1996).
4.11 Copy of a Stock Option Agreement between American
Resources of Delaware, Inc., and World Capital Funding,
Inc. (incorporated by reference to Exhibit 4.11 to
ARO's Form 8-K filed December 12, 1996).
10.1 Asset Purchase Agreement between American Resources of
Delaware, Inc. and Southern Gas Company, Inc. dated
October 6, 1993 (incorporated by reference to Exhibit
1.1 to ARO's Form 8-K filed October 19, 1993).
10.2 Amendment to Asset Purchase Agreement by and
between American Resources of Delaware, Inc. and
Southern Gas Company, Inc. dated February 28, 1994
(incorporated by reference to Exhibit 2.8 to ARO's Form
10-KSB for the fiscal year ended December 31, 1993 [the
"1993 Form 10-KSB"]).
10.3 Purchase Agreement between Southern Gas Holding
Company, Inc. and American Resources of Delaware, Inc.
dated February 24, 1994 (incorporated by reference to
Exhibit 2.2 to ARO's Form 8-K filed March 14, 1994).
10.13 Agreement among Southern Gas Holding Company, Inc.,
Gems Resources, Inc., and American Resources of
Delaware, Inc., dated February 21, 1994 (incorporated
by reference to Exhibit 4.11 to ARO's 1993 Form 10-
KSB).
10.14 Employment and Stock Option Agreement of Andrew J.
Kacic dated March 19, 1993 (incorporated by reference
to Exhibit 10.1 ARO's Form 10-SB).
10.15 Registration Rights Agreement dated March 19, 1993
between ARO and Andrew J. Kacic (incorporated by
reference to Exhibit 10.2 to ARO's Form 10-SB).
53
10.16 Employment and Stock Option Agreement dated March 19,
1993 between the Registrant and Charles A. Smith, III
dated March 19, 1993 (incorporated by reference to
Exhibit 10.3 to ARO's Form 10-SB).
10.17 Registration Rights Agreement between ARO and Charles
A. Smith, III dated March 19, 1993 (incorporated by
reference to Exhibit 10.4 to ARO's Form 10-SB).
10.18 Employment and Stock Option Agreement dated March 19,
1993 between ARO and Douglas L. Hawthorne (incorporated
by reference to Exhibit 10.5 to ARO's Form 10-SB).
10.19 Registration Rights Agreement dated March 19, 1993
between ARO and Douglas L. Hawthorne (incorporated by
reference to Exhibit 10.6 to ARO's Form 10-SB).
10.20 Agreement between ARO and Oilfield Investments Ltd.
dated March 8, 1994 (incorporated by reference to
Exhibit 10.28 to ARO's 1993 Form 10-KSB).
10.21 Office Lease dated June 1, 1986 between Nave Properties
and Southern Gas (assigned to SGCD) (incorporated by
reference to Exhibit 10.36 to ARO's 1993 Form 10-KSB).
10.22 Incentive Stock Option Plan (incorporated by reference
to Exhibit 10.0 to ARO's September 1994, Form 10-QSB).
10.23 Letter Agreement dated October 17, 1994 between ARO and
Settle Oil and Gas Company (incorporated by reference
to Exhibit 10.1 to ARO's September 1994, Form 10-QSB).
10.24 Letter Agreement dated December 30, 1994, between ARO
and Settle Oil and Gas Company (incorporated by
reference to Exhibit 10.24 to ARO's 1994 Form 10-KSB).
10.25 Letter Agreement dated January 12, 1995, between ARO
and Settle Oil and Gas Company (incorporated by
reference to Exhibit 10.25 to ARO's 1994 Form 10-KSB).
10.26 Letter Agreement dated February 20, 1995, between ARO
and Settle Oil and Gas Company (incorporated by
reference to Exhibit 10.26 to ARO's 1994 Form 10-KSB).
54
10.27 Agreement and Assignment dated September 30, 1994,
between Petroleum Exploration and Transmission, Inc.
and Southern Gas Company of Delaware, Inc.
(incorporated by reference to Exhibit 10.27 to ARO's
1994 Form 10-KSB).
10.28 Mortgage and Security Agreement dated September 30,
1994, between Southern Gas Company of Delaware, Inc.
and Melinda C. Provo (incorporated by reference to
Exhibit 10.28 to ARO's 1994 Form 10-KSB).
10.29 Promissory Note dated September 30, 1994 from Southern
Gas Company of Delaware, Inc. to Melinda C. Provo
(incorporated by reference to Exhibit 10.29 to ARO's
1994 Form 10-KSB).
10.30 Form of Put Agreement dated March 15, 1995, between
American Resources of Delaware, Inc. and Prima Capital,
L.L.C. (incorporated by reference to Exhibit 10.30 to
ARO's 1994 Form 10-KSB).
10.31 Form of Limited Liability Company Agreement of Crescent
Turnkey & Engineering, L.L.C. dated December 30, 1994
(incorporated by reference to Exhibit 10.31 to ARO's
1994 Form 10-KSB).
10.32 Domestic Turnkey Drilling Contract -- Offshore dated
December 30, 1994, between American Resources of
Delaware, Inc. and Crescent Turnkey Engineering, L.L.C.
(incorporated by reference to Exhibit 10.32 to ARO's
1994 Form 10-KSB).
10.33 Purchase and Sale Agreement dated effective October 31,
1994, between American Resources of Delaware, Inc. and
Settle Oil and Gas Company (incorporated by reference
to Exhibit 10.33 to ARO's 1994 Form 10-KSB).
10.34 Subscription Agreement for 22% Secured Convertible Note
of Settle Oil and Gas Company dated November 28, 1994,
and executed by American Resources of Delaware, Inc.
(incorporated by reference to Exhibit 10.34 to ARO's
1994 Form 10-KSB).
10.35 22% Secured Convertible Note dated November 28, 1994,
in the amount of $5,000,000 from Settle Oil and Gas
Company to American Resources of Delaware, Inc.
(incorporated by reference to Exhibit 10.35 to ARO's
1994 Form 10-KSB).
10.36 Assignment of Convertible Promissory Note dated
December 30, 1994, from American Resources of
Delaware, Inc. to Southern Gas Company of Delaware,
Inc. (incorporated by reference to Exhibit 10.36 to
ARO's 1994 Form 10-KSB).
55
10.37 Assignment of Convertible Promissory Note dated
December 30, 1994, from Southern Gas Company of
Delaware, Inc. to Century Offshore Management
Corporation, Settle Oil and Gas Company, and Southern
Gas Company of Delaware, Inc. (incorporated by
reference to Exhibit 10.37 to ARO's 1994 Form 10-KSB).
10.38 Mortgage and Security Agreement dated November 15,
1994, among Settle Oil and Gas Company, Century
Offshore Management Corporation and American Resources
of Delaware, Inc. (incorporated by reference to Exhibit
10.38 to ARO's 1994 Form 10-KSB).
10.39 Put Agreement dated as of March 15, 1995, between the
American Resources of Delaware, Inc., Southern Gas
Company of Delaware, Inc. and Prima Capital, LLC
(incorporated by reference to Exhibit 10.0 to ARO's
Form 10-QSB for the quarterly period ended March 31,
1995 [the "March 1995, Form 10-QSB"]).
10.40 $500,000 Promissory Note from Southern Gas Company of
Delaware, Inc. In favor of Rick G. Avare, Douglas L.
Hawthorne Retirement Plan-001, Dtd. February 22, 1995,
and Douglas L. Hawthorne (incorporated by reference to
Exhibit 10.1 to ARO's March 1995, Form 10-QSB).
10.41 Agreement dated January 31, 1995, between Southern Gas
Company of Delaware, Inc., Rick G. Avare, Douglas L.
Hawthorne Retirement Plan-001, Dtd. February 22, 1995,
and Douglas L. Hawthorne (incorporated by reference to
Exhibit 10.2 to ARO's March 1995, Form 10-QSB).
10.42 Amendment to Put Agreement dated as of July 1, 1995,
between American Resources of Delaware, Inc., Southern
Gas Company of Delaware, Inc. and Prima Capital, LLC
(incorporated by reference to Exhibit 10.0 to ARO's
Form 10-QSB for the quarterly period ended June 30,
1995 [the "June 1995, Form 10-QSB"]).
10.43 $900,000 Promissory Note from Settle (incorporated by
reference to Exhibit 10.1 to ARO's June 1995, Form 10-
QSB).
10.44 Participation agreement dated as of July 25, 1995,
between American Resources of Delaware, Inc. and its
Board of Directors (incorporated by reference to
Exhibit 10.2 to ARO's June 1995, Form 10-QSB).
10.45 Stock Option Agreement dated May 5, 1995, between
American Resources of Delaware, Inc. and GFL Ultra Fund
Limited (incorporated by reference to Exhibit 10.3 to
ARO's June 1995, Form 10-QSB).
56
10.46 First Amendment to Stock Option Agreement dated June
19, 1995, between American Resources of Delaware, Inc.
And GFL Ultra Fund Limited (incorporated by reference
to Exhibit 10.4 to ARO's June 1995, Form 10-QSB).
10.47 Second Amendment to Stock Option Agreement dated July
13, 1995, between American Resources of Delaware, Inc.
and GFL Ultra Fund Limited (incorporated by reference
to Exhibit 10.5 to ARO's June 1995, Form 10-QSB).
10.48 Promissory Note of September 28, 1995, to Den norske
Bank, A.S. (incorporated by reference to Exhibit 10.0
to ARO's Form 10-QSB for the quarterly period ended
September 30, 1995 [the "September 1995, Form 10-QSB]).
10.49 Amendment to Settle Note (incorporated by reference to
Exhibit 10.1 to ARO's September 1995, Form 10-QSB).
10.50 Asset Purchase Agreement of December 27, 1995, by and
between American Resources of Delaware, Inc., Southern
Gas Co. of Delaware, Inc., Arakis Energy Corporation
and AKS Energy Corporation (incorporated by reference
to Exhibit A to ARO's Form 8-K filed on March 12,
1996).
10.51 Joint Development Agreement of February 26, 1996,
between Southern Gas Co. of Delaware, Inc. and AKS
Energy Corporation (incorporated by reference to
Exhibit B to ARO's Form 8-K filed on March 12, 1996).
10.52 Joint Operating Agreement of December 1, 1994, between
Century Offshore Management Corporation, Settle Oil and
Gas Company and Southern Gas Co. of Delaware, Inc.
(incorporated by reference to Exhibit 10.52 to ARO's
Form 10-KSB for the fiscal year ended December 31, 1995
[the "1995 Form 10-KSB"]).
10.53 Stock Purchase Agreement of January 2, 1996, as
amended, between American Resources of Delaware, Inc.
and GFL Ultra Fund, Ltd. (incorporated by reference to
Exhibit 10.53 to ARO's 1995 Form 10-KSB).
10.54 Purchase Agreement of December 29, 1995, between
Southern Gas Holding Company and Southern Gas Co. of
Delaware, Inc. (incorporated by reference to Exhibit
10.54 to ARO's 1995 Form 10-KSB).
57
10.55 Severance Agreement of November 30, 1995, between
American Resources of Delaware, Inc. and Andrew J.
Kacic. (incorporated by reference to Exhibit 10.55 to
ARO's 1995 Form 10-KSB).
10.56 Second Amendment to Put Agreement of October 4, 1995,
between American Resources of Delaware, Inc., Prima
Capital, LLC, and Southern Gas Co. of Delaware, Inc.
(incorporated by reference to Exhibit 10.56 to ARO's
1995 Form 10-KSB).
10.57 Specimen Change of Control Agreement (incorporated by
reference to Exhibit 10.57 to ARO's Form 8-K filed
December 12, 1996).
10.58 Employment Agreement with Rick G. Avare (incorporated
by reference to Exhibit 10.58 to ARO's Form 8-K filed
December 12, 1996).
10.59 Specimen copy of the Indemnity Agreement with Officers
and Directors (incorporated by reference to Exhibit
10.59 to ARO's Form 8-K filed December 12, 1996).
10.60 Lead Generation Agreement with Corporate Relations
Group, Inc. (incorporated by reference to Exhibit 10.60
to ARO's Form 8-K filed December 12, 1996).
10.63 Participation Agreement of April 12, 1996, between
American Resources of Delaware, Inc. and Douglas L.
Hawthorne (incorporated by reference to Exhibit 10.3 to
ARO's Report on Form 10-QSB for the quarterly period
ended March 31, 1996).
10.64 Production Payment Conveyance of May 22, 1996, by and
between Southern Gas Co. of Delaware, Inc., and Austin
Energy Funding Partners (incorporated by reference to
Exhibit 10.4 to ARO's Report on Form 10-QSB for the
quarterly period ending June 30, 1996).
10.65 Asset Purchase Agreement by and between American
Resources of Delaware, Inc., Southern Gas Co. of
Delaware, Inc., and Century Offshore Management
Corporation dated July 3, 1996, for the acquisition of
the South Timbalier 148 properties (incorporated by
reference to Exhibit A to ARO's Form 8-K filed on July
18, 1996).
10.66 Asset Purchase Agreement by and between American
Resources of Delaware, Inc., Southern Gas Co. of
Delaware, Inc., and Century Offshore Management
Corporation dated July 3, 1996, for the acquisition of
the contractual rights for salt dome properties
(incorporated by reference to Exhibit B to ARO's Form 8-
K filed on July 18, 1996).
58
10.67 Capitalization Agreement and Termination of Purchase
and Sale Agreement by and between Southern Gas Co. of
Delaware, Inc., American Resources of Delaware, Inc.
and Century Offshore Management Corporation, dated
August 31, 1996 (incorporated by reference to Exhibit A
to ARO's Form 8-K/A filed on September 16, 1996).
10.68 Amendment to South Timbalier Purchase and Sale
Agreement by and between Southern Gas Co. of Delaware,
Inc., American Resources of Delaware, Inc. and Century
Offshore Management Corporation, dated August 31, 1996
(incorporated by reference to Exhibit B to ARO's Form 8-
K/A filed on September 16, 1996).
10.69 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Douglas L.
Hawthorne, dated September 30, 1996 (incorporated by
reference to Exhibit 10.9 to ARO's Form 10-QSB for the
quarterly period ending September 30, 1996 [the
"September 1996, Form 10-QSB"]).
10.70 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and The Kandy
Limited Partnership, dated September 30, 1996
(incorporated by reference to Exhibit 10.10 to ARO's
September 1996, Form 10-QSB).
10.71 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Donald A.
Schellpfeffer, dated September 30, 1996 (incorporated
by reference to Exhibit 10.11 to ARO's September 1996,
Form 10-QSB).
10.72 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Southern Gas
Holding Company, Inc., dated September 30, 1996
(incorporated by reference to Exhibit 10.12 to ARO's
September 1996, Form 10-QSB).
10.73 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Douglas L.
Hawthorne Retirement Plan-001 Dtd. 2/22/95, dated
September 30, 1996 (incorporated by reference to
Exhibit 10.13 to ARO's September 1996, Form 10-QSB).
10.74 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Douglas L.
Hawthorne, dated December 29, 1996 (incorporated by
reference to Exhibit 10.74 to ARO's Form 10-KSB for the
fiscal year ended December 31, 1996 [the "1996 Form 10-
KSB"]).
59
10.75 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and The Kandy
Limited Partnership, dated December 29, 1996
(incorporated by reference to Exhibit 10.75 to ARO's
1996 Form 10-KSB).
10.76 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Donald A.
Schellpfeffer, dated December 29, 1996 (incorporated by
reference to Exhibit 10.76 to ARO's 1996 Form 10-KSB).
10.79 Termination of Participation Agreement by and between
American Resources of Delaware, Inc. and Douglas L.
Hawthorne Retirement Plan-001 Dtd. 2/22/95, dated
December 29, 1996 (incorporated by reference to Exhibit
10.79 to ARO's 1996 Form 10-KSB).
10.80 Securities Purchase Agreement dated July 16, 1997
between ARO and Den norske Bank ASA (incorporated by
reference to Exhibit 10.80 to Company's Form 8-K filed
on July 25, 1997).
10.81 Registration Rights Agreement dated July 16, 1997
between ARO and Den norske Bank ASA (incorporated by
reference to Exhibit 10.81 to ARO's Form 8-K filed on
July 25, 1997).
10.82 Co-Sale Agreement dated July 16, 1997 among ARO, Rick
G. Avare, Southern Gas Holding Company, Inc. and Den
norske Bank ASA (incorporated by reference to Exhibit
10.82 to ARO's Form 8-K filed on July 25, 1997).
10.83 Letter of Intent between ARO and Prima Capital, LLC
(incorporated by reference to Exhibit 10.83 to ARO's
Form 8-K filed on September 24, 1997).
