<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 1-12530
ESENJAY EXPLORATION, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 73-1421000
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification Number)
500 NORTH WATER STREET, SUITE 1100 S.
Corpus Christi, Texas 78471
(Address of principal executive offices including zip code)
(512) 883-7464
(Issuer's telephone number including area code)
FRONTIER NATURAL GAS CORPORATION, 500 DALLAS STREET
SUITE 2920, HOUSTON, TEXAS 77002
(Former name, former address and former fiscal year, if changed
since last year)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [ X ] No [ ]
15,775,223 shares of the registrant's common stock were outstanding as
of November 11, 1998.
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No [ X ]
<PAGE>
ESENJAY EXPLORATION, INC.
FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements - General Information................................. 3
Condensed Consolidated Balance Sheets as of September 30,
1998 and December 31, 1997(unaudited) ............................... 4
Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 1998 and 1997(unaudited) ........ 5
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and 1997(unaudited) ................. 6
Notes to Condensed Consolidated Financial Statement (unaudited) ....... 7
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations .............................................10
PART II OTHER INFORMATION .........................................................18
SIGNATURES
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS - GENERAL INFORMATION
The Condensed Consolidated Financial Statements herein have been
prepared by the Company without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission (the "SEC"). As applicable under
such regulations, certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. The Company
believes the presentation and disclosures herein are adequate to make the
information not misleading, and the financial statements reflect all
elimination entries and normal adjustments which are necessary for a fair
presentation of the financial position as of September 30, 1998 and the
results of operations for the three and nine months ended September 30, 1998
and 1997.
Operating results for the nine-month period ended September 30, 1998 are
not necessarily indicative of the results for the full year. While the
condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements for the year ended December 31,
1997 and the related notes thereto included in Form 10-KSB and 10KSB/A as
filed with the SEC the reader should be aware of substantial changes which
occurred in 1998 including those set forth in Overview, Item 2 of this Form
10-QSB.
3
<PAGE>
ESENJAY EXPLORATION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................................. $ 134,257 $ 690,576
Accounts receivable, net of allowance for doubtful accounts of
$5,095 at September 30, 1998 and $15,488 at December 31, 1997 ............ 2,288,609 221,864
Prepaid expenses and other ................................................. 163,163 249,328
Receivables from affiliates ................................................ 124,494 105,171
------------- ------------
Total current assets ..................................................... 2,710,523 1,266,939
Property and equipment:
Gas and oil properties, at cost-
successful efforts method of accounting .................................. 70,095,666 3,235,848
Other property and equipment ............................................... 1,314,624 1,169,127
------------- ------------
71,410,290 4,404,975
Less accumulated depletion, depreciation and amortization ................. (1,560,298) (1,260,605)
------------- ------------
69,849,992 3,144,370
Other assets ................................................................. 150,590 164,699
------------- ------------
Total assets ............................................................. $ 72,711,105 $ 4,576,008
------------- ------------
------------- ------------
</TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Current liabilities:
Accounts payable ........................................................... $ 6,253,928 $ 911,396
Accounts payable to affiliates ............................................. 7,545,421 --
Revenue distribution payable ............................................... 978,559 68,131
Current portion of long-term debt .......................................... 167,757 401,085
Accrued and other liabilities .............................................. 1,034,074 299,704
------------- ------------
Total current liabilities ................................................ 15,979,739 1,680,316
Long-term debt ............................................................... -- 22,680
Non-recourse debt ............................................................ 864,000 864,000
Accrued interest on non-recourse debt ........................................ 288,074 194,274
Other long-term liabilities .................................................. -- 9,918
------------- ------------
Total liabilities ........................................................ 17,131,813 2,771,188
Commitments and contingencies
Stockholders' equity:
Cumulative convertible preferred stock $.01 par value; 5,000,000 shares
authorized; 0 and 85,961 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively
($0 and $859,610 aggregate liquidation preference at
September 30, 1998 and December 31, 1997 respectively) ................... -- 860
Common Stock:
Class A common stock, $.01 par value; 40,000,000 shares authorized;
15,775,223 and 1,656,001 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively ................... 157,752 16,560
Unamortized value of warrants ................................................ (6,791) (27,163)
Additional paid-in capital ................................................... 77,575,541 14,751,425
Accumulated deficit .......................................................... (22,147,210) (12,936,862)
------------- ------------
Total stockholders' equity ............................................... 55,579,292 1,804,820
------------- ------------
Total liabilities and stockholders' equity................................ $ 72,711,105 $ 4,576,008
------------- ------------
------------- ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
ESENJAY EXPLORATION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Gas and oil revenues .................................... $ 281,408 $ 87,084 $ 436,272 $ 544,693
Realized gain (loss) on commodity transactions .......... (30,376) (56,000) (128,938) (212,375)
Unrealized gain (loss) on commodity transactions ........ 10,817 (95,199) 97,888 (251,814)
Gain on sale of assets .................................. 1,947 263,737 5,375 396,087
Operating fees .......................................... 97,923 8,303 197,384 48,029
Other revenues .......................................... (40,253) 43,470 62,608 158,260
----------- ----------- ----------- -----------
Total revenues ........................................ 321,466 251,395 670,589 682,880
----------- ----------- ----------- -----------
Costs and expenses:
Lease operating expense ................................. 44,573 177,742 98,980 400,597
Production taxes ........................................ 20,084 4,018 25,036 18,273
Transportation and gathering costs ...................... 393 3,830 1,719 141,717
Depletion, depreciation and amortization ................ 196,729 400,435 335,095 619,959
Exploration costs-geological & geophysical .............. 2,240,281 36,508 5,028,381 169,747
Exploration costs-dry hole .............................. 133,666 620,143 1,173,767 1,748,498
Delay rentals ........................................... 40,956 14,766 46,039 131,098
Interest expense ........................................ -- -- 217,899 9,205
General and administrative expense ...................... 1,234,414 516,907 2,954,021 1,638,601
----------- ----------- ----------- -----------
Total costs and expenses .............................. 3,911,096 1,774,349 9,880,937 4,877,695
----------- ----------- ----------- -----------
Loss before provision for income taxes .................... (3,589,630) (1,522,954) (9,210,348) (4,194,815)
Benefit (provision) for income taxes ...................... -- -- -- --
----------- ----------- ----------- -----------
Net loss .................................................. (3,589,630) (1,522,954) (9,210,348) (4,194,815)
Cumulative preferred stock dividend ....................... -- 25,788 48,138 77,365
----------- ----------- ----------- -----------
Net loss applicable to common stockholders ................ $(3,589,630) $(1,548,742) $(9,258,486) $(4,272,180)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net loss per common and common equivalent share ........... ($ 0 .24) ($ 0.94) ($ 1.18) ($ 2.60)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Weighted average number of common shares
outstanding ( in thousands) ............................ 14,899 1,644 7,857 1,644
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
ESENJAY EXPLORATION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------
1998 1997
------------ -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss ............................................................. $ (9,210,348) $(4,194,815)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depletion, depreciation and amortization ............................. 335,095 619,959
Gain on sale of assets ............................................... (5,375) (396,087)
Gain on settlement of deferred compensation agreement ................ -- (25,794)
Amortization of financing costs and warrants ......................... 107,428 44,079
Writedown of gas and oil properties................................... -- 489,661
