<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, 1999
[ ] 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 (I.R.S. Employer
incorporation or organization) Identification Number)
500 NORTH WATER STREET, SUITE 1100
CORPUS CHRISTI, TEXAS 78471
(Address of principal executive offices including zip code)
(361) 883-7464
(Issuer's telephone number including area code)
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 [ ]
18,775,227 shares as the registrant's common stock were outstanding as
of November 11, 1999.
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No [ X ]
- -------------------------------------------------------------------------------
<PAGE>
ESENJAY EXPLORATION, INC.
FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements - General Information......................................................3
Condensed Consolidated Balance Sheets as of September 30, 1999 (unaudited) and
December 31, 1998...........................................................................4
Condensed Consolidated Statements of Operations for the three months and nine months
ended September 30, 1999 and 1998 (unaudited)...............................................5
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 1998 (unaudited)...............................................6
Notes to Condensed Consolidated Financial Statements (unaudited)...............................7
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..............................................................11
PART II. OTHER INFORMATION..............................................................................25
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GENERAL
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 results of operations for the
three and nine months ended September 30, 1999 and 1998.
Operating results for interim periods are not necessarily indicative of
the results for full years. It is suggested that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements for the year ended December 31, 1998 and the related notes thereto
included in Form 10-KSB and 10KSB/A as filed with the SEC. It is further
suggested that all comparative information be considered in the context of
certain acquisitions closed on May 14, 1998, which resulted in significant
changes to the scope, focus and method of doing business of the Company and may
diminish the value of the comparisons when analyzing relevant trends.
3
<PAGE>
ESENJAY EXPLORATION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
----------------- ---------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................... $ 1,060,615 $ 646,200
Accounts receivable, net of allowance for doubtful
accounts of $519,137 at September 30, 1999 and
$348,984 at December 31, 1998................................... 6,168,245 3,209,633
Prepaid expenses and other......................................... 954,096 122,422
Receivables from affiliates........................................ 258,278 963,700
----------------- ---------------
Total current assets...................................... 8,441,234 4,941,955
Property and equipment, successful efforts method of accounting......... 76,337,880 70,044,882
Less accumulated depletion, depreciation
and amortization................................................... (23,906,269) (15,517,656)
----------------- ---------------
52,431,611 54,527,226
Other assets .......................................................... 800,028 447,091
----------------- ---------------
Total assets.............................................. $ 61,672,873 $ 59,916,272
----------------- ---------------
----------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
SEPTEMBER 30, DECEMBER 31,
1999 1998
----------------- ---------------
<S> <C> <C>
Current liabilities:
Accounts payable................................................... $ 7,401,901 $ 8,993,859
Accounts payable to affiliate, net................................. 684,988 4,322,548
Revenue distribution payable....................................... 2,243,882 1,996,091
Current portion of long-term debt.................................. 11,013,162 101,236
Accrued and other liabilities...................................... 1,309,951 484,756
----------------- ---------------
Total current liabilities................................. 22,653,884 15,898,490
Commitments and Contingencies........................................... --- ---
Long-term debt ......................................................... 4,750,000 7,500,000
Non-recourse debt ...................................................... 864,000 864,000
Accrued interest on non-recourse debt .................................. 430,274 331,194
----------------- ---------------
Total liabilities ........................................ 28,698,158 24,593,684
Stockholders' equity:
Common stock:
Class A common stock, $.01 par value; 40,000,000 shares authorized;
18,775,227 outstanding at September 30,
1999 and 15,784,834 outstanding December 31, 1998............... 187,752 157,849
Preferred stock:
Series A preferred stock $.01 par value; 5,000,000 shares Authorized;
356,999 outstanding at September 30, 1999;
none at December 31, 1998....................................... 3,570 ---
Additional paid-in capital ........................................ 84,900,030 77,651,602