10.84 Copy of the letter of resignation from William Bishop
(incorporated by reference to Exhibit 10.84 to ARO's
Form 8-K filed on October 1, 1997).
10.85 Copy of the Stock Purchase Agreement between Prima
Capital, LLC and ARO (incorporated by reference to
Exhibit 10.85 to ARO's Form 8-K filed on November 19,
1997).
10.86 Copy of the First Amended and Restated Credit Agreement
between ARO and Den norske Bank, AS (incorporated by
reference to Exhibit 10.86 to ARO's Form 8-K filed on
November 19, 1997).
60
10.87 Purchase and Sale Agreement by and between ARO and K.E.
Resources, Ltd., entered into on December 16, 1997
(incorporated by reference to Exhibit 10.87 to ARO's
Form 8-K filed on December 30, 1997).
10.88 Press release announcing agreement to acquire offshore
Gulf of Mexico assets from TECO Oil & Gas, Inc.
(incorporated by reference to Exhibit 10.88 to ARO's
Form 8-K filed on January 16, 1998).
10.89 Purchase and Sale Agreement between American Resources
of Delaware, Inc., American Resources Offshore, Inc.,
TECO Oil & Gas, Inc. and TECO Energy, Inc.
(incorporated by reference to Exhibit 10.89 to ARO's
Form 8-K filed on March 16, 1998).
10.90 Promissory Note from American Resources Offshore, Inc.
in favor of TECO Oil & Gas, Inc. (incorporated by
reference to Exhibit 10.90 to ARO's Form 8-K filed on
March 16, 1998).
10.91 Warrant Agreement between American Resources of
Delaware, Inc. and TECO Oil & Gas, Inc. (incorporated
by reference to Exhibit 10.91 to ARO's Form 8-K filed
on March 16, 1998).
10.92 First Amendment to First Amended and Restated Credit
Agreement dated March 5, 1998 between American
Resources of Delaware, Inc., Southern Gas Co. of
Delaware, Inc., American Resources Offshore, Inc. and
DNB Energy Assets, Inc. (incorporated by reference to
Exhibit 10.92 to ARO's Report on Form 10-Q for the
quarterly period ending March 31, 1998).
10.93 Amended Purchase and Sale Agreement between American
Resources of Delaware, Inc., American Resources
Offshore, Inc, TECO Oil & Gas, Inc. and TECO Energy,
Inc. (incorporated by reference to Exhibit 10.93 to
ARO's Report on Form 8-K/A2 filed on May 19, 1998).
10.94 Intercreditor Agreement between American Resources of
Delaware, Inc., American Resources Offshore, Inc.,
Southern Gas Co. of Delaware, Inc., TECO Oil & Gas,
Inc. and DNB Energy Assets, Inc. (incorporated by
reference to Exhibit 10.94 to ARO's Report on Form 8-
K/A2 filed on May 19, 1998).
10.95 Certificate of Amendment dated July 2, 1998 amending
ARO's Restated Certificate of Incorporation
(incorporated by reference to Exhibit 10.95 to ARO's
Report on Form 10-Q for the quarterly period ending
June 30, 1998).
61
10.96 Certificate of Ownership and Merger Merging American
Resources Offshore, Inc., into American Resources of
Delaware, Inc. (incorporated by reference to Exhibit
10.96 to ARO's Report on Form 8-K filed on November 12,
1998).
16.01 Response letter from KPMG LLP to the Securities and
Exchange Commission (incorporated by reference to
Exhibit 16.01 to ARO's Report on Form 8-K/A filed on
January 15, 1999).
21.0 Subsidiaries of American Resources of Delaware,
Inc.*
23.1 Consent of Ernst & Young LLP.*
23.2 Consent of Netherland, Sewell & Associates, Inc.*
23.3 Consent of Richard M. Russell & Associates, Inc.*
23.4 Consent of Ryder Scott Company, Petroleum
Engineers*
23.5 Consent of KPMG LLP.*
* Filed herewith
(b) Reports on Form 8-K:
On October 1, 1998, ARO filed a Report on Form 8-K in
order to report the extension of the maturity date on its
bridge loans from DNB and the vesting of warrants in favor
of TECO due to nonpayment of the TECO Note.
On November 12, 1998, American Resources of Delaware,
Inc. filed a Report on Form 8-K reporting the merger of
American Resources Offshore, Inc., into American Resources
of Delaware, Inc. and the change of the name of American
Resources of Delaware, Inc. to American Resources Offshore,
Inc.
On January 11, 1999, ARO filed a Report on Form 8-K
reporting the sale of the Sunrise Prospect, the change in
Certified Accountant, the settlement of outstanding sales
and tangible property taxes assessed by the Kentucky Revenue
Cabinet, the initiation of litigation by a trade creditor,
the maturing of $16.5 million of Bridge Loans with Den
norske Bank and the notification by NASDAQ that ARO's
securities will be subject to delisting on April 5, 1999
unless certain criteria are met.
62
On January 15, 1999, ARO filed a Report on Form 8-K/A
which provided a copy of KPMG LLP's response letter to the
Securities and Exchange Commission.
On March 23, 1999, ARO filed a Report on Form 8-K
reporting the settlement of litigation and liens against
ARO's Grand Isle Block 55 property in the amount of
approximately $12 million, together with the settlement of
litigation filed against ARO's High Island Block 105
property in the amount of approximately $600,000.
On April 8, 1999, ARO filed a Report on Form 8-K
reporting that it had requested a hearing on its possible
delisting; and NASDAQ has set a hearing date of May 13,
1999, delaying any action to delist ARO until after the
hearing.
63
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
FOR THE YEARS ENDED
-------------------
DECEMBER 31, 1998, 1997 AND 1996
--------------------------------
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
FOR THE YEARS ENDED
-------------------
DECEMBER 31, 1998, 1997 AND 1996
--------------------------------
TABLE OF CONTENTS
PAGE NO.
--------
Independent Auditors' Reports F-1
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholders' Equity F-6
Consolidated Statements of Cash Flows F-9
Notes to Consolidated Financial Statements F-12
Oil and Gas Producing Activities (Unaudited) F-37
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors and Shareholders
American Resources Offshore, Inc.
We have audited the accompanying consolidated balance sheet
of American Resources Offshore, Inc. and subsidiary as of
December 31, 1998, and the related consolidated statements
of operations, stockholders' equity and cash flows for the
year ended December 31, 1998. These consolidated financial
statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan
and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial
position of American Resources Offshore, Inc. and subsidiary
as of December 31, 1998, and the results of their operations
and their cash flows for the year ended December 31, 1998 in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared
assuming that the Company will continue as a going concern.
As more fully described in Note 20 to the financial
statements, the Company incurred a net loss of $46.2 million
in 1998, and has a working capital deficiency of $89.7
million at December 31, 1998. In addition, the Company has
not complied with certain covenants of its debt agreements.
These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 20.
The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability
and classification of assets or the amounts and
classification of liabilities that might result from the
outcome of this uncertainty.
Ernst & Young LLP
New Orleans, LA
April 2, 1999
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors
American Resources Offshore, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of
American Resources Offshore, Inc. (formerly American Resources of
Delaware, Inc.) and subsidiaries as of December 31, 1997, and the
related consolidated statements of operations, stockholders'
equity, and cash flows for the years ended December 31, 1997 and
1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial
statements based on our audits
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial
position of American Resources Offshore, Inc. (formerly American
Resources of Delaware, Inc.) and subsidiaries as of December 31,
1997, and the results of their operations and their cash flows
for the years ended December 31, 1997 and 1996 in conformity with
generally accepted accounting principles.
KPMG LLP
Houston, TX
March 30, 1998
F-2
<PAGE>
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED BALANCE SHEET
--------------------------
DECEMBER 31, 1998 AND 1997
--------------------------
<TABLE>
ASSETS
1998 1997
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 255 $ 1,180
Accounts and notes receivable:
Trade 4,094 4,595
Notes 99 70
Related party 495 304
Allowance for doubtful accounts (474) (5)
------- -------
4,214 4,964
Deferred tax asset 298 112
Prepaid expenses and other 689 313
------- -------
Total current assets 5,456 6,569
------- -------
Oil and gas properties, at cost
(successful efforts method) 98,161 57,173
Property and equipment, at cost 14,645 12,353
------- -------
112,806 69,526
Less accumulated depreciation,
depletion and amortization (44,253) (18,276)
------- -------
Net property and equipment 68,553 51,250
Other assets 2,215 3,747
------- -------
Total assets $76,224 $ 61,566
======= =======
</TABLE>
(Continued)
See accompanying notes to consolidated financial statements.
F-3
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED BALANCE SHEET (CONTINUED)
--------------------------------------
DECEMBER 31, 1998 AND 1997
--------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
1998 1997
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Current liabilities:
Current portions of long-term debt 64,033 4,682
Debt in default 18,500 -
Note payable to related party - 225
Accounts payable - Trade 7,162 963
Unearned revenue 667 820
Accrued expenses and other 3,589 700
------ ------
Total current liabilities 93,951 7,390
Long-term debt, excluding
current portions 706 25,393
Unearned revenue 2,971 2,095
Deferred tax liability 298 2,166
Stockholders' equity:
Series 1993 8% convertible
preferred stock, par value
and liquidation preference
$12.00 per share; 1,000,000
shares authorized 1,871 2,182
Common stock, par value $.00001
per share; 50,000,000 shares
authorized - -
Additional paid-in-capital 22,860 22,500
Retained earnings (45,720) 553
Treasury stock at cost,
representing 201,890 shares
of common stock in 1998 and 1997 (713) (713)
------- -------
Total stockholders' equity (21,702) 24,522
------- -------
Commitments and contingencies
Total liabilities and
stockholders' equity $76,224 $61,566
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
<TABLE>
1998 1997 1996
---- ---- ----
(Dollars in thousands,
except share data)
<S> <C> <C> <C>
Operating Revenues:
Oil and gas production $ 26,724 $ 19,457 $ 8,540
Transportation 790 870 1,071
Marketing 7,751 17,499 22,713
Other 872 206 715
---------- ---------- ----------
36,137 38,032 33,039
---------- ---------- ----------
Operating Expenses:
Oil and gas production 4,967 2,584 1,402
Transportation 235 404 316
Marketing 7,910 17,418 22,270
Exploration costs 5,056 785 -
Depreciation, depletion and
Amortization 18,031 8,606 3,309
Impairment of assets 36,735 5,096 -
Administrative expenses 4,569 3,323 2,324
Other 107 138 206
---------- ---------- ----------
77,610 38,354 29,827
---------- ---------- ----------
Operating income (loss) (41,473) (322) 3,212
---------- ---------- ----------
Other income (expense):
Interest income 101 46 802
Interest expense (7,437) (2,747) (2,440)
Gain (loss) on sale of assets 236 (22) (175)
Other 3 6 152
---------- ---------- ----------
(7,097) (2,717) (1,661)
---------- ---------- ----------
Income (loss) before income
tax expense (benefit) (48,570) (3,039) 1,551
Income tax expense (benefit) (2,346) (1,192) 639
---------- ---------- ----------
Net income (loss) $ (46,224) $ (1,847) $ 912
Preferred dividends (49) (48) (70)
---------- ---------- ----------
Net income (loss) attributable
to common shares $ (46,273) $ (1,895) $ 842
========== ========= ==========
Per common share:
Basic $ (4.61) $ (0.21) $ 0.14
========== ========== ==========
Weighted average number of
common shares outstanding 10,029,415 9,021,810 6,123,635
========== ========== ==========
Diluted $ (4.61) $ (0.21) $ 0.13
========== ========== ==========
Weighted average number of
common shares and dilutive
potential common shares 10,029,415 9,021,810 6,895,446
========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
----------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1998
------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
8% PREFERRED STOCK COMMON STOCK
------------------------------- ---------------
NUMBER DISCOUNT NUMBER ADDITIONAL
OF PAR ON OF PAR PAID-IN RETAINED TREASURY
SHARES VALUE PREFERRED SHARES VALUE CAPITAL EARNINGS STOCK TOTAL
------ ----- ---------- ------ ----- ------- -------- ----- -----
<C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31, 1997 269 $3,226 $(1,044) 10,193,676 $102 $22,500 $553 $(713) $24,522
Conversion of
preferred stock
to common stock (38) (460) 149 38,335 - 311 - - -
Issuance of
common stock
dividend - - - 19,842 - 49 (49) - -
Net income - - - - - - (46,224) - (46,224)
--- ----- ---- ---------- --- ------ ------- ---- ------
Balance,
December 31,
1998 231 $2,766 $(895) 10,251,853 $102 $22,860 $(45,720) $(713) $21,702
=== ===== ==== ========== === ====== ======= ==== ======
</TABLE>
See accompanying notes to consolidated financial statements
F-6
AMERICAN RESOURCES OFFSHORE, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
8% PREFERRED STOCK COMMON STOCK
Number Discount Number Additional
of Par on Net of Par Convertible Paid-in Retained Treasury
Shares Value Preferred Value Shares Value Securities Capital Earnings Stock Total
------ ----- --------- ----- ------ ----- ---------- ------- -------- ----- -----
<C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31,
1996 268,851 $3,226 $(1,044) $2,182 6,520,296 $65 $4,998 $16,453 $2,537 $(52) $26,118
Issuance of
common stock
dividend on
8% preferred
stock - - - - 21,508 0 - 48 (48) - -
Conversion of
warrants to
common stock - - - - 8 0 - - - - -
Conversion of
convertible
securities and
dividend to
common stock - - - - 3,101,864 31 (4,520) 4,599 (79) - -
Redemption of
convertible
securities - - - - - - (478) (100) (11) - (589)
Common stock
issued, net of
placement costs - - - - 500,000 5 - 1,133 - - 1,133
Common stock
and options
issued for
professional
services - - - - 50,000 1 - 117 - - 117
Exercise of
Put Warrants - - - - - - - 250 - - 250
Treasury
stock
purchased - - - - - - - - - (661) (661)
Net income - - - - - - - - (1,846) - (1,846)
------- ----- ------ ----- ---------- --- ------ ------ ------ ---- ------
Balance,
December 31,
1997 268,851 $3,226$(1,044) $2,182 10,193,676 $102 - $22,500 $ 553 $(713) $24,522
======= ====== ====== ===== ========== === ====== ====== ====== ==== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
----------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1996
------------------------------------
(Dollars in thousands, except share data)
<TABLE>
6% JUNIOR
8% PREFERRED STOCK PREFERRED STOCK COMMON STOCK
------------------------------------- -----------------
Number Discount Number Number Additional
of Par on of Par of Par Convertible Paid-in Retained Treasury
Shares Value Preferred Shares Value Shares Value Securities Capital Earnings Stock Total
------ ----- --------- ------ ----- ------ ----- ---------- ------- -------- ----- -----
<C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31,
1995 268,851 $3,226 $2,182 117,000 $1 5,539,215 $55 $ - $14,608 $1,961 - $18,751
Conversion
of preferred
stock to
common stock - - - (58,941) - 224,822 2 - (10) - - (10)
Issuance of
common stock
dividend - - - - - 27,535 - - 70 (70) - -
Issuance of
common stock
and put warrants
in connection
with property
acquisition - - - - - 225,000 2 - 907 - - 907
Issuance of
common stock,
net of
placement
costs - - - - - 330,000 4 - 900 - - 900
Purchase and
retirement of
Series B
Preferred Stock - - - (58,059) (1) - - - (537) (266) - (803)
Purchase of
10,480 shares
of common stock
for treasury - - - - - - - - - - (52) (52)
Issuance of
convertible
securities,
net of issuance
cost - - - - - - - 4,998 - - - 4,998
Issuance of
common stock
in connection
with
convertible
securities - - - - - 173,724 2 - 540 - - 540
Stock
registration
costs - - - - - - - - (25) - - (25)
Net income - - - - - - - - - 912 - 912
------- ----- ----- ------- -- --------- -- ------ ------ ----- --- ------
Balance,
December 31,
1996 268,851 $3,226 $2,182 - - 6,520,296 $65 $4,998 $16,453 $2,537 $(52) $26,118
======= ===== ===== ======= == ========= == ====== ====== ===== === ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-8
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
<TABLE>
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating activities:
Net income (loss) $(46,224) $(1,847) $ 912
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation, depletion and
amortization 18,031 8,889 3,420
Impairment of assets 36,735 5,096 -
Exploration costs 5,056 785
Deferred income taxes (2,054) (1,242) 613
(Gain) loss on sale of assets (236) 22 175
Deferred revenue 723 (714) 3,590
Other 916 330 (173)
Change in operating assets and
liabilities:
Change in accounts receivable 310 1,822 (4,033)
Change in prepaid expenses and
other (376) 198 (148)
Change in accounts payable 6,199 (3,898) 2,128
Change in accrued expenses
and other 2,889 (11) (397)
-------- -------- ---------
Net cash provided by operating
activities $ 21,969 $ 9,430 $ 6,087
======== ======== ========
Investing activities:
Purchases of oil and gas properties (56,066) (9,699) (17,023)
Purchases of property and equipment (2,711) (669) (3,108)
Proceeds from sales of assets 2,390 4 550
Change in notes receivable 97 209 732
Investment in Common Stock of
Century Offshore - (2,500) -
Other - - (2)
-------- -------- --------
Net cash used in investing
activities $(56,290) $(12,655) $(18,851)
</TABLE>
(continued)
See accompanying notes to consolidated financial statements.