Unrealized (gain) loss on commodity transactions ..................... (97,888) 251,814
Exploration costs .................................................... 6,202,148 1,918,245
Other ................................................................ -- --
Changes in operating assets and liabilities
Trade and affiliate receivables .................................... (2,086,068) (94,882)
Prepaid expenses and other ......................................... 86,165 113,981
Other assets ....................................................... (1,141,033) 294,477
Accounts payable ................................................... 5,342,532 107,352
Accounts payable to affiliates ..................................... (601,197) --
Revenue distribution payable ....................................... 910,428 (298,390)
Accrued and other .................................................. 926,058 (98,730)
----------- -----------
Net cash provided by (used in) operating activities .................. 767,945 (1,269,130)
----------- -----------
Cash flows used in investing activities:
Capital expenditures - gas and oil properties ........................ (14,197,805) (3,055,258)
Capital expenditures - other property and equipment .................. (211,965) (304,616)
Proceeds from sale of assets ......................................... 36,441 1,002,540
----------- -----------
Net cash provided by (used in) investing activities ................ (14,373,329) (2,357,334)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of debt ....................................... 8,300,000 182,382
Repayments of long-term debt ......................................... (8,580,151) (202,490)
Proceeds from issuance of stock ...................................... 14,417,480 --
Preferred stock redeemed ............................................. (859,610) --
Preferred stock dividends paid ....................................... (228,654) (77,365)
----------- -----------
Net cash provided by (used in) financing activities ................ 13,049,065 (97,473)
----------- -----------
----------- -----------
Net increase (decrease) in cash and cash equivalents ............... (556,319) (3,723,937)
Cash and cash equivalents at beginning of period ..................... 690,576 4,956,656
----------- -----------
Cash and cash equivalents at end of period ........................... $ 134,257 $ 1,232,719
----------- -----------
----------- -----------
Supplemental disclosure of cash flow information:
Cash paid for interest ............................................. $ 612,469 $ 62,657
----------- -----------
Supplemental disclosure of non-cash investing and financing activities:
Acquisition of gas and oil properties ................................ $ 58,864,160 $ --
Proxy Costs .......................................................... 287,173 --
Assumption of related liabilities .................................... 8,146,618 --
Issuance of 10,106,706 shares of common stock ........................ 50,430,370 --
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
ESENJAY EXPLORATION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accompanying unaudited condensed consolidated financial statements
of Esenjay Exploration, Inc. and its subsidiaries and its predecessor,
Frontier Natural Gas Corporation, (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all information and
footnotes required by generally accepted accounting principles for complete
financial statements. Interim results for the nine-month period ended
September 30, 1998 are not necessarily indicative of results expected for the
full year.
A summary of the Companies' significant accounting policies is presented
on pages 30 and 31 of their 1997 Form 10KSB/A filed with the SEC. Users of
financial information are encouraged to refer to the footnotes contained
therein when reviewing interim financial results. There have been no material
changes in the accounting policies followed by the Company during 1998.
The accompanying interim condensed consolidated financial statements
contain all the material adjustments, which are in the opinion of management,
consistent with the adjustments necessary to present fairly the stated
consolidated financial position, results of operations, cash flows and
shareholders' equity of Esenjay Exploration, Inc. for the interim period.
Certain prior period amounts have been reclassified to conform to the current
period presentation.
2. LONG-TERM DEBT:
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
Note payable pursuant to a credit agreement with a bank of
$68,888 at September 30, 1998 and $293,888 at
December 31, 1997, interest at LIBOR rate
(reserve adjusted), plus one and seven-eighths
percent (1.875%) (7.25% at September 30, 1998
and December 31, 1997), payable in various
monthly installments through December 1998,
collateralized by producing oil and gas
properties; net of discount of $4,741 at
September 30, 1998 and $18,966 at December 31, 1997........... $ 64,147 $ 274,922
Non-recourse loan, payable out of an 8% ORRI on
the Starboard Prospect, interest accrued at 15%............... 864,000 864,000
Notes payable to bank, interest at 7.49% to 12.5%,
payable in various monthly installments through 1999,
collateralized by other property and equipment................ 3,610 48,843
Note payable, interest at 12%, payable monthly,
principal due December 31, 1997. ............................. 100,000 100,000
------------ ------------
1,031,757 1,287,765
Less current portion... ........................................ 167,757 401,085
------------ ------------
$ 864,000 $ 886,680
------------ ------------
------------ ------------
</TABLE>
On January 3, 1996, the Company entered into a $15,000,000 credit
agreement with a bank. The remaining funds were intended to be available for
specified future drilling and acquisition activities of the Company subject
to the approval of the bank. The Company repaid a substantial portion of this
borrowing with proceeds from the sale of its N.E. Cedardale properties in
September of 1996. Due to this early repayment of borrowings, the Company
reduced debt issuance costs by $293,000 and discount on notes payable by
$207,000 and recorded these amounts as interest expense. The loan is secured
by a mortgage on certain of the Company's producing properties. As part of
the credit agreement, the Company is subject to certain covenants and
restrictions, which included limitations on additional borrowing, and sales
of significant properties,
7
<PAGE>
working capital, cash, and net worth maintenance requirements and a minimum
debt to net worth ratio. As additional consideration for the loan, the
Company assigned the bank an overriding royalty interest in the mortgaged
properties. This credit agreement was amended effective October 23, 1998.
Terms of the agreement are set forth in note 6 hereto.
On March 12, 1996, the Company completed a financial package with a
group funded by a public utility to evaluate and develop a project in
Terrebonne Parish, Louisiana. This group may participate in 48% of all costs
of evaluation and development of the project area and provide a non-recourse
loan to fund $864,000 of the Company's 48% share of certain leasehold and
seismic evaluation costs of the project. The loan is secured by a mortgage on
the Company's interest in the project. As of September 30, 1998, the Company
has received advances aggregating $864,000 on the non-recourse loan. The
non-recourse loan will be paid solely by the assignment on an 8% overriding
royalty interest in the future revenues of the financed project. The loan is
now fully funded.
In conjunction with the Acquisition Agreement and Plan of Exchange
between the Company, Aspect Resources LLC ("Aspect") and Esenjay Petroleum
Corporation ("EPC") dated as of January 19, 1998 as amended (the "Acquisition
Agreement"), Aspect committed to lend the Company up to $1,800,000, and in
January and February advanced $500,000 on said credit facility. The Company
repaid the facility on February 23, 1998, when the Company entered into a
$7,800,000 credit agreement with Duke Energy Financial Services, Inc. The new
credit facility provided for up to $4,800,000 prior to closing of the
transactions set forth in the Acquisition Agreement, $1,800,000 of which
could be used directly by the Company and $3,000,000 to be utilized solely to
loan to EPC to pay exploratory costs incurred on the assets acquired from EPC
after the effective date of the acquisitions and prior to closing thereof. An
additional $3,000,000 became available to the Company after closing of the
Acquisitions to pay additional exploratory costs and to fund the costs of
redemption of the Company's convertible preferred stock. The credit facility
bore interest at a national prime rate plus 4%. In addition, the lender will
be paid cash payments equal to an overriding royalty of 0.6% of the Company's
interest in wells drilled by the Company while the credit facility is
outstanding. The lender also has a right to gather, process, transport and
market, at competitive market rates, natural gas produced from a majority of
the projects the Company acquired pursuant to the Acquisitions. The facility
was secured by mortgages on most of the Company's undeveloped exploration
projects. The assets acquired pursuant to the Acquisition Agreement are also
subject to such mortgages. The facility was repayable in eleven monthly
payments equal to 1/30 of the principal plus interest, plus a final monthly
payment of all remaining principal plus interest commencing August 31, 1998,
or sooner in the event the Company sold interests in the collateral or closed
any underwritten public offering of securities. The facility was repaid in
full on July 21, 1998, from proceeds of an underwritten offering of
securities.