F-9
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
<TABLE>
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Financing activities:
Proceeds from borrowings from
related parties $ - $ - $ 250
Proceeds from other borrowings 40,773 11,902 17,612
Proceeds from sale of stock to
Den norske - 1,330 -
Payments on borrowings from
related parties - (490) (250)
Payments on other borrowings (6,334) (7,048) (10,869)
Increase in deferred financing
and convertible issuance costs (1,043) (195) (462)
Stock issuance and registration
costs - (197) -
Issuance of common shares, net - - 900
Issuance of convertible securities - - 6,000
Redemption of convertible securities - (589) -
Purchase of 6% Junior Preferred
Stock - - (803)
Purchase of treasury stock - (661) (53)
Other - - (35)
-------- -------- --------
Net cash provided by financing
Activities $33,396 $4,052 $12,290
-------- -------- --------
Increase (decrease) in cash (925) 827 (474)
Cash and cash equivalents at
beginning of year 1,180 353 827
-------- -------- --------
Cash and cash equivalents at
end of year $ 255 $1,180 $ 353
======== ======== ========
</TABLE>
NON-CASH TRANSACTIONS:
During 1998, the Company expanded its holdings in the Gulf by
acquiring properties from TECO for $57.7 million. TECO agreed to
seller-finance $18.5 million of the purchase price in the form of
a promissory note (see Note 2).
During 1997, holders of $5,538,483 of the Convertible Securities
converted the securities into 3,052,188 shares of Common Stock
and received 49,676 shares of Common Stock dividends related to
the Convertible Securities. The remaining $461,517 was redeemed
by the Company for a price of $589,023.
During 1997, the Company entered into an Amendment to Lead
Generation Agreement with Corporate Relations Group (CRG) to
provide additional services in the public relations area. The
amendment provided for the termination of options previously
granted to CRG by ARO and the issuance to CRG of 50,000 shares of
registered stock in ARO. The shares were valued at $1.94 per
share which represents the closing bid price on April 21, 1997,
the date of the amendment.
During 1996, in connection with the acquisition of certain gas
properties and related equipment, the Company issued 225,000
shares of common stock and 225,000 common stock put warrants with
a combined value of $1,157,175 ($907,175 net of placement costs).
The Company also paid cash and assumed certain obligations in
connection with the acquisition, which was consummated on
February 26, 1996 (see Note 2).
In connection with the acquisition of certain gas properties, in
July 1996 the Company extinguished a $6.5 million note receivable
as partial consideration.
(continued)
See accompanying notes to consolidated financial statements.
F-10
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
The Company acquired 58,059 shares of the outstanding 6% Junior
Preferred Stock for $802,900 during 1996. Upon resolution of the
Board of Directors, the shares were retired.
The Company declared stock dividends and issued 19,842, 21,508
and 27,535 shares of common stock to holders of the Series 1993
and Series B Preferred Stock during 1998, 1997 and 1996,
respectively.
During 1996, 58,941 shares of Series B Preferred Stock were
converted into a total of 224,822 shares of common stock.
During 1996, in connection with the issuance of 4% convertible
securities in the aggregate principal amount of $6,000,000, the
Company issued 173,724 shares of common stock at an average value
of $3.11 per share as partial consideration for placement fees.
See accompanying notes to consolidated financial statements.
F-11
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
DECEMBER 31, 1998, 1997 AND 1996
--------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) GENERAL
American Resources Offshore, Inc. (ARO), (formerly
known as American Resources of Delaware, Inc.), a
Delaware corporation organized on August 14, 1992, was
formed to acquire the assets and assume certain
liabilities of Standard Oil and Exploration of
Delaware, Inc. (SOE) pursuant to SOE's Chapter 11
Bankruptcy Joint Plan of Reorganization which was
consummated effective April 22, 1993.
ARO and its wholly-owned subsidiary, Southern Gas Co.
of Delaware, Inc. (Southern Gas), are involved in the
production, gathering, purchasing, processing,
transporting and selling of natural gas primarily in
the Gulf Coast Region and the State of Kentucky. These
activities are considered to be one business segment
for financial reporting purposes.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the
accounts of ARO and its Subsidiary, collectively
referred to as the Company. All significant
intercompany balances and transactions have been
eliminated in consolidation.
Certain reclassifications have been made to prior year
financial statements to conform with the current year
presentation.
(C) CASH EQUIVALENTS
For purposes of the statement of cash flows, the
Company considers any liquid investments with an
original maturity of three months or less when
purchased as a cash equivalent.
(D) OIL AND GAS PROPERTIES
The Company uses the successful efforts method of
accounting for its oil and gas operations. The costs
of unproved leaseholds are capitalized pending the
results of exploration efforts. Significant unproved
leasehold costs are assessed periodically, on a
property-by-property basis, and a loss is recognized to
the extent, if any, that the cost of the property has
been impaired. The costs of individually insignificant
unproved leaseholds estimated to be nonproductive are
amortized over estimated holding periods based on
historical experience. As of January 1, 1996, the
Company began assessing the impairment of capitalized
costs of proved oil and gas properties and other long-
lived assets in accordance with Statement of Financial
Accounting Standards No. 121 (SFAS No. 121),
"Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of." Under this
method, the Company generally assesses its oil and gas
properties on a depletable unit basis utilizing its
current estimate of future revenues and operating
expenses. In the event net undiscounted cash flow is
less than the carrying value, an impairment loss is
recorded based on estimated fair value, which would
consider discounted future net cash flows. Impairments
of oil and gas properties held for sale is included in
the balance sheet as accumulated depreciation.
Depletion and amortization
(Continued)
F-12
and impairments of operating assets are included in the
balance sheet as adjustments to the oil and gas
properties asset account. Exploratory dry holes and
geological and geophysical charges on exploratory
projects are expensed. Depletion of proved leaseholds
and amortization and depreciation of the costs of all
development and successful exploratory drilling are
provided by the unit-of-production method based upon
estimates of proved and proved-developed oil and gas
reserves, respectively, for each property. The
estimated costs of dismantling and abandoning offshore
site remediation and significant onshore facilities are
provided currently using the unit-of-production method;
such costs for other onshore facilities are
insignificant and are expensed as incurred.
Significant changes in the various estimates discussed
above could affect the financial position and results
of operations of the Company.
On sale of an entire interest in an unproved property
for cash or cash equivalent, gain or loss on the sale
is recognized, taking into consideration the amount of
any recorded impairment if the property had been
assessed individually. If a partial interest in the
unproved property is sold, the amount received is
treated as a reduction of the cost of the interest
retained.
(E) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost.
Expenditures representing additions or improvements are
capitalized. Maintenance and repairs are charged to
expense as incurred. Upon retirement or disposition,
costs and accumulated depreciation are removed from the
accounts and the resulting gain or loss is recognized
in income.
Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of
the assets.
ESTIMATED
USEFUL LIVES
(YEARS)
------
Pipeline support facilities 7-15
Field equipment 7
Other 3-7
(F) GAS MARKETING ACTIVITIES
In the conduct of its marketing activities, the Company
enters into both long-term and short-term contracts to
purchase and/or sell at a future date specified
quantities of products at specified prices. Settlement
of such contracts may occur through the purchase, sale
and/or exchange of products in the open market or from
production. Resulting gains or losses, if any, are
recorded in the month of delivery. During 1995, the
Company entered into an exclusive marketing arrangement
with Southern Resources, Inc. (SRI), a third party
company, wherein the Company was the exclusive supplier
of all natural gas to be sold by SRI. Under the
agreement, after deduction of certain expenses, the
Company was entitled to receive not less than 50% of
the sales margin obtained. Included in the statements
of operations for the first four months of
(Continued)
F-13
1997 is the Company's 50% participation in SRI's
marketing revenues and expenses. The marketing
arrangement with SRI was terminated in May 1997.
(G) DRILLING REVENUES
At times, the Company performs drilling and completion
services for drilling programs, primarily under turnkey
drilling contracts in which it utilizes third party
contract drillers. Revenue is recognized upon the
completion of the initial producing zone.
(H) PIPELINE TRANSPORTATION REVENUE
Revenue from the transportation of gas is recognized on
the accrual basis as products are transported.
(I) DEFERRED FINANCING COSTS
In connection with obtaining credit facilities, the
Company has capitalized third party costs directly
associated with the closing thereof. The costs are
being amortized over the period of the credit
facilities. For the years ended December 31, 1998,
1997 and 1996, approximately $338,000, $96,000 and
$101,000, respectively, have been amortized to expense
in connection with these costs.
(J) INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Investments in companies which the Company has less
than a 20% interest are carried at cost less
impairment, if any. Dividends received are included in
other income. Dividends received in excess of the
Company's proportionate share of earnings are applied
as a reduction of the cost of the investment.
Investments in companies which the Company has a 20% to
50% interest are carried at cost, adjusted for the
Company's proportionate share of their undistributed
earnings or losses. Earnings or losses are included in
other income.
(K) INCOME TAXES
The Company follows the asset and liability method of
accounting for income taxes. Under this method,
deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences
between the financial statement carrying amounts of
existing assets and liabilities and their respective
tax basis and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary
differences are expected to be recovered or settled.
Under the asset and liability method, the effect on
deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that
includes the enactment date.
(L) STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," (Statement
No. 123) encourages, but does not require
(Continued)
F-14
companies to record compensation cost for stock-based
employee compensation plans at fair value. The Company
has elected to continue to account for stock-based
compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," (APB
Opinion 25) and related interpretations. Accordingly,
compensation cost for stock options issued to employees
and directors is measured as the excess, if any, of the
quoted market price of the Company's stock at the date
of grant over the amount an employee must pay to
acquire the stock.
(M) EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings per Share" (SFAS No. 128)
in 1997. This statement establishes standards for
computing and presenting earnings per share and
requires, among other things, dual presentation of
basic and diluted earnings per share on the face of the
statement of operations.
The following table provides a reconciliation between
basic and diluted earnings (loss) per share:
WEIGHTED
AVERAGE
COMMON PER
NET INCOME SHARES SHARE
(LOSS) OUTSTANDING AMOUNT*
------ ----------- -------
(THOUSANDS EXCEPT SHARE AMOUNTS)
Year Ended December 31, 1998:
Basic (loss) per share $(46,224) 10,029,415 $(4.61)
Diluted (loss) per share $(46,224) 10,029,415 $(4.61)
======= ==========
Year Ended December 31, 1997:
Basic (loss) per share $ (1,847) 9,021,810 $(0.21)
Diluted (loss) per share $ (1,847) 9,021,810 $(0.21)
======= =========
Year Ended December 31, 1996:
Basic earnings per share $ 912 6,123,635 $ 0.14
Effect of dilutive potential
common shares 771,811
------- ---------
Diluted earnings per share $ 912 6,895,446 $ 0.13
======= =========
*Adjusted for preferred stock dividends of $49,383,
$47,647 and $70,174 for 1998, 1997 and 1996,
respectively.
At December 31, 1998 and 1997, the stock options,
warrants and Convertible Preferred Stock were not
included in the computation of diluted loss per share
because the effect of their assumed exercise and
conversion would have an antidilutive effect on the
computation of diluted loss per share.
At December 31, 1996, the Convertible Preferred Stock
was not included in the computation of diluted earnings
per share because the effect of its assumed exercise
and conversion would have an antidilutive effect on the
computation of diluted earnings per share.
(Continued)
F-15
(N) USE OF ESTIMATES
Management of the Company has made a number of
estimates and assumptions relating to the reporting of
assets and liabilities and disclosure of contingent
assets and liabilities to prepare these consolidated
financial statements in conformity with generally
accepted accounting principles. Actual results could
differ from the estimates.
(2) TECO ACQUISITION
On March 5, 1998, the Company purchased interests in 43
leaseblocks in the Gulf of Mexico from TECO Oil & Gas, Inc.
(TECO). The purchase consisted of an average 30% interest
in approximately 198,300 acres containing 5 producing wells
and approximately $35 million PV10 of estimated proved
reserves as of December 31, 1997; partnership interests in
Louisiana Offshore Ventures and Texas 3D Ventures and access
to approximately 12,500 square miles of 3-D seismic data.
Louisiana Offshore Ventures and Texas 3D Ventures are
exploration and development partnerships managed by Houston
Energy Development (HED). HED has specialized in 3-D
seismic evaluation and prospect selection for over ten years
and provides the Company with access to 14 additional
geoscientists and 13 state of the art 3-D seismic
workstations. The Company believes that the TECO
acquisition provides ample opportunity to increase reserves,
production and cash flow from development and exploration
activities and, with HED, has identified numerous drilling
locations on the acquired properties.
As consideration for the properties, the Company paid $57.7
million, of which $1.3 million was paid in cash upon
execution of the Purchase and Sale Agreement, $21.4 million
was paid from funds borrowed under the Company's credit
facility, and $16.5 million was paid from funds borrowed
under bridge loans provided by DNB Energy Assets, Inc.
(DNB), successor to Den norske Bank, AS (Den norske), $1.5
million of which was due July 1, 1998, with the remainder
due September 30, 1998. The balance of $18,500,000 was in
the form of a promissory note in favor of TECO (TECO Note).
The bridge loans from DNB were amended to extend the
maturity date to December 31, 1998. DNB also amended the
interest rate to either the prime rate plus 1% or the LIBOR
plus 4%.
The TECO Note currently bears interest at the rate of 16%
per annum and increases 2% each quarter hereafter, with a
maximum interest rate of 18% beginning April 1, 1999. The
TECO Note matured on October 1, 1998 and is secured by a
lien on all properties of the Company and its subsidiaries;
however, the lien is second and inferior to the lien of DNB.
Additionally, pursuant to the terms of a warrant agreement
entered into between the parties relative to the TECO Note,
TECO has been vested with the rights to acquire 600,000
shares of ARO's common stock at $2.67 per share, plus
additional common stock in ARO equal to fifteen (15%)
percent of ARO's issued and outstanding common stock and
options or rights to purchase common stock for $0.00001 per
share, together with the right to appoint two members to
ARO's Board of Directors. TECO has not taken any action to
exercise its warrant rights or make any appointments to
ARO's Board at this time; however, TECO has not waived any
of its rights. TECO has filed a Schedule 13-D and Form 3
with the Securities and Exchange Commission ("SEC")
regarding such rights. TECO's rights to acquire fifteen
(15%) percent of ARO's issued and outstanding common stock
and options or
F-16 (Continued)
rights to purchase common stock will increase to twenty
(20%) percent if the TECO Note is not paid in full by April
1, 1999.
Assuming the acquisition had occurred on January 1, 1997,
the following unaudited proforma operating data gives effect
to the acquisition for the years ended December 31, 1998 and
1997:
December 31, December 31,
1998 1997
---- ----
Total revenue $ 37,143 $44,669
======== ========
Net (loss) from operations $(41,150) $(3,745)
======== =======
Basic and diluted (loss) per share $ (4.61) $ (.42)
======= =======
Basic and diluted earnings per share are based on 10,029,415
and 9,021,810 shares outstanding for December 31, 1998 and
1997, respectively.
(3) PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
(Dollars in thousands)
1998 1997
---- ----
Pipeline support facilities $10,547 $ 8,190
Field equipment 3,460 3,714
Other 638 449
------- -------
$14,645 $12,353
======= =======
For the years ended December 31, 1998, 1997 and 1996,
depreciation expense on property and equipment was
$1.1million, $1million and $878,000, respectively.
(4) OIL AND GAS PROPERTIES
A summary of oil and gas properties follows:
1998 1997
---- ----
(Dollars in thousands)
Proved properties - Developed - Gulf $29,168 $26,392
Proved properties - Undeveloped - Gulf 8,590 4,193
Unproved properties - Gulf 35,901 5,326
Proved properties - Developed -
Appalachian 21,944 18,704
Unproved properties - Appalachian 2,558 2,558
------ ------
$98,161 $57,173
====== ======
In February 1997, the Company through its wholly owned
subsidiary, Southern Gas, acquired a 25% working interest in
onshore Gulf Coast undeveloped properties located in Greene
and Wayne Counties, Mississippi, for approximately $300,000.
F-17 (Continued)
On April 2, 1997, the Company entered into an agreement to
acquire a 26.4% working interest in the Main Pass Block 53
from Great River Oil & Gas Corporation for approximately
$254,000. Drilling was completed during the third quarter
of 1997, and it was determined that the well is not
economically feasible.
In April 1997, the Company purchased from a director of the
Company an overriding royalty interest in the Ship Shoal B-3
well for $150,000 and also purchased from an
officer/director of the Company an overriding royalty
interest in the Ship Shoal B-4 well for $180,000.
In June 1997, the Company entered into a purchase agreement
to acquire interests in 26 natural gas wells from Daugherty
Petroleum, Inc., said wells being located in Whitley and
Knox Counties, Kentucky, on the Company's existing gathering
facilities. The wells contain an estimated 1.5 billion
cubic feet of natural gas reserves net to the Company, and
the purchase price was approximately $526,000. The purchase
transaction was completed in September 1997.
On September 15, 1997, the Company entered into a Letter of
Intent with Prima Capital, LLC (Prima) providing for the
acquisition of an interest in producing and non-producing
oil and gas properties located in Mississippi. (See Note
15.)
In September 1997, the Company purchased a 4.3% overriding
royalty interest in the Ship Shoal B-4 well for $330,000.
The value of the overriding royalty interest was based on
discounted reserve values as determined from the December
31, 1996 reserve report less amounts paid through June 1997.
On December 16, 1997, the Company entered into a Purchase
and Sale Agreement to acquire proved developed and
undeveloped oil and gas properties, platforms, equipment and
pipelines located offshore Louisiana on Ship Shoal Block
222, Ship Shoal Block 225 and West Cameron Block 368 from
K.E. Resources, Ltd. The purchase price was $2.5 million,
which was funded from the Company's line of credit with DNB.
The transaction was completed and funded on December 19,
1997.
On December 22, 1997, the Company entered into a Purchase
and Sale Agreement to acquire additional interests in the
properties located on West Cameron Block 368 from Apache
Corporation pursuant to a preferential right of first
refusal election. The purchase was $127,000, which was
funded from the Company's line of credit with DNB. This
transaction closed on January 5, 1998.
During the first quarter of 1998, the Company participated
in the drilling of a well on Galveston Block 213, a property
purchased in the TECO acquisition. The well commenced
production on May 28, 1998 and is currently producing at a
rate of approximately 10 million cubic feet equivalent of
gas (MMcfe) per day. The Company owns a 33.3% working
interest in the well which is being operated by Basin
Exploration, Inc.
On May 6, 1998, the Company entered into a Participation
Agreement to acquire 16.67% working interest in High Island
Block 105, offshore Texas. The well encountered natural gas
accumulation in the objective reservoir and was subsequently
cased and perforated for production. Attempted completion
operations were unsuccessful in sustaining production
because of reduced reservoir pressures. The
F-18 (Continued)
Company believes that production could be established in
this well utilizing stimulation and available compression
facilities on the platform.
In June 1998, the Company participated in the drilling of a
successful well on West Cameron Block 368 on which the
Company had existing production. The well was completed and
began producing during the fourth quarter of 1998. During
the third quarter of 1998, the Company completed an exchange
of working interest ownership with Century Offshore
Management Corporation that provides for the Company to
increase its working interest to 95% on a portion of West
Cameron Block 368 covering approximately 1,170 acres.
During the second quarter of 1998, the Company participated
in the drilling of a successful exploratory well on West
Cameron Block 172, a property purchased in the TECO
acquisition. The OCS G1998 #16ST well was drilled and
completed with an initial test rate of 11 MMcf of gas and
200 barrels of condensate per day. A
development/acceleration well, the OCS G1998 #18 well, was
drilled in the same fault block and encountered gas pay in
two additional reservoirs. The #18 well was also completed
and tested at an initial rate of 10.2 MMcf of gas and 90
barrels of condensate per day. Design and construction of a
platform and facilities for development of this discovery
were completed in December 1998. The Company's working
interest in the #16ST and #18 wells is 28.72% and 27%,
respectively. Additionally, the #19 well was drilled during
the first quarter of 1999. However, during the first
quarter of 1999, ARO was named a co-defendant in litigation
filed by the operator of High Island Block 105 seeking
approximately $600,000 for expenses incurred in the drilling
of a well. On March 10, 1999, ARO settled this litigation by
agreeing to convey its interest in the #19 well to the co-
defendant in exchange for approximately $600,000 and a 25%
reversionary interest after payout. Those proceeds were
utilized by ARO to settle this litigation. At the time of
this settlement, ARO was in default on its obligation to
advance an additional $733,752 for completion cost of the
#19 well and did not have the capital to make this advance.
As ARO would have been caused to non-consent this operation,
it agreed to convey its interest to the co-defendant, who
paid the completion costs.
During the first quarter of 1998, the Company entered into
an agreement with J. M. Huber Corporation (Huber) for the
development of Grand Isle Block 55, offshore Louisiana,
wherein two wells were to be drilled. During the drilling
of the initial well, reserves were encountered; however,
control of the well was lost necessitating the well to be
shut in and a sidetrack well to be initiated. The
additional costs of the re-drill as well as the cost of the
material and equipment lost in the original well, estimated
to be approximately $3.7 million, was reimbursable by the
Company's insurance program, less deductibles totaling
$300,000. During the third quarter of 1998, the Company
successfully completed the side track well and an additional
well from the A Platform on Grand Isle Block 55. Initial
production commenced in September 1998 at the rate of
approximately 1,500 barrels of oil per day. Huber did not
assign an ownership interest in the well to the Company
based upon Huber's interpretation of the participation
agreement that all trade creditors must be paid in full
prior to any such assignment. As of December 31, 1998, the
Company had trade payables of approximately $12 million in
association with the drilling of these wells. During the
first quarter of 1999, the Company settled the trade
payables by surrendering its interest in the Grand Isle
Block 55 wells to Huber. The financial statements for the
year ended December 31, 1998, do not reflect the operating
results relating to the production from the Huber well. The
settlement with Huber generated an impairment of
approximately $1.4 million which is reflected in the
financial statements for the
F-19 (Continued)
year ended December 31, 1998. The impairment represents the
net cash expenditures made by the Company for the Grand Isle
Block 55 well in which the Company does not have an
ownership interest.
For the years ended December 31, 1998, 1997 and 1996,
depletion expense on oil and gas properties was $14,586,951,
$7,594,523 and $2,431,633, respectively, or $1.25, $1.05 and
$0.80 per Mcf equivalent.
During 1998, ARO recorded an impairment of oil and gas
properties of $34.7 million compared with $5 million during
1997. The impairment includes an $8.2 million write down of
ARO's Appalachian properties based on its current efforts to
sell the Kentucky division of ARO. The Appalachian
impairment allowance is included in ARO's accumulated
depreciation, depletion and amortization. The impairment
also includes a $22.5 million write down of the TECO
properties. The write down was primarily the result of a
significant decline in the production on several of the TECO
wells coupled with a substantial decline in oil and gas
prices in 1998. Also included was an additional $4 million
impairment on other oil and gas properties. In addition to
the impairments of oil and gas properties, ARO also
recognized a $2 million impairment on its holding of Century
stock (see Notes 8 and 9).
In 1997, the Company recorded an impairment of $1.6 million
related to its Michigan properties and a $2 million
impairment related to oil and gas properties.
(5) LONG-TERM DEBT
A summary of long-term debt follows:
December 31, December 31,
1998 1997
---- ----
(Dollars in thousands)
Borrowings under the Company's
credit facility, as amended,
with DNB, reduction subject to
availability under borrowing base,
$48,173,000 available borrowing
base as of December 31, 1998,
monthly reduction against the
available borrowing base of $750,000
commencing January 1, 1999, interest
payable monthly at the Floating
Rate, or LIBO Rate plus 2 1/2%,
secured by substantially all of the
Company's oil and gas properties,
equipment and receivables. $48,173 28,700
Term Loan A, as amended, payable to
DNB, due December 31, 1998, with
interest payable monthly at the
Floating Rate plus 1%, or LIBO
Rate plus 4% per annum, secured
by substantially all of the
Company's oil and gas properties. 15,000 -
F-20 (Continued)
December 31, December 31,
1998 1997
---- ----
(Dollars in thousands)
Term Loan B payable to DNB, due
December 31, 1998, with interest
payable monthly at the Floating
Rate plus 1%, or LIBO Rate plus
4% per annum, secured by substantially
all of the Company's oil and
gas properties. 550 -
Note payable to TECO, with interest
at 14% per annum, increasing 2%
each quarter the note remains
unpaid, with a maximum rate of
18%, due October 1, 1998. 18,500 -
Note payable to related party,
recourse only to specific properties,
interest payable at prime rate plus
1% in connection with the purchase
of oil and gas properties from
Prima Capital, LLC. 987 1,500
Other notes 29 100
------- -------
83,239 30,300
Less - Current portion (64,033) (4,907)
Less - Debt in default (18,500) -
------- -------
Long-term debt $ 706 $25,393
======= =======
On September 28, 1995, the Company entered into a $20
million revolving credit facility through February 1, 2002
with Den norske. By November 1, 1997, the revolving credit
facility had been increased to $75 million and the available
borrowing base was increased to $30 million. On March 5,
1998, the borrowing base under the revolving credit facility
was assigned to DNB and increased to $50 million to
facilitate the purchase of oil and gas properties from TECO.
As of December 31, 1998, the balance due under the revolving
credit facility was $48,173,000. Additional borrowings
under the credit facility are dependent upon a
redetermination of the borrowing base, which is primarily
dependent upon the value of the mortgaged properties as
determined under DNB's internal lending procedures.
Reductions of the credit facility are also dependent upon
the borrowing base. Commencing January 1, 1999, monthly
principal reductions are $750,000. The borrowing base will
be redetermined semi-annually on each October 1st and April
1st prior to February 1, 2002.
On March 5, 1998, DNB also provided bridge loans totaling
$16 million in order for the Company to complete the
acquisition of the TECO properties. The bridge loans, as
amended, matured on December 31, 1998. DNB has not yet
demanded payment nor has it agreed to extend the terms of
the bridge loans.
Under the credit agreement with DNB, the Company is required
to maintain certain financial ratios relating to debt
coverage ratio, current ratio, tangible net worth, general
and administrative expenses and quarterly interest ratio.
At December 31, 1998, the
F-21 (Continued)
Company was not in compliance with all of the required
financial ratios; however, DNB agreed to temporarily waive
the compliance requirements at year-end 1998. Additionally,
at December 31, 1998, the Company was not in compliance with
other required financial covenants in the credit agreement;
and the Company has also not made the monthly principal
reductions required in 1999. Therefore, this debt is
classified as current in the accompanying balance sheets.
Also in order to complete the acquisition of the TECO
properties, on March 5, 1998, the Company executed a note
in favor of TECO in the amount of $18.5 million (see Note
2). The TECO Note matured on October 1, 1998; and by letter
dated October 2, 1998, TECO declared the Company in default.
However, TECO is a party to an agreement between the Company
and DNB which substantially limits TECO's remedies against
the Company unless the Bank is paid in full or declares a
default and takes affirmative action against the Company.
Additionally, pursuant to the terms of a warrant agreement
entered into between the parties relative to the TECO Note,
TECO has been vested with the rights to acquire 600,000
shares of ARO's common stock at $2.67 per share, plus
additional common stock in ARO equal to fifteen (15%)
percent of ARO's issued and outstanding common stock and
options or rights to purchase common stock for $0.00001 per
share, together with the right to appoint two members to
ARO's Board of Directors. TECO has not taken any action to
exercise its warrant rights or make any appointments to
ARO's Board at this time; however, TECO has not waived any
of its rights. TECO has filed a Schedule 13-D and Form 3
with the SEC regarding such rights. TECO's rights to
acquire fifteen (15%) percent of ARO's issued and
outstanding common stock and options or rights to purchase
common stock will increase to twenty (20%) percent if the
TECO Note is not paid in full by April 1, 1999.
(6) CONVERTIBLE SECURITIES PRIVATE PLACEMENT
In 1996, the Company privately placed 4% convertible
securities in the aggregate principal amount of $6,000,000
($4,997,554 net of placement costs) with a required
conversion of one year from date of issuance. The
securities were convertible at the option of the holders
into shares of common stock valued at the lesser of (1) the
closing bid price of the common stock as reported on NASDAQ
on the date of issuance of the security, or (2) 75% of the
average closing bid prices of the common stock as reported
on NASDAQ for the five trading days prior to the date of
conversion (the Conversion Price). As of June 9, 1997,
securities totaling $5,538,483 had been converted into
3,101,864 shares of common stock inclusive of 4% dividend
shares paid as of the date of conversion, and the remaining
$461,517 had been redeemed by the Company pursuant to its
rights under the security documents. The Company was not
required to pay any liquidated damages or additional
interest as a result of the conversion or redemption of the
securities.
The shares of common stock into which the securities were
convertible were registered under an S-3 Registration
Statement which was effective on January 23, 1997.
(7) INDEPENDENT CONTRACTOR AGREEMENTS
On November 27, 1996, the Company entered into a five year
corporate relations agreement with Corporate Relations
Group, Inc. (CRG), Winter Park, Florida, to assist the
Company with its shareholder relations. As consideration
for the agreement, the Company paid CRG $550,000 cash and
granted CRG a one year option to purchase 100,000 shares of
common stock for $3.00 per share, a two year option to
purchase
F-22 (Continued)
100,000 shares of common stock for $3.60 per share, a three
year option to purchase 100,000 shares of common stock for
$4.20 per share, a five year option to purchase 100,000
shares of common stock for $4.80 per share, and a five year
option to purchase 100,000 shares of common stock for $6.00
per share. The options had a fair value of approximately
$1.27 per share. On April 21, 1997, the Company entered
into an Amendment to Lead Generation Agreement with CRG to
provide additional services in the public relations area.
The Amendment also provided for the immediate termination of
the 500,000 options previously granted to CRG by the Company
and the issuance to CRG of 50,000 shares of registered stock
in the Company. The shares were valued at $1.94 per share
which represents the closing bid price on April 21, 1997.
The cost was amortized during 1997 due to the timing of the
services being performed.
(8) CENTURY/SETTLE TRANSACTIONS
Under a letter agreement dated October 17, 1994, the Company
had the right to acquire a 10% equity interest in Settle Oil
and Gas Company (Settle) for $4,000,000 (the Settle
Securities). Due to the fact that the Company was not in a
position to acquire this equity interest, the Agreement was
subsequently amended to permit a third party to acquire the
Settle Securities for $2.5 million. The funds used to effect
the foregoing acquisition were borrowed by the third party
from Prima, a limited liability company of which an
officer/director of the Company is a member. The third
party is also a member of Prima and the principal
stockholder of Southern Resources, Inc. Prima, in turn,
borrowed the funds it used to provide the foregoing loan
from a bank in Lexington, Kentucky. In connection with this
transaction, the Company entered into a Put Agreement with
Prima, dated March 15, 1995, which provided that, in the
event Prima obtained title to the Settle Securities, Prima
had the right to require the Company to purchase the Settle
Securities for $4,000,000 (the Prima Put) payable in cash
and common stock.
On July 21, 1995, a reorganization plan was approved by the
Bankruptcy Court and resulted in the merger of Settle into
Century Offshore Management Corporation (Century). Any and
all references to Settle subsequent to July 21, 1995, refer
to the merged entity which retained the name of Century.
The Put Agreement with Prima was terminated in July 1995,
and a new agreement, as amended, providing for the Company's
ability to call the Century Securities from the third party
member of Prima for $4,000,000 was substituted therefor (the
Call Agreement). The Call Agreement also provided for non-
refundable monthly installments of $31,250 (as originally
required under the Put Agreement) until such time as a total
of $1,000,000 was advanced under the Call Agreement
(including payments previously made under the Put
Agreement). In the event the Company elected to call the
Century Securities, the advance payments would be credited
toward the purchase price. Additionally, a $500,000
certificate of deposit held as collateral for Prima's loan
was liquidated by the Company and the funds were advanced to
Prima under the potential Call Agreement. Prima used the
$500,000 to purchase shares of Series B Preferred Stock from
a third party, which Preferred Stock it subsequently
converted to common stock. In the event the Company
exercised the Call option, the $500,000 would be credited
towards the purchase. The Company's right to call the
Settle Securities began January 15, 1997 and ended December
31, 1997.
F-23 (Continued)
On November 4, 1997, the Board of Directors approved the
exercise of the Company's rights under the Call Agreement;
and all funds due pursuant thereto had been paid on or
before December 31, 1997. The investment is reported on the
Balance Sheet in "Other Assets: Investment in Unconsolidated
Subsidiaries." See Note 9 regarding impairment of this
asset.