3. NOTES RECEIVABLE FROM EPC
The Duke Energy Financial Services, Inc. credit agreement provided for
up to $4,800,000 prior to the closing of the transactions provided for in the
Acquisition Agreement, of which $3,000,000 would be used by EPC to fund
exploratory costs incurred on the assets acquired by the Company and incurred
after the effective date of the Acquisition Agreement yet prior to closing.
The credit facility bore interest at a national prime rate plus 4%. The
facility was paid in full on July 21, 1998 from proceeds received in an
underwritten offering of common stock. At June 30, 1998 the fully funded loan
to EPC of $3,000,000 was offset against the account payable to affiliate EPC
of $4,993,992 and as a result, the note receivable from EPC was paid in full.
4. COMMITMENTS AND CONTINGENCIES
The Company previously entered into employment agreements with two
officers, which covered periods through December 31, 1999. In 1997 the
Company entered into incentive agreements and contract settlement agreements
with the two officers. Pursuant to the incentive agreements and contact
settlement agreements, in the event the transactions provided for in the
Acquisition Agreement closed, or in the event there is another transaction
which results in a change of control of the Company, it will pay incentive
payments totaling $246,400, as well as contract settlement payments totaling
$246,400 to said officers. Each of the incentive payments and the contract
payments may be paid in the form of promissory notes due not later than
September 30, 1998, however, the officers and the Company have agreed to
defer the outstanding principal repayment to no later than January 15, 1999.
Upon closing of the transactions provided for in the Acquisition Agreement
the employment agreements were settled by execution of said promissory notes.
As of September 30, 1998 the outstanding balance owed on the promissory notes
was $246,400.
The Company is a party to various lawsuits arising in the normal course
of business. Management believes the ultimate outcome of these matters will
not have a material effect on the Company's consolidated financial position,
results of operations and net cash flows.
8
<PAGE>
Pursuant to the credit agreement with the bank, the Company entered into
a natural gas swap agreement on 62,500 MMBTU of natural gas per month at
$1.566 per MMBTU for Mid-Continent gas for the period from April 1, 1996
through January 31, 1999. The swap was amended to 31,250 MMBTU on September
25, 1996, due to the sale of the N.E. Cedardale field. The Company recorded a
loss of $212,000 in connection with this reduction in quantities covered by
the swap agreement. Currently the Company's monthly natural gas production is
exceeding that of the natural gas swap that is in place. The total unrealized
gain on the amended swap agreement was $52,682 at September 30, 1998. The
total realized losses on the natural gas swap agreements were $30,376 and
$56,000 for the three months ended September 30, 1998 and 1997,
respectively, and $128,938 and $212,375 for the nine months ended September
30, 1998 and 1997 respectively.
5. ACQUISITIONS
On May 14, 1998, the Company acquired substantial interests in 28
projects from EPC and Aspect in exchange for 10,106,702 shares of the
Company's common stock. The estimated fair value on the date of acquisition
was approximately $66.7 million, which consists of the fair market value, as
determined by an independent third party, plus project costs up to the
closing of the Acquisition Agreement. The acquired projects are primarily
technology enhanced natural gas exploration projects along the Texas and
Louisiana Gulf Coast.
The Acquisitions have been recorded at their fair value and have been
included in the Company's consolidated financial statements from the date of
their acquisition. The following unaudited pro forma information presents a
summary of condensed consolidated results of operations as if the
Acquisitions had occurred on January 1, 1997:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
--------------------------- -----------------------------
1998 1997 1998 1997
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Revenues....................... $ 321,466 $ 346,594 $ 670,589 $ 934,694
Total costs and expenses....... 3,900,064 3,336,773 12,157,762 8,691,042
----------- ----------- ------------ -----------
Net loss....................... $(3,578,598) $(2,990,179) $(11,487,173) $(7,756,348)
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Basic and diluted loss per
share.......................... $ (0.24) $ (0.25) $ ( 0.90) $ (0.66)
</TABLE>
6. SUBSEQUENT EVENTS
On October 23, 1998, the Company amended and restated the $15,000,000
credit agreement dated January 3, 1996 with Bank of America NT & SA ("B of
A"). The amended agreement provided for an immediate borrowing base up to
$9,000,000 ($8,250,000 if the Company does a third party financing in which
the third party lender shared in certain collateral of B of A). The Company
has drawn $6,000,000 pursuant to the B of A loan facility. The loan is in two
tranches. Tranche A is a revolving facility with no required principal
payments for two years, after which it converts into a 36 month term loan.
Tranche B is payable interest only until maturity in 18 months. Both loans
are at a varied interest rate utilizing either the B of A's Alternate
Reference Rate (Alternate Reference Rate is the greater of (i) B of A's
Reference Rate and (ii) the Federal Funds effective rate plus 0.50%) or the
Interbank rate plus 2% for Tranche A or 4% for Tranche B. The remaining funds
will be available for specific future drilling activities of the Company,
subject to the approval of the bank. The loan is secured by a mortgage or a
negative pledge on all properties currently owned by the Company. In
addition, B of A received a 2.0% overriding royalty interest proportionately
reduced to the Company's net interest in the properties classified proven as
of the date of closing and received a five year warrant to purchase 95,000
shares of common stock at a price equal to the average daily closing price of
the Company's common stock for the thirty days prior to closing of the credit
agreement.
The Company has also received a commitment for an additional $9,000,000
credit facility from Duke Energy Financial Services, Inc. Pursuant to the
commitment Duke Energy Financial Services, Inc. would share certain
collateral with B of A. This commitment is subject to final due diligence and
final negotiation of complete documentation including an inter-creditor
agreement with B of A.
In order to minimize the pricing risk associated with oil and gas sales,
the Company entered into a twelve-month hedging transaction with Bank of
America Financial Engineering and Risk Management Group. The hedging
instrument called for the delivery of 4,700 MMBTUs per day at a price of
$2.30 per MMBTU, before basis differential adjustments, for the period
November 1, 1998 through October 31, 1999.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis reviews Esenjay Exploration,
Inc.'s and/or its predecessor Frontier Natural Gas Corporation's operations
for the three and nine month periods ended September 30, 1998 and 1997 and
should be read in conjunction with the consolidated financial statements and
notes related thereto. Certain statements contained herein that set forth
management's intentions, plans, beliefs, expectations or predictions of the
future are forward-looking statements. It is important to note that actual
results could differ materially from those projected in such forward-looking
statements. The risks and uncertainties include but are not limited to
potential unfavorable or uncertain results of 3-D seismic surveys not yet
completed, drilling costs and operational uncertainties, risks associated
with quantities of total reserves and rates of production from existing gas
and oil reserves and pricing assumptions of said reserves, potential delays
in the timing of planned operations, competition and other risks associated
with permitting seismic surveys and with leasing gas and oil properties,
potential cost overruns, potential dry holes and regulatory uncertainties and
the availability of capital to fund planned expenditures as well as general
industry and market conditions.
OVERVIEW
OVERVIEW OF HISTORICAL DEVELOPMENTS. In mid-1996, the Company refocused
its activities from acquiring gas reserves principally in the Mid-Continent
region of the United States to concentrate on exploration and related
development drilling projects in Southern Louisiana and along the Gulf Coast
region of Alabama, Mississippi and Texas. The Company's most significant
project (prior to the acquisitions described below) had been its Starboard
Project in Terrebonne Parish, Louisiana, which is 3-D seismic based and which
was a primary focus in 1996 and 1997, and which project has now reached the
drilling phase. During 1996 and 1997, the Company's drilling activities,
which were based primarily on 2-D seismic data, were largely unsuccessful.