On July 3, 1995, the Company made an unsecured working
capital loan to Settle in the amount of $900,000. At
December 31, 1996, the outstanding balance on the loan was
$183,053. The loan bore interest at the rate of 10% per
annum and was payable in 21 equal monthly installments of
$46,894 commencing on July 31, 1995, and on the last day of
each month thereafter until paid in full. The note was paid
in full during 1997.
(9) INVESTMENT IN UNCONSOLIDATED SUBSIDIARIES
On December 30, 1994, the Company invested in the formation
of a new Limited Liability Company (the LLC) whose purpose
was to perform contract drilling services for the Company
and third parties. The LLC was capitalized at $250,000 with
the Company providing $110,000 for a 44% ownership. Century
and certain of Century's officers and directors were also
members of the LLC, with a combined ownership interest of
45%. In October 1997, the operating committee voted to
liquidate the LLC. As of December 31, 1998, the remaining
investment is $47,451. During 1998 and 1997, the Company
recognized losses of $0 and $234,409, respectively.
In 1997, the Company acquired 2,471.3 shares of the common
stock of Century under the Call Agreement (see Note 8) for
$4 million. Due to the subsequent decline in oil and gas
prices, the Company determined there was an other than
temporary decline in the carrying value of the Century
common stock. In 1998 and 1997, the Company recorded
impairments of $2.0 million and $1.5 million, respectively,
to its investment in Century, resulting in a net book value
of $.5 million and $2.5 million, respectively. The
impairment of the Century stock was determined by comparing
the carrying value of the stock on the Company's books,
after the exercise of the Century "Call Agreement," to the
estimated fair value of the stock based on the most recent
sale activity.
(10) UNEARNED REVENUE
On May 22, 1996, the Company conveyed an approximate 2.2
billion cubic feet (Bcf) volumetric production payment in
Appalachian wells recently purchased from AKS through a
facility sponsored by William Energy Services Company, a
subsidiary of the Williams Companies, Inc. and structured by
NationsBank. The Company received $4,300,000 ($4,147,300
after related costs) for the production payment, which has
an anticipated six year term. Of the funds received,
$2,500,000 was used to reduce the Company's credit facility
with its primary lender. The Company used the remainder of
the funds for working capital and further acquisition and
development activities in the Gulf Coast Region.
As a result of the transaction, the Company has recorded
unearned revenue which is being recognized as the required
volumes are delivered under the production payment
conveyance.
ARO sells all of its current Gulf Coast Region gas
production through H&N Gas, Ltd. ARO utilizes forward sales
contracts for a significant portion of its Gulf Coast Region
gas production to achieve more predictable cash flows and to
reduce the effect of
F-24 (Continued)
fluctuations in gas prices. During 1998, ARO's Gulf Coast
Region production averaged 28.8 MMcfe per day. At March 15,
1999, ARO had forward sales arrangements through August 1999
with respect to 20 MMcfe per day at an average price of
$1.86 per thousand cubic feet ("Mcf"). During 1998, ARO
sold call options for 20 MMcfe per day at a call price of
$2.70 per Mcf, which expire in March 2000. In exchange for
establishing a ceiling of $2.70 per Mcf over the option
term, ARO received an average option premium of $0.14 per
Mcf on the volumes contracted for under the call option
agreement. These contracts were terminated in January 1999
at a profit of $680,114. ARO continuously reevaluates its
sales contracts in light of market conditions, commodity
price forecasts, capital spending plans and debt service
requirements.
(11) INCOME TAXES
The provision (benefit) for income taxes for the years ended
December 31, 1998, 1997 and 1996 is summarized as follows:
1998 1997 1996
---- ---- ----
(Dollars in thousands)
Current tax expense $ 1 $ 49 $ 26
====== ======== =====
Deferred tax (benefit) $(292) $(1,242) $613
===== ======= ====
The Company's effective tax benefit (5%) in 1998 is less
than the effective tax rate because of changes to its
valuation allowance for deferred tax assets. The Company's
effective tax benefit (39%) in 1997 and effective tax rate
(41%) in 1996 are different from the U.S. federal income tax
rate of 34% primarily because of state income taxes.
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred
tax liabilities at December 31, 1998 and 1997 are presented
as follows:
1998 1997
---- ----
(Dollars in thousands)
Deferred tax assets:
Net operating loss carryforwards $6,970 $2,425
Basis differences in oil and
gas properties 11,978 -
Basis differences in
unconsolidated investee 1,400 600
Allowance for doubtful accounts 298 110
Other 17 50
------- ------
Total gross deferred tax assets 20,663 3,185
Less - Valuation allowance (19,239) (638)
------- ------
Net deferred tax assets 1,424 2,547
F-25 (Continued)
Deferred tax liabilities:
Basis differences in oil
and gas properties $ - $ 3,226
Basis differences in property
and equipment 1,308 1,371
Other 116 4
------- -------
Deferred tax liabilities 1,424 4,601
------- -------
Net deferred tax asset (liability) $ 0 $(2,054)
======= =======
Current deferred tax asset $ 298 $ 112
======= ======
Non-current deferred tax liability $ 298 $2,166
======= ======
In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that
some portion or all of the deferred tax assets will not be
realized. The Company has established a valuation allowance
for such deferred tax assets to the extent such amounts are
not likely to be utilized to offset existing deferred tax
liabilities reversing in the same period.
At December 31, 1998, the Company had approximately $34.7
million and $35.5 million of net operating loss (NOL)
carryforwards available to offset future taxable income for
federal and state purposes, respectively. The carryforwards
expire from 1999 to 2018.
The Tax Reform Act of 1986 significantly limits the amount
of NOL available to offset future taxable income when a
change of ownership occurs. Such a limitation of the NOL in
a given year could prevent the Company from realizing the
full benefit of the NOL within the 15 year statutory limit.
The Company had one change in ownership prior to 1997. The
Company believes that the limitations, if any, would not
have a significant impact on the consolidated financial
statements.
(12) FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and
estimated fair values of the Company's financial instruments
at December 31, 1998. Financial Accounting Standards Board
Statement No. 107 (FASB No. 107), "Disclosures About Fair
Value of Financial Instruments," defines the fair value of a
financial instrument as the amount at which the instrument
could be exchanged in a current transaction between willing
parties.
CARRYING FAIR
AMOUNT VALUE
------ -----
Financial assets:
Cash and cash equivalents $ 255 $ 255
Trade accounts receivable 4,094 4,094
Related party receivables 495 495
Notes receivable 380 380
Century Stock 500 500
F-26 (Continued)
CARRYING FAIR
AMOUNT VALUE
------ -----
Financial liabilities:
Trade accounts payable 7,162 7,162
Related party notw 987 987
Accrued expenses 556 556
Long-term debt 706 706
The following table presents the carrying amounts and
estimated fair values of the Company's financial instruments
at December 31, 1997. FASB No. 107, defines the fair value
of a financial instrument as the amount at which the
instrument could be exchanged in a current transaction
between willing parties.
CARRYING FAIR
AMOUNT VALUE
------ -----
Financial assets:
Cash and cash equivalents $1,180 $1,180
Trade accounts receivable 4,595 4,595
Related party receivables 304 304
Notes receivable 477 477
Century Stock 2,500 2,500
Financial liabilities:
Trade accounts payable 963 963
Related party notw 1,500 1,500
Accrued expenses 525 525
Long-term debt 28,800 28,800
The carrying amounts shown in the tables are included in the
consolidated balance sheet under the indicated captions.
The following methods and assumptions were used to estimate
the fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS, TRADE ACCOUNTS RECEIVABLE,
RELATED PARTY RECEIVABLES, CURRENT INSTALLMENTS OF
LONG-TERM DEBT, TRADE ACCOUNTS PAYABLE, RELATED PARTY
PAYABLE AND ACCRUED EXPENSES: The carrying amounts
approximate fair value because of the short maturity of
those instruments.
NOTES RECEIVABLE: The fair value is determined as the
present value of expected cash flows discounted at the
interest rate currently offered by the Company, which
management believes approximates rates which would be
offered by local lending institutions for loans of
similar terms to companies with comparable credit risk.
LONG-TERM DEBT: The fair value of the Company's long-
term debt carries market interest rates; therefore, the
current value approximates market value.
(13) COMMON STOCK PRIVATE PLACEMENTS
In July 1997, pursuant to a Securities Purchase Agreement,
the Company's primary lender, Den norske, purchased 500,000
shares of common stock of the Company for a
F-27 (Continued)
price of $2.66 per share, for a total of $1,330,000
($1,132,911 net of placement costs). The Company and Den
norske also entered into a Registration Rights Agreement
wherein Den norske was granted certain demand and piggyback
registration rights with respect to the shares purchased.
(14) STOCKHOLDERS' EQUITY
The Company has authorized fifty million (50,000,000) shares
of Common Stock. Outstanding at December 31, 1998 and 1997
are 10,251,853 and 10,193,676 shares, respectively.
The Company has authorized one million (1,000,000) shares of
Series 1993 Preferred Stock and two million (2,000,000)
shares of Series Preferred Stock subject to designation by
the Board of Directors:
Series 1993 Preferred Stock is convertible into one share of
common stock with a liquidation preference of $12 per share.
Dividends are payable semiannually at the rate of 8% per
share based upon the total number of shares outstanding.
Out0standing at December 31, 1998 and 1997 are 230,516 and
268,851 shares, respectively.
Series B Preferred Stock, designated by the Board of
Directors, was convertible into common stock based on a
conversion factor of $10.00 divided by 73% of the common
stock's closing bid price on the conversion date. The
Series B Preferred Stock had a liquidation preference of
$10.00 per share, but was junior to the Series 1993
Preferred Stock. Dividends were payable quarterly at the
rate of 6% in cash or common stock, at the Company's option.
There were 1,000,000 shares authorized and zero shares
outstanding at December 31, 1997. During the first quarter
of 1997, the Company's Board of Directors adopted a
resolution eliminating Series B Preferred Stock and
returning the 1,000,000 shares to the status of authorized
but unissued Preferred Stock, without designation. The
Certificate eliminating the Series B Preferred Stock was
filed in the Office of the Secretary of State of Delaware on
April 16, 1997.
The Company paid dividends on the Series 1993 Preferred
Stock through the issuance of 19,842 and 21,508 shares of
common stock in 1998 and 1997, respectively.
In April 1997, due to a decline in the market price of the
Company's common stock to a level below its book value, the
Board of Directors authorized the Company to repurchase up
to $2 million of the Company's common stock in market
transactions from time to time at prices deemed to be
favorable by the Company. As of December 31, 1998 and 1997,
the Company had acquired 201,890 and 141,410 shares at an
average price of $3.54 and $2.91, respectively, per share.
During the fourth quarter of 1997, the Company acquired
50,000 shares of its common stock from AKS for $5.00 per
share pursuant to the put provisions contained in a Purchase
& Sale Agreement dated December 27, 1995.
On January 15, 1999, the Board of Directors declared
dividends payable in common stock on January 22, 1999, to
holders of the Series 1993 Preferred Stock totaling 9,220
shares.
The Company has registered on a Form S-8 registration
statement, as amended, 650,000 shares of common stock to be
issued pursuant to its 1994 Employee Stock Compensation Plan
(ESC). The ESC provides for stock compensation through the
F-28 (Continued)
award of the Company's common stock to persons whose
experience, ability and services are considered valuable.
At December 31, 1998, 321,000 shares have been issued under
the ESC at prices ranging from $1.94 to $8.00 per share.
The Company has reserved and registered under a Form S-8
registration statement 2,000,000 shares of common stock to
be issued pursuant to a 1994 Compensatory Stock Option Plan
(CSO). The CSO is a nonstatutory stock option plan intended
as an employment incentive to aid in attracting and
retaining in the employ or service of the Company persons of
experience and ability and whose services are considered
valuable.
The Company applies APB Opinion 25 in accounting for the CSO
and non-plan options. Accordingly, no compensation cost has
been recognized for the CSO and non-plan options granted in
1998, 1997 or 1996. Had compensation cost been determined
on the basis of fair value pursuant to FASB 123, net income
and earnings per share would have been reduced as follows:
1998 1997 1996
---- ---- ----
INCOME (LOSS) BEFORE INCOME
TAX EXPENSE (BENEFIT)
---------------------
As reported $(46,224) $(1,847) $ 912
======== ======= =====
Proforma $(46,224) $(1,994) $ 464
======== ======= =====
BASIC EARNINGS PER SHARE
- - ------------------------
As reported $ (4.61) $ (0.21) $0.14
======== ======= =====
Proforma $ (4.61) $ (0.23) $0.06
======== ======= =====
DILUTED EARNINGS PER SHARE
- - --------------------------
As reported $ (4.61) $ (0.21) $0.13
======== ======= =====
Proforma $ (4.61) $ (0.23) $0.06
======== ======= =====
The fair value of each option granted is estimated on the
grant date using the Black-Scholes option-pricing model with
the following weighted average assumptions:
1998 1997 1996
---- ---- ----
Dividend Yield N/A -- --
Risk-free interest rate N/A 5.00% 5.73%
Expected life N/A 5 YRS. 4 YRS.
Expected volatility N/A 69.47% 69.47%
A summary of the status of CSO and non-plan options granted
to employees, consultants, officers and directors for the
purchase of the Company's common stock follows:
F-29 (Continued)
CSO NON-PLAN
--- --------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
------ ----- ------ -----
Balance,
December 31, 1997 1,976,410 $5.12 1,143,987 $3.83
Granted - - - -
Exercised - - - -
Terminated (237,500) (3.37) (190,000)
(3.79)
-------- ---- -------- ----
Balance,
December 31, 1998 1,738,910 $5.36 953,987 $3.83
========= ==== ======= ====
Weighted average fair
value of options granted
during 1998 N/A
====
At December 31, 1998, 1,738,910 CSO options and 783,987 non-
plan options were fully vested. The remaining 170,000 non-
plan options will vest over the next one to two years.
CSO NON-PLAN
--- --------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
------ ----- ------ -----
Balance,
December 31, 1996 1,943,910 $5.16 1,426,320 $4.14
Granted 37,500 3.00 300,000 3.00
Exercised - - - -
Terminated (5,000) (6.00) (582,333)
(4.16)
-------- ---- -------- ----
Balance,
December 31, 1997 1,976,410 $5.12 1,143,987 $3.83
========= ==== ========= ====
Weighted average fair
value of options granted
during 1997 N/A
====
At December 31, 1997, 1,918,577 CSO options and 843,987 non-
plan options were fully vested. The remaining 57,833 CSO
options and 300,000 non-plan options will vest over the next
one to three years.
F-30 (Continued)
CSO NON-PLAN
--- --------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
------ ----- ------ -----
Balance,
December 31, 1995 1,484,410 $5.42 1,226,320 $3.78
Granted 498,500 4.50 600,000 4.35
Exercised - - - -
Terminated (39,000) (6.45) (400,000)
(3.38)
-------- ---- -------- ----
Balance,
December 31, 1996 1,943,910 $5.16 1,426,320 $4.14
========= ==== ========= ====
Weighted average fair
value of options granted
during 1996 $1.66
=====
The following is a summary of the status of CSO and non-plan
options outstanding at December 31, 1998:
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
EXERCISE AVERAGE AVERAGE AVERAGE
PRICE REMAINING EXERCISE EXERCISE
RANGE NUMBER LIFE PRICE NUMBER PRICE
----- ------ ---- ----- ------ -----
$3.00 - $3.50 537,986 4.3 $3.24 367,986 $3.34
$4.00 - $4.50 1,242,487 2.5 4.24 1,242,487 4.24
$6.00 - $8.00 912,424 5.6 6.54 912,424 6.54
The following is a summary of the status of CSO and non-plan
options outstanding at December 31, 1997:
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
EXERCISE AVERAGE AVERAGE AVERAGE
PRICE REMAINING EXERCISE EXERCISE
RANGE NUMBER LIFE PRICE NUMBER PRICE
----- ------ ---- ----- ------ -----
$3.00 - $3.60 815,486 4.5 $3.20 515,486 $3.32
$4.00 - $4.80 1,392,487 3.8 4.25 1,334,654 4.44
$6.00 - $8.00 912,424 6.6 6.54 912,424 6.54
At December 31, 1998, the Company has reserved 2,180,686
shares of common stock which are issuable upon the exercise
of the following warrants:
In connection with a common stock private placement
closed in 1995, the Company has issued 41.17 Class A
Warrants and 41.17 Class B Warrants. Each Class A and
Class B Warrant is convertible to 5,000 shares of
common stock. The Class A Warrants have exercise
prices of $3.50 and $5.00 per share, respectively. The
Warrants are exercisable for thirty-six months,
F-31 (Continued)
commencing October 8, 1997. The Company has a call
right on the Class A and Class B Warrants at a share
price of $5.50 and $7.00, respectively.
The Company has outstanding 200,000 common stock
warrants issued in connection with various consulting
agreements. Each Warrant is convertible into one share
of common stock at an exercise price of $2.75 per
share. The warrants expire in May 2000.
In connection with a common stock private placement
closed in 1996, the Company issued 100 1996 Class A
Warrants. Each 1996 Class A Warrant is convertible to
1,650 shares of common stock. The 1996 Class A
Warrants are exercisable through October 8, 1999, and
have an exercise price of $4.00 per share.
In conjunction with the purchase of properties from
TECO, the parties entered into a warrant agreement
(TECO Warrant Agreement) granting TECO warrants to
acquire 600,000 shares of common stock of the Company
(First Warrants) at a price of $2.67 per share if the
TECO Note was not paid in full by October 1, 1998.
Additionally, the TECO Warrant Agreement granted TECO
warrants to acquire common stock equal to 10% of the
Company's outstanding common stock and options if the
TECO Note was not paid in full by October 1, 1998.
This percentage will increase by an additional 5% if
the TECO Note is not paid in full by January 1, 1999,
and by an additional 5% if the TECO Note is not paid in
full by April 1, 1999 (collectively, Secondary
Warrants). The price per share of common stock
evidenced by the Secondary Warrants is $.00001. As of
December 31, 1998, TECO had been vested with 600,000
First Warrants and 1,380,504 Secondary Warrants, all of
which are exercisable through July 1, 1999.
The weighted average price of the 2,180,686 shares of common
stock reserved upon exercise of all outstanding warrants is
$2.09.
(15) RELATED PARTY TRANSACTIONS
Significant related party transactions which are not
disclosed elsewhere in these consolidated financial
statements are discussed in the following paragraphs (see
Notes 4, 5, 8, 14, 16, and 19).
In 1998, 1997 and 1996, the Company, pursuant to the terms
of an employment and stock option agreement, has paid or
accrued compensation to the Company's Chairman of $25,500,
$40,000 and $60,000, respectively. The Chairman has been
assisting Management in various financing transactions.
In 1998, 1997 and 1996, the Company paid $189,260,
$279,421and $276,500, respectively, to purchase gas from a
company owned 20% by a director of the Company and which
participated as a joint venture partner in drilling various
wells in the Appalachian area.
The Company paid or accrued interest of approximately
$21,500 during 1996 related to advances and notes payable
from Southern Gas Holding Co., Inc. (SGH), a company
primarily owned by a director of the Company. At December
31, 1998 and 1997, the Company has made advances to SGH
totaling $464,106 and $230,784, respectively, which the
principal of SGH intends to secure with assets of .
However,
F-32 (Continued)
due to a significant decrease in the value of the
collateral, ARO has fully reserved the receivable from SGH
as of December 31, 1998.
On September 15, 1997, the Company entered into a Letter of
Intent with Prima, a limited liability company in which an
officer/director owns a 20% interest, providing for the
acquisition of an interest in certain producing and non-
producing oil and gas properties (the Properties) located in
Mississippi. The purchase price for the Properties was
$2,800,000 payable $1,300,000 on or before closing which
occurred October 10, 1997, and the balance of $1,500,000 in
an interest bearing note with recourse only to the
Properties, with interest thereon at 1 1/2% over Prime,
payable interest only until March 1998 and amortizing
thereafter over a two year period. The Company already
owned up to 3.5% interest in the Properties; and after
reviewing an independent geologist's report on the
Properties, the Letter of Intent was approved by a majority
of the disinterested directors of the Company at a special
meeting of the Board of Directors held on September 15,
1997. As of December 31, 1998 and 1997, the balance due
Prima under the note was approximately $987,160 and $1.5
million, respectively.
(16) LEASES
Future minimum rental payments for operating leases with
noncancelable lease terms in excess of one year are as
follows:
YEARS ENDING
DECEMBER 31,
------------
1999 $106,970
2000 98,874
2001 15,304
-------
$219,148
=======
The Company rents equipment and office space under various
operating leases. Rental expense for the years ended
December 31, 1998, 1997 and 1996, was approximately
$145,000, $52,000 and $61,200, respectively. Included in
1998, 1997 and 1996 is $37,800 paid to an officer/director
of the Company related to office space rental. The lease
agreement was effective through February 28, 1998 at a
monthly rate of $3,100 and is currently operating on a month-
to-month basis.
(17) DEFINED CONTRIBUTION PLAN
The Company maintains a Defined Contribution Plan (the Plan)
for all full-time employees of the Subsidiaries. Employees
are entitled to make contributions based on their percentage
of compensation.
The Company provides a matching contribution up to 5% of
each employee's compensation. For the years ended December
31, 1998, 1997 and 1996, approximately $69,000, $44,250 and
$32,500, respectively, were recognized as a general and
administrative expense for contributions to the Plan.
F-33 (Continued)
(18) SIGNIFICANT CUSTOMER CONCENTRATION
The Company's primary market areas are the Appalachian
Region of Kentucky and the Gulf Coast Region. For the years
ended December 31, 1998, 1997 and 1996, most of the
Company's gas sales are on credit to major industrial or
local distributing companies. Trade receivables are not
generally collateralized; however, the Company's customers'
historical and future credit positions are thoroughly
analyzed prior to extending credit. In certain instances,
the Company will require a letter of credit.
Appalachian Region:
------------------
Approximately 86%, 27% and 31% of the Company's gas sales in
1998, 1997 and 1996, respectively, are subject to fixed
pricing contracts, while the remainder are based on spot
prices. The Company presently uses its marketing operations
to provide gas supplies to customers solely to meet delivery
requirements when internal production will not suffice. The
Company provides gas supplies to industrial end users and
local distributing companies primarily for commercial use.
Marketing Revenues from major customers are summarized
below:
(DOLLARS IN THOUSANDS)
1998 1997 1996
---- ---- ----
$ % $ % $ %
- - - - - -
Company A - - 9,506 53 15,650 69
Company B 3,481 45 3,119 18 2,543 11
Company C 1,151 15 - - - -
Gulf Coast Region:
-----------------
The Company sells all of its current Gulf Coast gas
production through H&N Gas, Ltd. The Company sells more
than 10% of its Gulf Coast oil production to Citgo Petroleum
Corporation, Texon Corporation, Conoco and through contracts
administered by I.P. Petroleum Company.
(19) COMMITMENTS AND CONTINGENCIES
In December 1995, the Company entered into a severance
agreement with its former President and Chief Executive
Officer who resigned effective December 31, 1995. Under the
agreement, the executive was paid $85,000 and received the
sum of $10,000 per month through March 31, 1998. In return,
the executive surrendered 515,590 CSO common stock options
under a Severance Plan which had exercise prices between
$6.00 and $8.00 per share and expired between March 18,
2003, and February 1, 2005. In return, the executive
received 643,987 common stock options at an exercise price
of $4.00 per share and which expire on November 29, 2000.
He also retains 46,203 CSO common stock options immediately
exercisable, previously issued to him, at $3.50 per share
which expire on October 11, 2002. The Company also agreed
to provide for payment of an office lease through October
1996, and assigned a 1% gross overriding royalty interest in
certain oil and gas properties.
During 1997, the Kentucky Revenue Cabinet assessed Southern
Gas for outstanding sales tax of approximately $1.5 million,
plus penalties and interest, allegedly owed to
F-34 (Continued)
the Commonwealth of Kentucky by Southern Gas Company
("SGC"), a dissolved company, prior to Southern Gas'
acquisition of the assets of SGC. During the first quarter
of 1999, the Company received notification from the Kentucky
Revenue Cabinet that the Cabinet had accepted the Company's
Offer in Settlement in the amount of $47,499 for any and all
outstanding sales and tangible property taxes.
In the normal course of business, the Company enters into
short-term supply and purchase agreements. These agreements
can stipulate either a fixed contract price or a floating
price based on spot prices.
Management attempts to schedule deliveries to mitigate any
possible adverse effects of changing prices; however, gas
prices are susceptible to change due to industry supply and
demand positions.
(20) GOING CONCERN ASSUMPTION
As of December 31, 1998, the Company had current liabilities
in excess of current assets of approximately $6.3 million
(excluding current portion of long-term debt), was not in
compliance with its primary credit facility and bridge loans
with DNB in the approximate amounts of $48 million and $15.6
million, respectively, and was in default under its $18.5
million loan with TECO. As more particularly described in
Item 1, "Description of Business--Overview," of this Report
on Form 10-K, this situation is primarily the result of: i)
the lack of available outside funding to complete the
scheduled refinancing of interim loans and capital
expenditures associated with the acquisition and development
of properties from TECO; ii) the decline of production in
oil and gas prices; iii) the more than 60% decline in the
Company's two largest producing fields; and iv) the
approximately $16 million in trade payables incurred as a
result of the capital requirements for the development of
additional wells, a substantial portion of which were
settled subsequent to year-end 1998 for less than face value
and reflected in the December 31, 1998 financial statements.
It is important to note that DNB has not yet demanded
payment nor has it agreed to extend the term of the bridge
loans; and TECO is a party to an agreement between the
Company and DNB which substantially limits TECO's remedies
against the Company unless the Bank is paid in full or
declares a default and takes affirmative action against the
Company (see Note 5 for further discussion).
The Company has taken the following measures in an attempt
to remedy the above deficiencies:
On October 29, 1998, the Company's wholly-owned subsidiary,
American Resources Offshore, Inc., was merged into the
Company for the purpose of reducing administrative expenses.
During the fourth quarter of 1998, the Board of Directors
authorized and the Company entered into discussions with
third parties for the sale of its Appalachian properties.
In the event the Company sells these properties, the
proceeds will be used to reduce its outstanding indebtedness
to DNB, which would also result in a substantial reduction
of interest expenses. Further, the sale of these properties
would result in an additional reduction of the Company's
administrative expenses.
During the first quarter of 1999, the Company settled
approximately $12 million of trade payables incurred as a
result of the capital requirements for the development of
F-35 (Continued)
additional wells by surrendering its interest in its Grand
Isle Block 55 wells to the operator of the wells.
ARO's Management continues to explore all possible
alternatives for the restructuring of the company, including
the refinancing of debt and possible business combinations
with third parties.
The financial statements do not include any adjustments at
December 31, 1998, to reflect the recoverability and
classification of assets or the amounts and classification
of liabilities that might result from the outcome of the
Company's uncertain immediate future.
F-35 (Continued)
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
--------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
The following supplemental information regarding oil and gas
activities of the Company is presented pursuant to the disclosure
requirements promulgated by the Securities and Exchange
Commission (SEC) and Statement of Financial Accounting Standards
No. 69 (SFAS No. 69), "Disclosures About Oil and Gas Producing
Activities."
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
CAPITALIZED COSTS RELATING TO OIL AND
GAS PRODUCING ACTIVITIES:
Proved undeveloped oil and gas
Properties $ 8,590 $ 4,193 $ 4,193
Proved oil and gas properties 51,112 45,096 38,257
Unproved oil and gas properties 38,459 7,884 5,686
Support equipment and facilities 10,547 8,190 8,062
------- ------- -------
108,708 65,363 56,198
Less accumulated depreciation,
depletion, amortization, and
impairment (67,453) (16,737) (5,704)
------- ------- -------
Net capitalized costs $41,255 $48,626 $50,494
======= ======= =======
COSTS INCURRED IN OIL AND GAS PRODUCING
PROPERTY ACQUISITION, EXPLORATION AND
DEVELOPMENT ACTIVITIES:
Property acquisition costs:
Proved $19,119 $ 3,715 $18,440
Unproved 43,005 3,794 2,925
Exploration costs - 929 -
Development costs 9,834 1,357 3,315
------- ------- -------
$71,958 $ 9,795 $24,680
======= ======= =======
RESULTS OF OPERATIONS FOR OIL AND GAS
ACTIVITIES:
Oil and gas sales $26,724 $19,457 $ 8,540
Gain (loss) on sale of oil and gas
properties - - (152)
Exploration costs (5,056) (785) -
Production costs (4,967) (2,584) (1,402)
Depreciation, depletion and
amortization (13,403) (7,676) (2,432)
Impairment of oil and gas properties (34,735) (3,596) -
------- ------- -------
Results of operations for oil and
gas producing activities (excluding
corporate overhead) $(31,473) $ 4,816 $ 4,554
======= ======= =======
F-37
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
---------------
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
--------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
Reserve Quantity Information for the Year Ended December 31,
1998, 1997 and 1996:
The following estimates of proved developed and proved
undeveloped reserve quantities, and related standardized measure
of discounted net cash flow, are estimates only and have been
provided by Richard M. Russell & Associates, Inc.
(Kentucky/Appalachian Region properties); Netherland, Sewell &
Associates, Inc. (Gulf Coast Region properties of South Timbalier
148 and Ship Shoal 150); Ryder Scott Company (all Gulf Coast
Region properties except South Timbalier 148 and Ship Shoal 150);
and McConnell Consulting, Inc. (Michigan properties), independent
engineering consulting firms. The amounts do not purport to
reflect realizable values or fair market values of the Company's
reserves. The Company emphasizes that reserve estimates are
inherently imprecise and that estimates of new discoveries are
more imprecise than those of currently producing oil and gas
properties. Accordingly, these estimates are expected to change
as future information becomes available. All of the Company's
reserves are located in the United States, and primarily in the
State of Kentucky and the Gulf Coast Region.
The success of future development efforts and the amount, timing
and costs thereof may significantly increase or decrease the
Company's total unproved and proved developed reserve volumes,
the "Standardized Measure of Discounted Future Net Flows," and
the components and changes therein.
Proved reserves are estimated reserves of crude oil (including
condensate and natural gas liquids), and natural gas that
geological and engineering data demonstrate with reasonable
certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions. Proved
developed reserves are those expected to be recovered through
existing wells, equipment, and operating methods. Gas volumes
are expressed in millions of cubic feet and oil reserves in
thousands of barrels.
1998 1997 1996
---- ---- ----
OIL GAS OIL GAS OIL GAS
--- --- --- --- --- ---
Proved developed and
undeveloped reserves:
Beginning of year 1,385 35,917 1,202 35,692 756 24,741
Revisions of previous
estimated (407) (6,787) 137 (4,378) (45) (2,346)
Purchases of minerals
in place 269 25,911 268 3,714 691 18,373
Extensions and
discoveries 50 5,506 204 5,468 - -
Production (374) (9,428) (426) (4,579) (200) (1,830)
Sales and transfers of
minerals in place (38) (1,888) - - - (3,246)
----- ------ ----- ------ ----- ------
Total proved developed &
undeveloped reserves 885 49,231 1,385 35,917 1,202 35,692
===== ====== ===== ====== ===== ======
Proved developed reserves:
Beginning of year 1,092 30,175 909 29,033 756 19,702
End of year 665 38,702 1,092 30,175 909 29,033
===== ====== ===== ====== ===== ======
F-38
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
--------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND
CHANGES THEREIN RELATING TO PROVED OIL AND GAS RESERVES AS OF
DECEMBER 31, 1998, 1997 AND 1996:
The standardized measure of discounted future net cash flows is
computed by applying year-end prices of oil and gas (with
consideration of price changes only to the extent provided by
contractual arrangements) to the estimated future production of
proved gas reserves, less estimated future expenditures (based on
year-end costs) to be incurred in developing and producing the
proved reserves, less estimated future income tax expenses (based
on year-end statutory tax rates, with consideration of future tax
rates already legislated) to be incurred on pre-tax net cash
flows less tax basis of the properties and available credits, and
assuming continuation of existing economic conditions. The
estimated future net cash flows are then discounted using a rate
of 10% a year to reflect the estimated timing of the future cash
flows.
The average crude oil price at year-end 1998 and 1997 used for
this calculation was $9.53 and $16.47, respectively, per barrel.
The average natural gas price used was $2.13 and $2.83,
respectively, for Gulf Coast, $2.46 and $2.45, respectively, for
Kentucky Region and $0 and $2.41, respectively, for Michigan. In
general, oil and natural gas prices declined in early 1997 and
continued to decline in 1998.
At December 31, 1998, 1997 and 1996, the Company's future
discounted net cash flow from proved reserves was located as
follows:
GULF
KENTUCKY COAST MICHIGAN TOTAL
-------- ----- -------- -----
(DOLLARS IN THOUSAND)
1998 $13,389 $38,033 - $51,422
1997 $18,636 $29,092 $ 45 $47,773
1996 $16,972 $41,679 $1,299 $59,950
======= ======= ====== =======
At December 31, 1998, 1997 and 1996, the South Timbalier 148
Field accounted for approximately 14%, 38% and 0%, respectively,
of the Company's future net cash flows from proved reserves in
the Gulf Coast Region. Other fields with a significant
percentage of proved reserved at December 31, 1998, were West
Cameron 172 and South Timbalier 211, with 21.4% and 20%,
respectively, of proved reserves. Both West Cameron 172 and
South Timbalier 211 were a part of the TECO acquisition in 1998.