This fact, along with an unexpected drop in production from the Company's
Mobile Bay area wells, reduced the Company's cash and capital resources at
the time the drilling phase of the Starboard Project was approaching.
To address the Company's capital needs, the Board of Directors, at its
meeting on August 12, 1997, directed management to look for potential assets
to acquire in exchange for the Company's Common Stock, to identify and review
potential business consolidation opportunities, identify potential partners
to help fund the Company's proposed drilling activities on the Starboard
Project and in other locations, and to consider any other avenues to
strengthen the Company's capital resources and diversify its exploration
opportunities. The Board also directed management to reduce overhead wherever
prudently possible and the Company retained an investment advisor to aid in
achieving these objectives. The Company explored a series of such
transactions and the Board, after receipt of the advice of management and its
investment advisor, and receipt of due diligence reports and other materials,
unanimously agreed that a transaction with Aspect and EPC was the best option
for the Company's shareholders. This process led to the Company entering into
the Acquisition Agreement among the Company, EPC, and Aspect. This
Acquisition Agreement, and certain provisions of it, required approval of the
shareholders of the Company. At a special meeting of shareholders held on May
14, 1998 the shareholders approved the Acquisition Agreement, a
recapitalization of the Company pursuant to which each outstanding share of
common stock would convert into one-sixth (1/6) of a share of new common
stock (the "Reverse Split"), a plan and agreement of merger pursuant to which
the Company would reincorporate in the state of Delaware and would change its
name to Esenjay Exploration, Inc. (the "Reincorporation"), and the election
of seven directors.
On May 14, 1998 after the Special Meeting of Shareholders, the Company
closed the transactions provided for in the Acquisition Agreement,
implemented the Reverse Split, and completed the Reincorporation. As a result
of the split, seventeen additional shares were issued, due to the rounding up
of partial shares issued. All references in the accompanying financial
statements to the number of common shares have been restated to reflect the
foregoing. In addition, as required by the Acquisition Agreement, the Company
called for redemption, all of its issued and outstanding cumulative
convertible preferred stock and did redeem said preferred stock. The result
of the foregoing is that the Company conveyed a substantial majority of its
Common Stock to acquire an array of significant technology enhanced natural
gas oriented exploration projects. The Company believes the Acquisitions will
facilitate expanded access to capital markets due to the value and diversity
of its exploration project portfolio. The Company also believes the members
of EPC's management that joined the Company after consummation of the
acquisitions significantly enhanced the Company's management team.
On July 21, 1998 the Company closed an underwritten offering of
4,000,000 shares of its common stock at a price of $4.00 per share. The net
proceeds to the Company were approximately $14,880,000. After the offering the
Company had 15,762,723 shares outstanding.
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OVERVIEW OF CURRENT ACTIVITIES. As a result of the above-described
acquisitions, restructuring, and the underwritten offering, the Company
believes it is positioned for a period of significant exploration activity on
its technology enhanced projects. Many of the projects have reached the
drilling stage. In many instances the requisite process of geological and/or
engineering analysis, followed by acreage acquisition of leasehold rights and
seismic permitting, and 3-D seismic field data acquisition, then processing
of the data and finally its interpretation,took several years of time and the
investment of significant capital. Management believes the acquisition of
projects at this advanced stage has not only reduced the drilling risk, but
should allow the Company to consistently drill on a broad array of
exploration prospects over the next twelve months. Included are several
prospects planned to be drilled in the fourth quarter of 1998 and first
quarter of 1999 by the Company which have significant potential to its net
interest. As evidence of this activity the Company has participated in the
drilling of 20 wells from March through the date hereof with working
interests which range from 8% to 79%. Out of the 20 wells drilled, 11 wells
have been completed, 8 were dry holes, and 1 is being drilled. Several of the
successful wells went into production in the third quarter, and management
expects its net oil and gas revenues in the fourth quarter of 1998 to exceed
$400,000 per month from this new drilling alone.
The Company entered the fourth quarter having gone from nominal second
quarter production and large operating cash flow deficits to a company which
has added $400,000 to $500,000 per month in oil and gas revenues. This should
allow it to achieve positive operating cash flow in the fourth quarter and
beyond (prior to capex costs and new 3-D seismic data acquisition costs,
which costs the successful efforts accounting method utilized by the Company
mandate to be expensed rather than capitalized). In addition, since the end
of the third quarter, the Company has received commitments for or closed long
term financings for $17,250,000, and has entered preliminary agreements to
sell certain project interests to two industry partners for a total of
approximately $7,600,000. Both financings and both project sales are expected
to close prior to year-end, and the resultant aggregate availability of
only $24,000,000 in cash resources is expected to enhance working capital and
fund the Company's exploration plan in the fourth quarter and early 1999.
(see "Liquidity and Capital Resources")
The Company will look to a variety of sources to fund its continuing
capital expenditures budget, including it's new credit facilities and sales of
promoted project interests to industry partners, as it seeks to maximize its
interests and manage its risks while aggressively pursuing its exploration
projects. (see "Liquidity and Capital Resources")
The Company utilizes the successful efforts method of accounting basis.
Its accounting treatment requires it to expense most of its 3-D seismic data
acquisition costs. The Company believes such data to be a valuable asset and
a substantial portion of its expensed costs have been and are anticipated to
continue to be in the future, costs associated with the acquisition of 3-D
seismic data. It booked the exploration projects acquired pursuant to the
Acquisition Agreement at their estimated fair market value based on a third
party fairness opinion. As a result of the tax rules applicable to the
acquisitions, the Company will likely not be able to fully use its existing
net operating loss carry forward in the future.
YEAR 2000
The Company has recognized the need to ensure its systems, equipment and
operations will not be adversely impacted by the change to the calendar Year
2000. The total costs of connecting all internal systems, equipment and
operations to the Year 2000 has not been fully quantified, but it is not
expected to be a material cost to the Company. However, the Company is
continuing its efforts in addressing the Year 2000 issue as it relates to any
potential impact on the Company's operations. The Company will be conducting
a review of operational (field) systems that are the responsibility of third
party companies doing business with the Company. Any third party companies
doing business with the Company found to be not adequate in addressing the
Year 2000 issue, will be identified in the review, along with the potential
impact of non-compliant vendors. As such, the Company, at this time, cannot
fully assess the extent to which further actions will be required and cannot
at this time make any statements as to whether or not this issue will have a
material effect upon further operations. The Company has not yet established
a contingency plan, but intends to formulate one to address unavoided or
unavoidable risks and expects to have the contingency plan formulated by July
1999.
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THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUE. Total revenue increased 27.87% from $251,395 for the quarter
ended September 30, 1997 to $321,466 for the quarter ended September 30,
1998. This is primarily attributable to factors described below.
Total gas and oil revenues increased 223.15% from $87,084 to $281,408.
The increase in gas and oil revenues was primarily attributed to accrued
revenues of $256,614 due from wells placed in production during the quarter
ended September 30, 1998. The increase in oil and gas revenue was partially
offset by a decrease in gain on sale of assets of $261,790 from a gain of
$263,737 reported in the third quarter of 1997 to $1,947 reported in the
third quarter of 1998. This is reflective of a decrease in assets sold for
the period.
Operating fees to the Company increased from $8,303 for the third
quarter 1997 to $97,923 in the third quarter 1998. This increase was
attributed to the increase in operated properties, resulting from drilling
activity during the third quarter 1998. The Company realized losses from
various commodity transactions totaling $30,376 in the third quarter 1998 as
compared to $56,000 for the third quarter 1997. These losses were attributed
to various transactions in which the Company hedged future gas delivery
obligations as a requirement of its bank loan facility. Gains and losses are
determined by the spot prices being higher or lower than the hedge contracts
for the same time period. In addition to the realized losses the Company
accrued $10,817 in unrealized gains for the quarter ended September 30, 1998.
This offset prior recognized losses at a time when actual revenues were less
than hedge quantities; this is no longer the case. The Company had accrued an
unrealized loss of $95,199 for the quarter ended September 30, 1997.
In addition to the foregoing, the Company had other revenues of
$(40,253) in the third quarter of 1998 as compared to $43,470 in the third
quarter of 1997. Included in the third quarter 1998 other revenues is a
reversal of an over-accrued interest income from an affiliate of $60,976.
COSTS AND EXPENSES. Total costs and expenses of the Company increased
120.42% from $1,774,349 in the third quarter of 1997 to $3,911,096 in the
third quarter of 1998. This increase in costs and expenses was primarily
attributable to a combination of increases in exploration costs - geological
and geophysical, general and administrative costs, delay rental costs and
production taxes, offset by decreases in exploration costs - dry hole,
depletion, depreciation and amortization costs, lease operating expense and
transportation and gathering costs. The increases in costs are mostly
attributable to the expansion of the Company's exploration projects and staff
incurred after the acquisitions which closed in May of 1998.
EXPLORATION COSTS - GEOLOGICAL AND GEOPHYSICAL increased 6,036.41% from
$36,508 for the third quarter 1997 to $2,240,281 for the third quarter 1998.
These exploration costs reflect the costs of topographical, geological and
geophysical studies and include the expenses of geologists, geophysical crews
and other costs of acquiring and analyzing 3-D seismic data. The Company's
aggressive exploration drilling program has added to these costs for the
third quarter of 1998. The Company considers 3-D seismic data a valuable
asset, however, its successful efforts accounting method requires such costs
to be expensed for accounting purposes.
GENERAL AND ADMINISTRATIVE COSTS increased 138.81% from $516,907 for the
third quarter of 1997 to $1,234,414 for the third quarter of 1998. This is
attributed to increases in operational expenses primarily the increase in
salaries and other professional services as a direct result of increased
activity after the closing pursuant to the Acquisition Agreement.
DELAY RENTALS increased 177.37% from $14,766 in the third quarter 1997
to $40,956 for the third quarter of 1998. This was attributed to increased
rentals due on the Company's Starboard Project in Terrebonne Parish,
Louisiana.
PRODUCTION TAXES increased 399.85% from $4,018 for the third quarter of
1997 to $20,084 for the third quarter of 1998, due to accrued revenues of
wells placed in production during the third quarter of 1998.
INTEREST EXPENSE was zero dollars for both periods as the Company
capitalized all interest in its ongoing projects. Capitalized amounts totaled
$139,102 for the third quarter of 1998 and $56,235 for the third quarter of
1997.
EXPLORATION COSTS - DRY HOLE decreased 78.45% from $ 620,143 for the
third quarter 1997 compared to $133,666 for the third quarter of 1998.
During the third quarter of 1997 the Company participated in two dry holes
totaling $615,058, as compared to the third quarter 1998 the Company
participated in three dry holes totaling $133,594.
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DEPLETION, DEPRECIATION AND AMORTIZATION costs decreased 50.87% from
$400,435 in the third quarter 1997 to $196,729 for the third quarter 1998.
This decrease was attributed to the ceased production and write-offs of
$323,353 from the Company's Mobile Bay wells, during the third quarter of
1997, offset by $150,428 in increased DD&A for the third quarter of 1998 due
to the onset of production from wells drilling during 1998.
LEASE OPERATING EXPENSES decreased 74.92% from $177,742 for the third
quarter of 1997 to $44,573 for the third quarter of 1998. During the third
quarter of 1997 the Company incurred $135,899 in lease operating costs
associated with the Company's Mobile Bay operations, which have since been
plugged and abandoned. Costs incurred during the third quarter of 1998
include $7,136 attributed to rework activity, and $37,113 which is attributed
to ongoing operations.
TRANSPORTATION AND GATHERING COSTS decreased 89.74% from $3,830 for the
third quarter of 1997 to $393 for the third quarter of 1998. The decrease in
transportation and gathering costs is due to ceased production from the
Mobile Bay Wells and reduced production from a property located in West
Felicia Parish, Louisiana.
NET INCOME (LOSS). The net loss increased from $1,522,954 to $3,589,630
for the quarters ended September 30, 1997 and September 30, 1998,
respectively. This increase was due to the factors discussed above.
The net loss per common share decreased from a net loss of $0.94 per
share for the third quarter of 1997 to a net loss of $0.24 per share in the
third quarter of 1998. This is reflective of the increase in net loss of
$2,066,676 from the third quarter of 1997 as compared to the third quarter of
1998 and offset by the increase in numbers of shares outstanding. As a result
of additional stock issued to an investment advisor, the asset acquisition
which closed on May 14, 1998, and an underwritten common stock offering
finalized July 21, 1998, approximately 14,899,000 weighted average common
equivalent shares were outstanding at September 30, 1998 as compared to
approximately 1,644,000 at September 30, 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1997.
REVENUE. Total revenues decreased 1.80% from $682,880 for the nine
months ended September 30, 1997 to $670,589 for the nine months ended
September 30, 1998.
Total gas and oil revenues decreased 19.90% from $544,693 to $436,272.
The decrease in gas and oil revenue was attributed to the combined effects of
ceased production from the Company's Mobile Bay Wells and the sale of
properties discussed below and was offset by accrued revenues on wells placed
in production during the third quarter of 1998. Gas and oil revenues
associated with Mobile Bay declined from $60,808 for the nine months ended
September 30, 1997 compared to no revenues for the nine months ended
September 30, 1998. Effective July 1, 1997 the Company sold its interest in
various properties located in Texas, Oklahoma and Arkansas, revenues
attributed to these properties for the nine months ended September 30, 1997
were $61,995 as compared to no revenue for the nine months ended September
30, 1998.
In addition to the decrease in gas and oil revenues for the nine months
ended September 30, 1998 there was a decrease in gain on sale of assets of
$390,712 from $396,087 reported for the nine months ended September 30, 1997
to $5,375 reported for the nine months ended September 30, 1998. As a result
of the increase in operations stemming from both exploratory and
developmental drilling, operating fees increased 310.97% from $48,029 for the
nine months ended September 30, 1997 to $197,384 for the nine months ended
September 30, 1998. The Company realized a loss from various commodity
transactions totaling $128,938 for the nine months ended September 30, 1998
as compared to $212,375 for the same period of 1997. These losses were
attributed to various transactions in which the Company hedged its future gas
delivery obligations as a requirement of its bank loan facility. In addition
to the realized losses from commodity transactions, the Company accrued
$97,888 in unrealized gain for the nine months ended September 30, 1998 as
compared to an accrued loss of $251,814 for the same period of 1997. In
addition to the foregoing the Company had other revenues of $62,608 for the
nine months ended September 30, 1998 as compared to the $158,260 for the nine
months ended September 30, 1997.