At December 31, 1998, 1997 and 1996, the Gausdale Field accounted
for approximately 61%, 67% and 58% of the Company's future net
cash flows from proved reserves in the Kentucky Region.
F-39 (Continued)
AMERICAN RESOURCES OFFSHORE, INC.
---------------------------------
AND SUBSIDIARY
--------------
OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
--------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
----------------------------------------------------
1998 1997 1996
---- ---- ----
Standard measure of discounted
future net cash flows at
December 31:
Future cash inflows $110,468 $113,391 $124,117
Future production costs (20,206) (20,925) (16,015)
Future development costs (10,703) (6,982) (8,893)
Future taxes (1,679) (2,759) (2,501)
------- ------- -------
77,880 82,725 96,708
Future net cash flows, 10% annual
discount for estimated timing of
cash flows (26,458) (34,952) (36,758)
------- ------- -------
Standardized measure of
discounted future net cash
flows relating to proved
gas reserves $ 51,422 $ 47,773 $ 59,950
======= ======= =======
The following reconciles the change in the standardized measure
of discounted future net cash flows during the years 1998, 1997
and 1996:
1998 1997 1996
---- ---- ----
Beginning of year $47,773 $59,950 $29,448
Sales of gas produced, net of
production costs (21,833) (16,874) (7,138)
Net changes in prices and
production costs (8,315) (8,580) 4,933
Extensions and discoveries 4,436 9,476 -
Revisions of previous quantity
estimates (7,422) (4,970) (2,660)
Change from purchases of
minerals in place 35,666 3,947 36,341
Change from sale and transfers
of minerals in place (2,812) - (2,362)
Changes in future development (1,295) - -
Changes in future taxes 937 (117) 42
Accretion of discount 4,777 3,811 2,656
Changes in timing and other (490) 1,130 (1,310)
------- ------- -------
End of year $51,422 $47,773 $59,950
======= ======= =======
The change from purchases of minerals in place reflects the
Company's acquisition of properties from TECO in 1998 and the
South Timbalier 148 lease block located offshore Louisiana and
various fields located in Kentucky from AKS in 1996.
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED
THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED,
THEREUNTO DULY AUTHORIZED.
AMERICAN RESOURCES OF DELAWARE, INC.
By: /s/ Rick G. Avare
----------------------------------
Rick G. Avare
President, CEO and Director
Date: April 14, 1999
----------------
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed by the following persons on
behalf of the registrant in the capacities and on the dates
indicated.
Signature Title Date
/s/ Douglas L. Hawthorne Chairman of the Board
- - ------------------------ and Director April 14, 1999
Douglas L. Hawthorne
/s/ Rick G. Avare President, Chief Executive
- - ------------------------ Officer, and Director
Rick G. Avare (Principal Executive
Officer) April 14, 1999
/s/ Leonard K. Nave Director and President,
- - ------------------------ Southern Gas Company
Leonard K. Nave of Delaware, Inc. April 14, 1999
/s/ Ralph A. Currie Chief Financial Officer April 14, 1999
- - ------------------------
- - ------------------------ Director
David Fox, Jr.
/s/ Len Aldridge
- - ------------------------ Director April 14, 1999
Len Aldridge
- - ------------------------ Director
Robert L. McIntyre
- - ------------------------ Director
Joseph P. Shields
<PAGE>
EXHIBIT INDEX
AMERICAN RESOURCES OF DELAWARE, INC.
EXHIBIT PAGE
NUMBER DESCRIPTION NO.
3.9 By-Laws of the Company, as amended (incorporated by *
reference to Exhibit 3.2 to the Registrant's
Form 10-SB).
3.10 Restated Certificate of Incorporation filed with the *
Delaware Secretary of State (incorporated by
reference to Exhibit 3.10 to the Company's
Form 8-K filed December
12, 1996).
3.11 Copy of the Certificate eliminating the Series B *
Preferred Stock (incorporated by reference to
Exhibit 3.11 to the Company's Form 8-K filed on
April 24, 1997).
3.12 Certificate of Amendment of Restated Certificate *
of Incorporation filed with the Delaware Secretary
of State on July 11, 1997 (incorporated by
reference to Exhibit 3.12 to the Company's
Form 8-K filed on July 25, 1997).
4.1 Specimen Common Stock Certificate (incorporated by *
reference to Exhibit 4.1 to the Registrant's
Form 10-SB).
4.2 Specimen Preferred Stock Certificate (incorporated *
by reference to Exhibit 4.2 to the Registrant's
Form 10-SB).
4.3 Specimen Warrant Certificate and Agreement *
(incorporated by reference to Exhibit 4.3 to the
Registrant's Form 10-SB).
4.5 Warrant Agreement dated as of October 6, 1994 *
between American Resources of Delaware, Inc.
and GFL Ultra Fund, Ltd. (incorporated by
reference to Exhibit 4.1 to the Registrant's
September, 1994, Form 10-QSB).
4.6 Warrant Agreement dated as of November 10, 1994 *
between American Resources of Delaware, Inc.
and GFL Ultra Fund, Ltd. (incorporated by
reference to Exhibit 4.6 to the Registrant's
Form 10-KSB for the fiscal year ended
December 31, 1994 [the "1994 Form 10-KSB"]).
i
4.9 Specimen copy of the Convertible Debenture Purchase *
Agreement, with exhibits. (incorporated by
reference to Exhibit 4.9 to the Company's
Form 8-K filed December 12, 1996).
4.10 Specimen copy of a Stock Option Agreement between *
American Resources of Delaware, Inc., and Corporate
Relations Group, Inc. (incorporated by reference to
Exhibit 4.10 to the Company's Form 8-K filed
December 12, 1996).
4.11 Copy of a Stock Option Agreement between American *
Resources of Delaware, Inc., and World Capital
Funding, Inc. (incorporated by reference to
Exhibit 4.11 to the Company's Form 8-K filed
December 12, 1996).
10.1 Asset Purchase Agreement between American Resources *
of Delaware, Inc. and Southern Gas Company, Inc.
dated October 6, 1993 (incorporated by reference
to Exhibit 1.1 to the Registrant's Form 8-K filed
October 19, 1993).
10.2 Amendment to Asset Purchase Agreement by and between *
American Resources of Delaware, Inc. and Southern
Gas Company, Inc. dated February 28, 1994
(incorporated by reference to Exhibit 2.8 to the
Registrant's Form 10-KSB for the fiscal year ended
December 31, 1993 [the "1993 Form 10-KSB"]).
10.3 Purchase Agreement between Southern Gas Holding *
Company, Inc. and American Resources of
Delaware, Inc. dated February 24, 1994
(incorporated by reference to Exhibit 2.2 to the
Company's Form 8-K filed March 14, 1994).
10.13 Agreement among Southern Gas Holding Company, Inc., *
Gems Resources, Inc., and American Resources of
Delaware, Inc., dated February 21, 1994
(incorporated by reference to Exhibit 4.11 to
the Registrant's 1993 Form 10-KSB).
10.14 Employment and Stock Option Agreement of Andrew J. *
Kacic dated March 19, 1993 (incorporated by reference
to Exhibit 10.1 the Registrant's Form 10-SB).
10.15 Registration Rights Agreement dated March 19, 1993 *
between the Registrant and Andrew J. Kacic
incorporated by reference to Exhibit 10.2 to
the Registrant's Form 10-SB).
10.16 Employment and Stock Option Agreement dated *
March 19, 1993 between the Registrant and
Charles A. Smith, III dated March 19, 1993
(incorporated by reference to Exhibit 10.3 to
the Registrant's Form 10-SB).
ii
10.17 Registration Rights Agreement between the Company *
and Charles A.Smith, III dated March 19, 1993
(incorporated by reference to Exhibit
10.4 to the Registrant's Form 10-SB).
10.18 Employment and Stock Option Agreement dated *
March 19, 1993 between the Registrant and Douglas
L. Hawthorne (incorporated by reference to
Exhibit 10.5 to the Registrant's Form 10-SB).
10.19 Registration Rights Agreement dated March 19, 1993 *
between the Registrant and Douglas L. Hawthorne
(incorporated by reference to Exhibit 10.6 to
the Registrant's Form 10-SB).
10.20 Agreement between the Company and Oilfield *
Investments Ltd. dated March 8, 1994 (incorporated
by reference to Exhibit 10.28 to the Registrant's
1993 Form 10-KSB).
10.21 Office Lease dated June 1, 1986 between Nave *
Properties and Southern Gas (assigned to SGCD)
(incorporated by reference to Exhibit 10.36 to
the Registrant's 1993 Form 10-KSB).
10.22 Incentive Stock Option Plan (incorporated by *
reference to Exhibit 10.0 to the Registrant's
September, 1994, Form 10-QSB).
10.23 Letter Agreement dated October 17, 1994 between *
the Registrant and Settle Oil and Gas Company
(incorporated by reference to Exhibit 10.1 to
the Registrant's September, 1994, Form 10-QSB).
10.24 Letter Agreement dated December 30, 1994, between *
the Registrant and Settle Oil and Gas Company
(incorporated by reference to Exhibit 10.24 to
the Registrant's 1994 Form 10-KSB).
10.25 Letter Agreement dated January 12, 1995, between *
the Registrant and Settle Oil and Gas Company
(incorporated by reference to Exhibit 10.25 to
the Registrant's 1994 Form 10-KSB).
10.26 Letter Agreement dated February 20, 1995, between *
the Registrant and Settle Oil and Gas Company
(incorporated by reference to Exhibit 10.26 to
the Registrant's 1994 Form 10-KSB).
10.27 Agreement and Assignment dated September 30, 1994, *
iii
between Petroleum Exploration and Transmission, Inc.
and Southern Gas Company of Delaware, Inc.
incorporated by reference to Exhibit
10.27 to the Registrant's 1994 Form 10-KSB).
10.28 Mortgage and Security Agreement dated September 30, *
1994, between Southern Gas Company of Delaware,
Inc. and Melinda C. Provo (incorporated by
reference to Exhibit 10.28 to the Registrant's
1994 Form 10-KSB).
10.29 Promissory Note dated September 30, 1994 from *
Southern Gas Company of Delaware, Inc. to
Melinda C. Provo (incorporated by reference
to Exhibit 10.29 to the Registrant's 1994
Form 10-KSB).
10.30 Form of Put Agreement dated March 15, 1995, *
between American Resources of Delaware, Inc.
and Prima Capital, L.L.C. (incorporated
by reference to Exhibit 10.30 to the
Registrant's 1994 Form 10-KSB).
10.31 Form of Limited Liability Company Agreement of *
Crescent Turnkey & Engineering, L.L.C. dated
December 30, 1994 (incorporated by
reference to Exhibit 10.31 to the Registrant's
1994 Form 10-KSB).
10.32 Domestic Turnkey Drilling Contract -- Offshore *
dated December 30, 1994, between American
Resources of Delaware, Inc. and Crescent
Turnkey Engineering, L.L.C. (incorporated
by reference to Exhibit 10.32 to the
Registrant's 1994 Form 10-KSB).
10.33 Purchase and Sale Agreement dated effective *
October 31, 1994, between American Resources
of Delaware, Inc. and Settle Oil and Gas Company
(incorporated by reference to Exhibit 10.33
to the Registrant's 1994 Form 10-KSB).
10.34 Subscription Agreement for 22% Secured Convertible *
Note of Settle Oil and Gas Company dated
November 28, 1994, and executed by American
Resources of Delaware, Inc. (incorporated
by reference to Exhibit 10.34 to the Registrant's
1994 Form 10-KSB).
10.35 22% Secured Convertible Note dated November 28, 1994, *
in the amount of $5,000,000 from Settle Oil and
Gas Company to American Resources of Delaware,
Inc. (incorporated by reference to Exhibit 10.35
to the Registrant's 1994 Form 10-KSB).
10.36 Assignment of Convertible Promissory Note dated *
December 30, 1994, from American Resources of
Delaware, Inc. to Southern Gas Company of
Delaware, Inc. (incorporated by reference to
Exhibit 10.36 to the Registrant's 1994 Form 10-KSB).
iv
10.37 Assignment of Convertible Promissory Note dated *
December 30, 1994, from Southern Gas Company of
Delaware, Inc. to Century Offshore Management
Corporation, Settle Oil and Gas Company,
and Southern Gas Company of Delaware, Inc.
(incorporated by reference to Exhibit 10.37
to the Registrant's 1994 Form 10-KSB).
10.38 Mortgage and Security Agreement dated November 15, *
1994, among Settle Oil and Gas Company, Century
Offshore Management Corporation and American
Resources of Delaware, Inc. (incorporated by
reference to Exhibit 10.38 to the Registrant's
1994 Form 10-KSB).
10.39 Put Agreement dated as of March 15, 1995, between the *
American Resources of Delaware, Inc., Southern
Gas Company of Delaware, Inc. and Prima Capital,
LLC (incorporated by reference to Exhibit 10.0
to the Registrant's Form 10-QSB for the quarterly
period ended March 31, 1995 [the "March, 1995,
Form 10-QSB"]).
10.40 $500,000 Promissory Note from Southern Gas Company *
of Delaware, Inc. In favor of Rick G. Avare,
Douglas L. Hawthorne Retirement Plan-001, Dtd.
February 22, 1995, and Douglas L. Hawthorne
(incorporated by reference to Exhibit 10.1 to
the Registrant's March, 1995, Form 10-QSB).
10.41 Agreement dated January 31, 1995, between Southern *
Gas Company of Delaware, Inc., Rick G. Avare,
Douglas L. Hawthorne Retirement Plan-001, Dtd.
February 22, 1995, and Douglas L. Hawthorne
(incorporated by reference to Exhibit 10.2 to
the Registrant's March, 1995, Form 10-QSB).
10.42 Amendment to Put Agreement dated as of July 1, 1995, *
between American Resources of Delaware, Inc.,
Southern Gas Company of Delaware, Inc. and
Prima Capital, LLC (incorporated by reference
to Exhibit 10.0 to the Registrant's Form 10-QSB
for the quarterly period ended June 30, 1995
[the "June, 1995, Form 10-QSB"]).
10.43 $900,000 Promissory Note from Settle (incorporated *
by reference to Exhibit 10.1 to the Registrant's
June, 1995, Form 10-QSB).
10.44 Participation agreement dated as of July 25, 1995, *
between American Resources of Delaware, Inc. and
its Board of Directors (incorporated by reference
to Exhibit 10.2 to the Registrant's June, 1995,
Form 10-QSB).
v
10.45 Stock Option Agreement dated May 5, 1995, between *
American Resources of Delaware, Inc. and GFL
Ultra Fund Limited (incorporated by reference to
Exhibit 10.3 to the Registrant's June, 1995,
Form 10-QSB).
10.46 First Amendment to Stock Option Agreement dated *
June 19, 1995, between American Resources of
Delaware, Inc. And GFL Ultra Fund Limited
(incorporated by reference to Exhibit 10.4 to
the Registrant's June, 1995, Form 10-QSB).
10.47 Second Amendment to Stock Option Agreement dated *
July 13, 1995, between American Resources of
Delaware, Inc. and GFL Ultra Fund Limited
(incorporated by reference to Exhibit 10.5
to the Registrant's June, 1995, Form 10-QSB).
10.48 Promissory Note of September 28, 1995, to Den norske *
Bank, A.S. (incorporated by reference to
Exhibit 10.0 to the Registrant's Form 10-QSB
for the quarterly period ended September 30, 1995
[the "September, 1995, Form 10-QSB]).
10.49 Amendment to Settle Note (incorporated by reference *
to Exhibit 10.1 to the Registrant's September,
1995, Form 10-QSB).
10.50 Asset Purchase Agreement of December 27, 1995, by *
and between American Resources of Delaware, Inc.,
Southern Gas Co. of Delaware, Inc., Arakis Energy
Corporation and AKS Energy Corporation (incorporated
by reference to Exhibit A to the Registrant's
Form 8-K filed on March 12, 1996).
10.51 Joint Development Agreement of February 26, 1996, *
between Southern Gas Co. of Delaware, Inc. and AKS
Energy Corporation (incorporated by reference to
Exhibit B to the Registrant's Form 8-K filed on
March 12, 1996).
10.52 Joint Operating Agreement of December 1, 1994, *
between Century Offshore Management Corporation,
Settle Oil and Gas Company and Southern Gas Co. of
Delaware, Inc. (incorporated by reference
to Exhibit 10.52 to the Registrant's Form 10-KSB
for the fiscal year ended December 31, 1995
[the "1995 Form 10-KSB"]).