COSTS AND EXPENSES. Total costs and expenses of the Company increased
102.57% from $4,877,695 for the nine months ended September 30, 1997 compared
to $9,880,937 for the nine months ended September 30, 1998. The increase was
primarily attributable to a combination of increases in exploration
costs-geological and geophysical, general and administrative costs, interest
expense and production taxes. Partially offsetting the foregoing increases in
expenses were decreases in exploration costs incurred for dry holes, lease
operating expenses, depletion, depreciation and amortization, transportation
and gathering costs and delay rentals.
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EXPLORATION COSTS - GEOLOGICAL AND GEOPHYSICAL increased 2,862.28% from
$169,747 for the nine months ended September 30, 1997 to $5,028,381 for the
nine months ended September 30, 1998. These exploration costs reflect the
costs of topographical, geological and geophysical studies and include the
expenses of geologists, geophysical crews and other costs of acquiring and
analyzing 3-D seismic data. The Company's exploration portfolio and its
aggressive drilling program has greatly increased these costs for the nine
months ended September 30, 1998 as compared with the same period of 1997. The
Company considers 3-D seismic data a valuable asset, however, its successful
efforts accounting method requires such costs to be expensed for accounting
purposes.
GENERAL AND ADMINISTRATIVE EXPENSES increased 80.28% from $1,638,601 for
the nine months ended September 30, 1997 as compared to $2,954,021 for the
nine months ended September 30, 1998. This was primarily attributable to
increases in operational expenses incurred after May 14, 1998, the effective
date of the Acquisition Agreement with Aspect and EPC and costs associated
with said acquisitions, after which time the scope of the Company's
activities increased significantly.
INTEREST EXPENSE increased 2,267.18% from $9,205 for the nine months
ended September 30, 1997 to $217,899 for the nine months ended September 30,
1998. The increase in interest expense was primarily attributed to the credit
facility dated February 23, 1998 between the Company and Duke Energy
Financial Services, Inc. The Company capitalized a large portion of its
interest in its on-going projects, which capitalized amounts totaled $300,321
for the nine months ended September 30, 1998 and $170,827 for the nine months
ended September 30, 1997.
PRODUCTION TAXES increased 37.01% from $18,273 for the nine months ended
September 30, 1997 to $25,036 for the nine months ended September 30, 1998.
The increase in production taxes was attributed to a combination of accrued
revenues of wells placed in production during the third quarter of 1998,
which increase was partially offset by a production tax refund from the State
of Oklahoma for a production enhancement project completed in 1994.
EXPLORATION COSTS - DRY HOLE COST decreased 32.87% from $1,748,498 for
the nine months ended September 30, 1997 to $1,173,767 for the nine months
ended September 30, 1998
LEASE OPERATING EXPENSE decreased 75.29% from $400,597 for the nine
months ended September 30, 1997 to $98,980 for the nine months ended
September 30, 1998. The reduction in lease operating costs is attributable to
the sale of certain Company properties, effective July 1, 1997, and ceased
operational costs for the Company's Mobile Bay wells. Lease operating costs
associated with the Mobile Bay wells for the nine months ended September 30,
1997 was $155,648 with an additional $110,000 accrued for plugging and
abandonment costs. During the nine months ended September 30, 1998, the
Company reversed over-accrued plugging and abandonment costs on the Mobile
Bay wells of $68,739. The Company also recorded $45,483 in costs attributable
to workovers, $108,632 in operational costs associated with ongoing
operations and $11,000 in costs associated with sold properties.
DEPLETION, DEPRECIATION AND AMORTIZATION ("DD&A") decreased 45.95% from
$619,959 for the nine months ended September 30, 1997 to $335,095 for the
nine months ended September 30, 1998. The decrease to DD&A was primarily
attributable to the July 1, 1997 sale of certain Company properties located
in Texas, Oklahoma, and Arkansas and the ceased production from the Mobile
Bay wells, offset by $192,842 in DD&A associated with wells placed in
production during the nine months ended September 30, 1998.
TRANSPORTATION AND GATHERING COSTS decreased 98.79% from $141,717 for
the nine months ended September 30, 1997 to $1,719 for the nine months ended
September 30, 1998. The decrease in transportation and gathering cost was
almost entirely attributable to the ceased production of the Mobile Bay Wells.
DELAY RENTAL EXPENSE decreased 64.88% from $131,098 for the nine months
ended September 30, 1997 to $46,039 for the nine months ended September 30,
1998. These rental payments were associated with the Company's Starboard
Prospect and various other prospects.
NET INCOME (LOSS) The net loss increased from $4,194,815 to $9,210,348
for the nine months ended September 30, 1997 and September 30, 1998
respectively. This increase was due to the factors discussed above.
The net loss per common share decreased from a net loss of $2.60 per
share for the nine months ended September 30, 1997 to a net loss of $1.18 for
the nine months ended September 30, 1998. This is reflective of the increase
in net loss of $5,015,533 from the nine months ended September 30, 1997 as
compared to the nine months ended September 30, 1998.
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The increased net loss was offset by the increased number of weighted average
common equivalent shares at September 30, 1998, resulting from the public
offering finalized August 14, 1996, additional stock issued to an investment
advisor, the asset acquisition which closed May 14, 1998, and the
underwritten common stock offering closed July 21, 1998. Approximately
7,857,000 weighted average common equivalent shares were outstanding at
September 30, 1998 as compared to approximately 1,644,000 at September 30,
1997.
KNOWN AND ANTICIPATED TRENDS, CONTINGENCIES AND DEVELOPMENTS IMPACTING
FUTURE OPERATING RESULTS
The Company's future operating results will be substantially dependent upon
the success of the Company's efforts to develop the properties acquired in the
Acquisitions, as well as the Starboard Project and other prospects. Because the
Company divested substantially all of its oil and gas properties in the
Mid-Continent region by the end of 1996, revenues from the operation and sale of
such properties have been substantially reduced during 1997 and will be reduced
in future years. Further, following a sharp and unexpected drop in production
from the Company's Mobile Bay wells during the fourth quarter of 1996, the
Company's share of revenues from Mobile Bay was substantially reduced during
1997.
As a result of the loss of revenues from the Mid-Continent region and
Mobile Bay, the Company's revenues during 1997 were sharply reduced. While
management believes that the Acquisitions and the Starboard Project represent
the most promising prospects in the Company's history, and the wells drilled
on projects acquired pursuant to the Acquisitions in 1998 are expected to
substantially increase the Company's revenues, the capital expenditures
planned on the Acquisitions and the Starboard Project will continue to
require substantial outlays of capital to explore, develop and produce. 1998
drilling results have in fact resulted in substantial revenue increases which
will be evidenced in the fourth quarter. Capital from sources other than cash
flow from operations will continue to be required for funding planned
exploration activities.
LIQUIDITY AND CAPITAL RESOURCES
The Company has budgeted over $25.0 million to fund the drilling of over
30 wells on the Exploration Projects and other exploration costs over the
next 12 months. The Company's sources of financing include borrowing capacity
under the Bank Credit Agreement and other credit facilities, the sale of
promoted interests in the Exploration Projects to industry partners and cash
provided from operations. The Company received over $14,000,000 in net
proceeds from a public offering of common stock effective July 16, 1998. Of
such proceeds, $7.8 million was used to repay the Duke Credit Facility, and
the remainder is being used for exploration activities on the Exploration
Projects, including the payment of costs incurred by affiliates on the
exploration projects acquired on May 14, 1998 which costs were incurred after
the effective date of November 1, 1997 and prior to closing, and for working
capital and general corporate purposes.
The Company entered the fourth quarter having gone from nominal second
quarter gas and oil production and large operating cash flow deficits to a
company which has added $400,000 to $500,000 per month in oil and gas
revenues, most of which is attributable to wells which commenced production
in September and October of 1998. This should allow it to achieve positive
operating cash flow in the fourth quarter and beyond (prior to capex costs
and new 3-D seismic data acquisition costs, which costs the successful
efforts accounting method utilized by the Company mandate to be expensed
rather than capitalized). In addition, since the end of the third quarter,
the Company has received commitments for or closed long term financings for
$17,250,000 and has entered preliminary agreements to sell certain project
interests to two industry partners for a total of approximately $7,600,000.
Both financings and both project sales are expected to close prior to
year-end, and the resultant aggregate availability of approximately
$24,850,000 in cash is expected to enhance working capital and fund the
Company's exploration plan in the fourth quarter and early 1999.
On October 23, 1998, the Company amended and restated the $15,000,000
credit agreement dated January 3, 1996 with Bank of America NT & SA ("B of
A"). The amended agreement provided for an immediate borrowing base up to
$9,000,000 ($8,250,000 if the Company does a third party financing in which
the third party lender would share in certain collateral of B of A). The
Company has drawn $6,000,000 pursuant to the B of A loan facility. The loan
is in two tranches. Tranche A is a revolving facility with no required
principle payments for two years after which it converts into a 36 month term
loan. Tranche B is payable in interest only until maturity in eighteen
months. Both loans are at a varied interest rate utilizing either the B of
A's Alternate Reference Rate (Alternate Reference Rate is the greater of (i)
B of A's Reference Rate and (ii) the Federal Funds effective rate plus 0.50%)
or the Interbank rate plus 2% for Tranche A and 4% for Tranche B. The
remaining funds will be available for specific future drilling activities of
the Company, subject to the approval of the bank. The loan is secured by a
mortgage on all properties currently owned by the Company. In addition, B of
A received a 2.0% overriding royalty interest, proportionately reduced to the
Company's net interest, in the properties classified proven as of the date of
closing and received a five year warrant to purchase 95,000 shares of common
stock at a price equal to the average daily closing price of the Company's
common stock for the thirty days prior to closing of the credit agreement.
Proceeds of the loan primarily supplement working capital.
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The Company has received an additional loan commitment from Duke Energy
Financial Services, Inc. ("Duke") The commitment, which is subject to
completion of due diligence and negotiation of a final credit agreement and
an inter-creditor agreement with B of A, provides for Duke to loan up to
$9,000,000 to the Company for eighteen months. The loan will amortize on a
quarterly basis for five quarters with a final principal payment at the end
of eighteen months of $1.9 million being due. Duke will be paid interest at a
rate of prime plus 4%. It will also receive a right to gather and process, at
fair market value, gas and condensate from a designated area of interest, and
a revenue interest in certain of the Company's future drilling activities not
to exceed 0.49% of the Company's net interest. Proceeds will primarily
supplement exploration costs.
The Company will require additional sources of capital to fund its
exploration budget over the next 12 months. It anticipates substantial growth
of its credit facility with B of A as proven reserves of gas and oil are
added by its exploration program. It also plans to continue to sell promoted
interests in certain of its Exploration Projects to fund its exploration
program over the next 12 months.
The Company historically has addressed its long-term liquidity needs
through the issuance of debt and equity securities, through bank credit and
other credit facilities and with cash provided by operating activities. Its
major obligations at September 30, 1998, consisted principally of (i)
servicing loans under the Bank Credit Agreement and other loans, (ii) funding
of the Company's exploration activities, and (iii) funding of the day-to-day
general and administrative costs.
The Company booked the assets acquired in the Acquisitions at $54.2
million, which was the estimated fair market value of such assets as
determined by an independent third party, plus costs incurred on the acquired
assets after the effective date of November 1, 1997 and prior to closing on
May 14, 1998. Items affected by the Acquisitions include (i) an increase in
the Company's current liabilities by the assumption of approximately $4.755
million of net post-effective date costs related to the assets acquired in
the Acquisitions, plus $1 million of additional current liabilities assumed
from EPC pursuant to the Acquisition Agreement, (ii) an increase in overhead
resulting from the hiring of additional technical staff and additional
management; and (iii) adopting a business plan that budgets over $25.0
million net to the Company's interest in exploratory costs over the next 12
months. Certain costs associated with these obligations will be offset by
future revenues from wells drilled since the effective date of the
Acquisitions and other revenue anticipated from wells scheduled to be drilled
in the third and fourth quarter of 1998.
Many of the factors that may affect the Company's future operating
performance and long-term liquidity are beyond the Company's control,
including, but not limited to, oil and natural gas prices, governmental
actions and taxes, the availability and attractiveness of financing and its
operational results. The Company continues to examine alternative sources of
long-term capital, including bank borrowings, the issuance of debt
instruments, the sale of common stock or other equity securities, the
issuance of net profits interests, sales of promoted interests in its
Exploration Projects, and various forms of joint venture financing. In
addition, the prices the Company receives for its future oil and natural gas
production and the level of the Company's production will have a significant
impact on future operating cash flows.
In order to minimize the pricing risk associated with oil and gas sales,
the Company entered into a twelve-month hedging transaction with Bank of
America Financial Engineering and Risk Management Group. The hedging
instrument called for the delivery of 4,700 MMBTUs per day at a price of
$2.30 per MMBTU before basis differential adjustments for the period November
1, 1998 through October 31, 1999.
WORKING CAPITAL. At September 30, 1998, the Company had a cash balance
of $134,257 and a working capital deficit of $13,269,216 as compared to a
cash balance of $690,576 and a working capital deficit of $413,377 at
December 31, 1997. The working capital deficit was primarily attributable to
substantial exploratory costs, including the substantial costs of 3-D seismic
data acquisition and analysis, incurred in 1998, deficit cash flow from
operations incurred in the first three quarters of 1998, and the receipt of
approximately $9,000,000 less in net proceeds then planned from the sale of
common stock of the Company in the third quarter. In regard to said sale, the
Company sold fewer shares for less money per share than planned in its July
underwriting primarily due to market conditions beyond its control. As a
result, it slowed its exploratory drilling in the third quarter. Gas and oil
revenues from wells which went into production in 1998 are anticipated to
generate revenues which will equal or exceed ongoing costs of operations
(prior to capital expenditures and the cost of new 3-D seismic data
acquisitions) in the fourth quarter and beyond. Since the end of the third
quarter, the company has received the previously described financing
commitments and entered the previously described contracts to sell interests
in projects which collectively will provide, if closed, over $24,000,000 in
available cash resources prior to fiscal year-end. Such cash resources will
substantially improve working capital and further provide significant capital
for planned capital expenditures. As a result the Company plans to resume a
more aggressive pace of exploratory drilling.
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SUMMARY. The Company believes it is positioned for a period of
significant exploration activity on its technology enhanced projects. Many of
the projects have reached the drilling stage. In many instances the requisite
process of geological and/or engineering analysis, followed by acreage
acquisition of leasehold rights and seismic permitting, and 3-D seismic field
data acquisition, then processing of the data and finally its interpretation
took several years of time and the investment of significant capital.
Management believes the acquisition of projects at this advanced stage has
not only reduced the drilling risk, but should allow the Company to
consistently drill on a broad array of exploration prospects over the next
twelve months. Included will be several prospects planned to be drilled in
the fourth quarter of 1998 and the first quarter of 1999 by the Company which
have extremely high potential to its net interest. As evidence of this
activity the Company has participated in the drilling of 20 wells from March
through the date hereof, with working interests which range from 8% to 79%.