10.53 Stock Purchase Agreement of January 2, 1996, as *
amended, between American Resources of Delaware,
Inc. and GFL Ultra Fund, Ltd. (incorporated by
reference to Exhibit 10.53 to the Registrant's
1995 Form 10-KSB).
vi
10.54 Purchase Agreement of December 29, 1995, between *
Southern Gas Holding Company and Southern Gas
Co. of Delaware, Inc. (incorporated by
reference to Exhibit 10.54 to the Registrant's
1995 Form 10-KSB).
10.55 Severance Agreement of November 30, 1995, between *
American Resources of Delaware, Inc. and
Andrew J. Kacic. (incorporated by reference to
Exhibit 10.55 to the Registrant's 1995
Form 10-KSB).
10.56 Second Amendment to Put Agreement of October 4, 1995, *
between American Resources of Delaware, Inc.,
Prima Capital, LLC, and Southern Gas Co. of
Delaware, Inc. (incorporated by reference
to Exhibit 10.56 to the Registrant's 1995
Form 10-KSB).
10.57 Specimen Change of Control Agreement (incorporated *
by reference to Exhibit 10.57 to the Registrant's
Form 8-K filed December 12, 1996).
10.58 Employment Agreement with Rick G. Avare *
(incorporated by reference to Exhibit 10.58 to
the Registrant's Form 8-K filed December 12, 1996).
10.59 Specimen copy of the Indemnity Agreement with *
Officers and Directors (incorporated by
reference to Exhibit 10.59 to the Registrant's
Form 8-K filed December 12, 1996).
10.60 Lead Generation Agreement with Corporate Relations *
Group, Inc. (incorporated by reference to
Exhibit 10.60 to the Registrant's
Form 8-K filed December 12, 1996).
10.63 Participation Agreement of April 12, 1996, between *
American Resources of Delaware, Inc. and
Douglas L. Hawthorne (incorporated by
reference to Exhibit 10.3 to the Registrant's
Report on Form 10-QSB for the quarterly
period ended March 31, 1996).
10.64 Production Payment Conveyance of May 22, 1996, by *
and between Southern Gas Co. of Delaware, Inc.,
and Austin Energy Funding Partners (incorporated
by reference to Exhibit 10.4 to the Registrant's
Report on Form 10-QSB for the quarterly period
ending June 30, 1996).
10.65 Asset Purchase Agreement by and between American *
Resources of Delaware, Inc., Southern Gas Co. of
Delaware, Inc., and Century Offshore Management
Corporation dated July 3, 1996, for the
acquisition of the South Timbalier 148
properties (incorporated by reference to
Exhibit A to the Registrant's Form 8-K
filed on July 18, 1996).
vii
10.66 Asset Purchase Agreement by and between American *
Resources of Delaware, Inc., Southern Gas Co. of
Delaware, Inc., and Century Offshore Management
Corporation dated July 3, 1996, for the
acquisition of the contractual rights for
salt dome properties (incorporated by reference
to Exhibit B to the Registrant's Form 8-K
filed on July 18, 1996).
10.67 Capitalization Agreement and Termination of Purchase *
and Sale Agreement by and between Southern Gas Co.
of Delaware, Inc., American Resources of Delaware,
Inc. and Century Offshore Management Corporation,
dated August 31, 1996 (incorporated by reference to
Exhibit A to the Registrant's Form 8-K/A filed on
September 16, 1996).
10.68 Amendment to South Timbalier Purchase and Sale *
Agreement by and between Southern Gas Co. of
Delaware, Inc., American Resources of Delaware,
Inc. and Century Offshore Management Corporation,
dated August 31, 1996 (incorporated by reference
to Exhibit B to the Registrant's Form 8-K/A
filed on September 16, 1996).
10.69 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Douglas L.
Hawthorne, dated September 30, 1996 (incorporated
by reference to Exhibit 10.9 to the Registrant's
Form 10-QSB for the quarterly period ending
September 30, 1996 [the "September, 1996,
Form 10-QSB"]).
10.70 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and The Kandy
Limited Partnership, dated September 30, 1996
(incorporated by reference to Exhibit 10.10
to the Registrant's September, 1996, Form 10-QSB).
10.71 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Donald A.
Schellpfeffer, dated September 30, 1996
(incorporated by reference to Exhibit 10.11
to the Registrant's September, 1996, Form 10-QSB).
10.72 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Southern
Gas Holding Company, Inc.,dated September 30, 1996
(incorporated by reference to Exhibit 10.12
to the Registrant's September, 1996, Form 10-QSB).
viii
10.73 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Douglas L.
Hawthorne Retirement Plan-001 Dtd. 2/22/95, dated
September 30, 1996 (incorporated by reference to
Exhibit 10.13 to the Registrant's September, 1996,
Form 10-QSB).
10.74 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Douglas L.
Hawthorne, dated December 29, 1996 (incorporated
by reference to Exhibit 10.74 to the Registrant's
Form 10-KSB for the fiscal year ended December
31, 1996 [the "1996 Form 10-KSB"]).
10.75 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and The Kandy
Limited Partnership, dated December 29, 1996
(incorporated by reference to Exhibit 10.75
to the Registrant's 1996 Form 10-KSB).
10.76 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Donald A.
Schellpfeffer, dated December 29, 1996 (incorporated
by reference to Exhibit 10.76 to the Registrant's
1996 Form 10-KSB).
10.79 Termination of Participation Agreement by and between *
American Resources of Delaware, Inc. and Douglas L.
Hawthorne Retirement Plan-001 Dtd. 2/22/95,
dated December 29, 1996 (incorporated by
reference to Exhibit 10.79 to the Registrant's
1996 Form 10-KSB).
10.80 Securities Purchase Agreement dated July 16, 1997 *
between the Company and Den norske Bank ASA
(incorporated by reference to Exhibit 10.80 to
Company's Form 8-K filed on July 25, 1997).
10.81 Registration Rights Agreement dated July 16, 1997 *
between the Company and Den norske Bank ASA
(incorporated by reference to Exhibit 10.81
to the Company's Form 8-K filed on July 25, 1997).
10.82 Co-Sale Agreement dated July 16, 1997 among the *
Company, Rick G. Avare, Southern Gas Holding
Company, Inc. and Den norske Bank ASA (incorporated
by reference to Exhibit 10.82 to the Company's
Form 8-K filed on July 25, 1997).
10.83 Letter of Intent between the Company and Prima *
Capital, LLC (incorporated by reference to
Exhibit 10.83 to the Company's Form 8-K
filed on September 24, 1997).
ix
10.84 Copy of the letter of resignation from William *
Bishop (incorporated by reference to Exhibit 10.84
to the Company's Form 8-K filed on October 1, 1997).
10.85 Copy of the Stock Purchase Agreement between Prima *
Capital, LLC and the Company (incorporated by
reference to Exhibit 10.85 to the Company's
Form 8-K filed on November 19, 1997).
10.86 Copy of the First Amended and Restated Credit *
Agreement between the Company and Den norske Bank,
AS (incorporated by reference to Exhibit 10.86
to the Company's Form 8-K filed on November 19, 1997).
10.87 Purchase and Sale Agreement by and between the *
Company and K.E. Resources, Ltd., entered into on
December 16, 1997 (incorporated by reference to
Exhibit 10.87 to the Company's Form 8-K
filed on December 30, 199).
10.88 Press release announcing agreement to acquire offshore*
Gulf of Mexico assets from TECO Oil & Gas, Inc.
(incorporated by reference to Exhibit 10.88 to
the Company's Form 8-K filed on January 16, 1998).
10.89 Purchase and Sale Agreement between American *
Resources of Delaware, Inc., American Resources
Offshore, Inc., TECO Oil & Gas, Inc. and TECO Energy,
Inc. (incorporated by reference to Exhibit 10.89 to
the Company's Form 8-K filed on March 16, 1998).
10.90 Promissory Note from American Resources Offshore, *
Inc. in favor of TECO Oil & Gas, Inc. (incorporated
by reference to Exhibit 10.90 to the Company's
Form 8-K filed on March 16, 1998).
10.91 Warrant Agreement between American Resources of *
Delaware, Inc. and TECO Oil & Gas, Inc.
(incorporated by reference to Exhibit 10.91 to
the Company's Form 8-K filed on March 16, 1998).
10.92 First Amendment to First Amended and Restated Credit *
Agreement dated March 5, 1998 between American
Resources of Delaware, Inc., Southern Gas Co. of
Delaware, Inc., American Resources Offshore, Inc.
and DNB Energy Assets, Inc. (incorporated by
reference to Exhibit 10.92 to ARO's Report on
Form 10-Q for the quarterly period ending
March 31, 1998).
10.93 Amended Purchase and Sale Agreement between American *
Resources of Delaware, Inc., American Resources
Offshore, Inc, TECO Oil & Gas, Inc. and TECO
Energy, Inc. (incorporated by reference to
Exhibit 10.93 to ARO's Report on Form 8-K/A2
filed on May 19, 1998).
x
10.94 Intercreditor Agreement between American Resources *
of Delaware,Inc., American Resources Offshore,
Inc., Southern Gas Co. of Delaware, Inc., TECO
Oil & Gas, Inc. and DNB Energy Assets, Inc.
(incorporated by reference to Exhibit 10.94 to
ARO's Report on Form 8-K/A2 filed on May 19, 1998).
10.95 Certificate of Amendment dated July 2, 1998 amending *
ARO's Restated Certificate of Incorporation
(incorporated by reference to Exhibit 10.95
to ARO's Report on Form 10-Q for the quarterly
period ending June 30, 1998).
10.96 Certificate of Ownership and Merger Merging American *
Resources Offshore, Inc., into American Resources
of Delaware, Inc. (incorporated by reference to
Exhibit 10.96 to ARO's Report on Form 8-K
filed on November 12, 1998).
16.01 Response letter from KPMG LLP to the Securities and *
Exchange Commission (incorporated by reference to
Exhibit 16.01 to ARO's Report on Form 8-K/A filed
on January 15, 1999).
21.0 Subsidiaries of American Resources of Delaware, Inc. 121
23.1 Consent of Ernst & Young LLP. 122
23.2 Consent of Netherland, Sewell & Associates, Inc. 123
23.3 Consent of Richard M. Russell & Associates, Inc. 124
23.4 Consent of Ryder Scott Company, Petroleum Engineers. 125
23.5 Consent of KPMG LLP. 126
* Previously filed
xi
Exhibit 21.0
SUBSIDIARIES OF AMERICAN RESOURCES OFFSHORE, INC.
1. Southern Gas Co. of Delaware, Inc., a Delaware corporation
Exhibit 23.1
Consent of Independent Auditors
-------------------------------
The Board of Directors
American Resources Offshore, Inc.
We consent to incorporation by reference in the following
Registration Statements of American Resources Offshore, Inc. and
in the related Prospectuses of our report dated April 2, 1999
related to the consolidated financial statements of American
Resources Offshore, Inc. and subsidiary as of December 31, 1998,
and for the year then ended included in this Annual Report (Form
10-K) for the year ended December 31, 1998.
(a) The Company's Registration Statement on Form S-8, Commission
File No. 33-78882 (1994 Employee Stock Compensation Plan).
(b) The Company's Registration Statement on Form S-8, Commission
File No. 33-78884 (1994 Compensatory Stock Option Plan).
(c) The Company's Registration Statement on Form S-8, Commission
File No. 33-82422 (1994 Employee Stock Compensation Plan -
Additional Shares).
(d) The Company's Registration Statement on Form S-8, Commission
File No. 33-95260 (1994 Compensatory Stock Option Plan -
Additional Shares).
(e) The Company's Registration Statement on Form S-8, Commission
File No. 333-654 (Andrew J. Kacic Severance Agreement).
(f) The Company's Registration Statement on Form S-3, Commission
File No. 333-18821 (effective January 23, 1997).
Ernst & Young LLP
New Orleans, Louisiana
April 13, 1999
Exhibit 23.2
NSAI Netherland, Sewell
& Associates, Inc.
- - -------------------------
CONSENT OF INDEPENDENT PETROLEUM ENGINEERS AND GEOLOGISTS
---------------------------------------------------------
As independent oil and gas consultants, Netherland, Sewell &
Associates, Inc. hereby consents to (a) the use of our report
setting forth our estimates of proved reserves and future
revenue, as of December 31, 1998, to the interest of American
Resources Offshore, Inc. and subsidiary (ARO) in certain oil and
gas properties, (b) all references to our firm included in or
made a part of ARO's Annual Report on Form 10-K for the year
ended December 31, 1998, and (c) the incorporation by reference
thereof into ARO's Registration Statement on Form S-8 (Nos. 33-
78882, 33-78884, 33-82422, 33-95260, and 333-654) and Form S-3
(Nos. 333-656 and 333-18821).
NETHERLAND, SEWELL & ASSOCIATES, INC.
By: /s/ Frederic D. Sewell
---------------------------------
Its: President
--------------------------------
Dallas, Texas
April 8, 1999
Exhibit 23.3
RICHARD M. RUSSELL & ASSOCIATES, INC.
- - -----------------------------------------------------------------
CONSULTING ENGINEERS
CONSENT OF INDEPENDENT CONSULTING ENGINEER
------------------------------------------
As independent consulting engineer, Richard M. Russell &
Associates, Inc. consents to a) the use of our report dated
February 15, 1999 setting forth our estimates of reserves and
future revenue as of January 1, 1999 to the interest of American
Resources Offshore, Inc. and subsidiary (ARO) in certain oil and
gas properties, and b) all references to our firm included in or
made a part of ARO's annual report on Form 10-K for the year
ended December 31, 1998, c) the incorporation by reference
thereof into ARO's Registration Statement on Form S-8 (Nos. 33-
78882, 33-78884, 33-82422, 33-95260, and 333-654) and Form S-3
(Nos. 333-656 and 333-18821), and d) the reference to our firm
under the heading "Experts" in the prospectus.
Richard M. Russell & Associates, Inc.
By: /s/ Richard M. Russell
---------------------------------
Richard M. Russell
President
Nashville, Tennessee
April 13, 1999
2003 BLAIR BOULEVARD NASHVILLE, TENNESSEE 37212
615-385-5446 FAX 615-292-7375 E MAIL RCYCLE @IX.NETCOM.COM
Exhibit 23.4
Ryder Scott Company
Petroleum Engineers
- - -------------------
CONSENT OF INDEPENDENT PETROLEUM ENGINEERS AND GEOLOGISTS
---------------------------------------------------------
As independent oil and gas consultants, Ryder Scott Company
hereby consents to (a) the use of our report setting forth our
estimates of proved reserves and future revenue, as of December
31, 1998, to the interest of American Resources Offshore, Inc.
and subsidiary (ARO) in certain oil and gas properties, (b) all
references to our firm included in or made a part of ARO's annual
report on Form 10-K for the year ended December 31, 1998 (c) the
incorporation by reference thereof into ARO's Registration
Statement on Form S-8 (Nos. 33-78882, 33-78884, 33-82422, 33-
95260, and 333-654) and Form S-3 (Nos. 333-656 and 333-18821),
and (d) the reference of our firm under the heading "Experts" in
the prospectus.
RYDER SCOTT COMPANY
PETROLEUM ENGINEERS
Houston, Texas
April 8, 1999
<PAGE>
Exhibit 23.5
Consent of Independent Auditors
-------------------------------
The Board of Directors
American Resources Offshore, Inc. and Subsidiaries:
We consent to incorporation by reference in the following
registration statements of American Resources Offshore, Inc. and
Subsidiaries of our report dated March 30, 1998 related to the
consolidated balance sheet of American Resources Offshore, Inc.
and Subsidiaries as of December 31, 1997, and the related
statements of operations, stockholders' equity and cash flows for
the years ended December 31, 1997 and 1996, which report appears
in the December 31, 1998 annual report on Form 10-K of American
Resources Offshore, Inc. and Subsidiaries.
(a) The company's registration statement on Form S-8, Commission
File No. 33-78882 (1994 Employee Stock Compensation Plan).
(b) The company's registration statement on Form S-8, Commission
File No. 33-78884 (1994 Compensatory Stock Option Plan).
(c) The company's registration statement on Form S-8, Commission
File No. 33-82422 (1994 Employee Stock Compensation Plan -
Additional Shares).
(d) The company's registration statement on Form S-8, Commission
File No. 33-95260 (1994 Compensatory Stock Option Plan -
Additional Shares).
(e) The company's registration statement on Form S-8, Commission
File No. 333-654 (Andrew J. Kacic Severance Agreement).
(f) The company's registration statement on Form S-3, Commission
File No. 333-18821 (effective January 23, 1997).
KPMG LLP
Houston, Texas
April 14, 1999
(Date)
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