Out of the 20 wells drilled, 11 wells have been completed, 8 were dry holes
and 1 is being drilled. Several of the successful wells went into production
in the third quarter, and management expects its net oil and gas revenues in
the fourth quarter of 1998 to exceed $400,000 per month from this new drilling
alone.
In that the Company will not fund most of its capital expenditure budget
from cash flow, the Company will continue to look to a variety of sources to
fund its continuing capital expenditures budget including credit facilities
and sales of promoted project interests to industry partners, as it seeks to
maximize its interests and manage its risks while aggressively pursuing its
exploration projects. This process will be limited more by capital
availability than by its inventory of drillable prospects.
Timing of funding its exploration budget will determine the pace of
drilling and, to the extent drilling is successful, the growth of future oil
and gas revenues. Assuming closing of committed credit facilities and the
sale of project interests under contract, the Company will aggressively drill
its exploration projects over the next six months. Management believes
expanded credit facilities will be available to it in 1999 if it achieves
meaningful exploratory and developmental drilling success and that strategic
sales of prospect interests will be effected which will allow it to continue
its planned exploration activities throughout the year.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS. In 1997, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 128, "Earnings per Share"
and SFAS No. 129, "Disclosure Information about Capital Structure," which
have been reflected in the Company's year-end 1997 financial statements. In
1997, FASB also issued SFAS No. 130, "Reporting Comprehensive Income", SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information", and SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities" each of which require expanded disclosures effective in
future periods. The Company does not expect the application of these
statements to have a material effect on its financial position, liquidity or
results of operations.
17
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Esenjay Petroleum Corporation ("EPC") was a defendant in a lawsuit
regarding injuries to an oilfield worker that resulted in a judgment against
EPC of approximately $17,700,000. The judgment was settled by EPC's insurers,
who agreed to make cash payments to the plaintiff, and by EPC who agreed to
implement a mutually agreeable work safety plan. The settlement was entered
into and approved by the court entering an agreed judgment on December 3,
1997. On approximately April 16, 1998, the plaintiff filed an action against
both EPC and the Company alleging, in part, that EPC has failed and refused
to implement an appropriate safety plan and entered negotiations with the
Company to convey material assets to it which, if consummated, would negate
plaintiffs benefits to be obtained by EPC's safety plan, thereby fraudulently
inducing plaintiff to settle the judgment against EPC. The Company believes
the claims are not supported by the facts and are without merit. The Company
and EPC intend to vigorously defend the claims. Further, the Company is
indemnified by EPC for any losses incurred by the Company in said lawsuit
other than its' attorney fees.
ITEM 2. CHANGES IN SECURITIES.
On July 21, 1998, the Company closed an underwritten offering of
4,000,000 shares of its common stock at a price of $4.00 per share. The net
proceeds to the Company in the underwritten offering were approximately
$14,880,000, and as a result the Company had 15,775,223 shares outstanding as
of November 11, 1998. The proceeds were utilized to fully repay the credit
facility from Duke Energy Financial Services, Inc., to reduce accounts
payable, and for working capital and exploration costs.
ITEM 3. OTHER INFORMATION.
As a result of the completion of the acquisitions as set forth in the
Acquisition Agreement, the Company has been able to expand its business
strategy. The strategy being implemented is to expand its reserves,
production and cash flow through the implementation of an exploration program
that focuses on (i) obtaining dominant positions in core areas of
exploration; (ii) enhancing the value of its exploration projects and
reducing exploration risks through the use of 3-D seismic and CAEX
technologies; (iii) maintaining an experienced technical staff with the
expertise necessary to take advantage of the Company's proprietary 3-D
seismic and CAEX seismic data; (iv) reducing exploration risks by focusing on
the identification of moderate depth gas reservoirs, which the Company
believes are conducive to direct hydrocarbon detection technologies; and (v)
retaining control over critical exploration decisions. The value, scope and
advanced stage of technological evaluation of the focused core areas
represented in the properties acquired pursuant to the Acquisition Agreement
have allowed the Company to seek to implement this strategy.
ITEM 4. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
The following is filed as an exhibit to Part I of this Form 10-Q
Exhibit No. 11 Computation of Earnings Per Common Share
Exhibit No. 27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K for the quarter ended
September 30, 1998.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned thereunto duly authorized.
ESENJAY EXPLORATION, INC.
Date: NOVEMBER 16, 1998 By: /s/ Michael E. Johnson
----------------------------------------
Michael E. Johnson, President
(Principal Executive Officer for
the quarterly reporting period) and
Director
Date: NOVEMBER 16, 1998 By: /s/ David B. Christofferson
----------------------------------------
David B. Christofferson, Senior
Vice President
General Counsel, Principal
Financial Officer
Date: NOVEMBER 16, 1998 By: /s/ Howard E. Williams
----------------------------------------
Howard E. Williams, Vice President
Principal Accounting Officer
19
<PAGE>
EXHIBIT 11 TO FORM 10QSB
ESENJAY EXPLORATION, INC.
Computation of Loss Per Common Share
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
----------------------------- ----------------------------
1998 1997 1998 1997
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE
Weighted average of common shares
Outstanding ........................................ 14,898,728 1,644,317 7,856,842 1,644,317
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
Basic loss per share ............................. $ (0.24) $ (0.94) $ (1.18) $ (2.60)
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
DILUTED EARNINGS PER SHARE
Weighted Average Common Shares
outstanding ........................................ 14,898,728 1,644,317 7,856,842 1,644,317
Shares issuable from assumed conversion of
Common share options and warrants ................ 7,500 -- 7,500 --
Convertible preferred stock ...................... -- 28,654 -- 28,654
------------ ----------- ----------- -----------
Weighted average common shares
Outstanding, as adjusted ........................... 14,906,228 1,672,971 7,864,342 1,672,971
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
Diluted loss per share ........................... $ (0.24) $ (0.91) $ (1.18) $ (2.51)
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
EARNINGS FOR BASIC AND DILUTED
COMPUTATION
Net loss .............................................. $ (3,589,630) $(1,522,954) $(9,210,348) $(4,194,815)
Preferred stock dividend .............................. -- (25,788) (48,138) (77,365)
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
Net income to common shareholders
(basic earnings per share computation).............. (3,589,630) (1,548,742) (9,258,486) (4,272,180)
Preferred shares dividend ............................. -- 25,788 -- 77,365
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
Net loss to common shareholders, as adjusted
(diluted earnings per share computation)............ $ (3,589,630) $(1,522,954) $(9,258,486) $(4,194,815)
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
</TABLE>
This calculation is submitted in accordance with Regulation S-K; although it
is contrary to paragraphs 13 through 16 of the Financial Accounting Standards
Board's Statement of Financial Standard No. 128, because it produces an
antidilutive result.
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 134,257
<SECURITIES> 0
<RECEIVABLES> 2,293,704
<ALLOWANCES> (5,095)
<INVENTORY> 0
<CURRENT-ASSETS> 2,710,523
<PP&E> 71,410,290
<DEPRECIATION> (1,560,298)
<TOTAL-ASSETS> 72,711,105
<CURRENT-LIABILITIES> 15,979,739
<BONDS> 0
0
0
<COMMON> 157,752
<OTHER-SE> 55,421,540
<TOTAL-LIABILITY-AND-EQUITY> 72,711,105
<SALES> 436,272
<TOTAL-REVENUES> 670,589
<CGS> 0
<TOTAL-COSTS> 9,663,038
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 217,899
<INCOME-PRETAX> (9,210,348)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,210,348)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,210,348)
<EPS-PRIMARY> (1.18)
<EPS-DILUTED> (1.18)
</TABLE>