Accumulated deficit................................................ (52,116,637) (42,486,863)
----------------- ---------------
Total stockholders' equity................................ 32,974,715 35,322,588
----------------- ---------------
Total liabilities and stockholders' equity................ $ 61,672,873 $ 59,916,272
----------------- ---------------
----------------- ---------------
</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,
1999 1998 1999 1998
--------------- --------------- -------------- --------------
<S> <C> <C>
Revenues:
Gas and oil revenues............................ $ 2,577,335 $ 281,408 $ 4,334,441 $ 436,272
Realized gain (loss) on commodity transactions.. 33,557 (30,376) 231,580 (128,938)
Unrealized gain on commodity transactions --- 10,817 --- 97,888
Gain on sale of assets.......................... 1,924,273 1,947 2,034,905 5,375
Operating fees.................................. 69,803 97,923 223,154 197,384
Other revenues.................................. 10,474 (40,253) 34,911 62,608
--------------- --------------- -------------- --------------
Total revenues.............................. 4,615,442 321,466 6,858,991 670,589
--------------- --------------- -------------- --------------
Costs and expenses:
Lease operating expense......................... 109,622 44,966 482,210 100,699
Production taxes................................ 158,241 20,084 273,475 25,036
Depletion, depreciation and amortization........ 1,065,641 196,729 2,241,468 335,095
Amortization of unproved properties............. 1,692,600 --- 6,050,600 ---
Impairment of assets............................ 358,106 --- 358,106 ---
Exploration costs - geological and geophysical.. 280,896 2,240,281 1,565,374 5,028,381
Exploration costs - dry hole.................... 332,820 133,666 398,098 1,173,767
Interest expense................................ 212,538 --- 520,977 217,899
General and administrative expense.............. 1,266,805 1,234,414 4,348,901 2,954,021
Delay Rentals................................... 178,547 40,956 249,556 46,039
--------------- --------------- -------------- --------------
Total costs and expenses.................... 5,655,816 3,911,096 16,488,765 9,880,937
Loss before provision for income taxes............... (1,040,374) (3,589,630) (9,629,774) (9,210,348)
Benefit (provision) for income taxes................. --- --- --- ---
Net loss............................................. (1,040,374) (3,589,630) (9,629,774) (9,210,348)
Cumulative preferred stock dividend.................. --- --- --- 48,138
--------------- --------------- -------------- --------------
Net loss applicable to common stockholders........... $(1,040,374) $(3,589,630) $(9,629,774) $(9,258,486)
--------------- --------------- -------------- --------------
--------------- --------------- -------------- --------------
Net loss per common and common equivalent share...... $ (0.06) $ (0.24) $ (0.61) $ (1.18)
--------------- --------------- -------------- --------------
--------------- --------------- -------------- --------------
Weighted average number of common shares
Outstanding ( in thousands)................. 16,062 14,899 15,882 7,857
--------------- --------------- -------------- --------------
--------------- --------------- -------------- --------------
</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,
----------------------------------------
1999 1998
------------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss...................................................... $(9,629,774) $(9,210,348)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depletion, depreciation and amortization ..................... 2,241,468 335,095
Amortization of unproven property............................. 6,050,600 ---
Impairment of assets.......................................... 358,106 ---
Gain on sale of assets........................................ (2,034,905) (5,375)
Amortization of financing costs and warrants.................. 73,886 107,428
Unrealized loss on commodity transactions..................... --- (97,888)
Exploration costs - dry hole.................................. 398,098 1,173,767
Changes in operating assets and liabilities:
Trade and affiliate receivables........................... (2,074,369) (2,086,068)
Prepaid expenses and other................................ (814,205) 86,165
Other assets.............................................. (659,025) (1,141,033)
Accounts payable.......................................... 632,028 5,342,532
Accounts payable to affiliates............................ (937,560) (601,197)
Revenue distribution payable.............................. 247,791 910,428
Accrued and other......................................... 844,282 926,058
------------------- -----------------
Net cash used in operating activities......................... (5,303,579) (4,260,436)
------------------- -----------------
Cash flows from investing activities:
Capital expenditures - gas and oil properties................. (10,116,390) (9,169,424)
Capital expenditures - other property and equipment........... (172,429) (211,965)
Proceeds from sale of assets.................................. 8,435,500 36,441
------------------- -----------------
Net cash used in investing activities..................... (1,853,319) (9,344,948)
------------------- -----------------
Cash flows from financing activities:
Proceeds from issuance of common stock........................ 159,387 8,300,000
Proceeds from issuance of debt................................ 8,920,000 14,417,480
Repayments of long-term debt.................................. (1,508,074) (8,580,151)
Preferred stock redeemed...................................... --- (859,610)
Preferred stock dividends paid................................ --- (228,654)
------------------- -----------------
Net cash provided by financing activities................. 7,571,313 13,049,065
------------------- -----------------
Net increase (decrease) in cash and cash equivalents...... 414,415 (556,319)
Cash and cash equivalents at beginning of period................... 646,200 690,576
------------------- -----------------
Cash and cash equivalents at end of period......................... $ 1,060,615 $ 134,257
------------------- -----------------
------------------- -----------------
Supplemental disclosure of cash flow information:
Cash paid for interest........................................ $ 1,326,919 $ 612,469
------------------- -----------------
------------------- -----------------
Supplemental disclosure of non-cash investing and financing activities:
Sale of oil and gas properties in satisfaction
of payable to affiliates............................. $ 2,700,000 ---
Acquisition of assets..................................... 8,333,853 $ 58,864,160
Proxy Costs............................................... 288,087 287,173
Assumption of related liabilities......................... 923,252 8,146,618
Issuance of common stock.................................. 6,723,378 50,430,370
Issuance of preferred stock............................... 687,223 ---
</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 of the information and footnotes required by
generally accepted accounting principles for complete financial statements.
Interim results are not necessarily indicative of results for a full year.
The Company uses the successful efforts method of accounting for gas
and oil exploration and development costs. All costs of acquired wells,
productive exploratory wells, and development wells are capitalized and
depleted by the unit of production method based upon estimated proved
developed reserves. Exploratory dry hole costs, geological and geophysical
costs, and lease rentals on non-producing leases are expensed as incurred. Gas
and oil leasehold acquisition costs are capitalized. Costs of unproved
properties are transferred to proved properties when reserves are proved.
Valuation allowances are provided if the net capitalized costs of gas and oil
properties at the field level exceed their realizable values based on expected
future cash flows. Unproved properties are periodically assessed for
impairment and, if necessary, a loss is recognized. The Company recognized
$358,106 of impairments of unproved properties for the three and nine month
periods ended September 30, 1999.
In addition, the $54,200,000 fair market value assigned to unproven gas
and oil exploration projects contributed by Esenjay Petroleum Corporation
("EPC") and Aspect Resources LLC ("Aspect") pursuant to certain acquisitions of
undeveloped exploration projects (the "Acquisitions") which closed on May 14,
1998, until such time as the book value of each such project is either drilled
and transferred to producing properties or is otherwise evaluated as impaired,
are being amortized on a straight-line basis over a period not to exceed
forty-eight months. The total remaining net book value of the properties
acquired pursuant to the Acquisition, which was not transferred to producing
properties and/or amortized, was $17,154,294 and $32,686,300, respectively, at
September 30, 1999 and December 31, 1998.
A summary of all of the Company's significant accounting policies is
presented on pages 40 and 41 of its 1998 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 1999.
The accompanying interim financial statements contain all material
adjustments, which are in the opinion of management, consistent with the
adjustments necessary to present the fairly stated consolidated financial
position, results of operations and cash flows of Esenjay Exploration, Inc. for
the interim period. Certain prior period amounts have been reclassified to
conform with the current period presentation.
7
<PAGE>
2. LONG-TERM DEBT:
Long-term debt consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
<S> <C> <C>
Note payable repaid in 1999..................................................... $ --- $ 1,236
Non-recourse loan, payable out of an 8% ORRI on the Starboard Prospect,
interest accrued at 15%...................................................... 864,000 864,000
Note payable, interest at 12%, payable monthly, is currently due................ 100,000 100,000
Loan with Bank of America NT&SA ("B of A"), in two Tranches: Tranche A is a
revolving credit facility which terminates October 13, 2000, thereafter
converting the unpaid balance into a five year term loan requiring quarterly
principle and interest payments; Tranche B is payable as to interest only
until maturity on April 13, 2000, at which time payment in full is required.
Both loans are at a varied interest rate utilizing either the B of A's
Alternative Reference Rate (Alternative 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 loan is
secured by a mortgage on most properties
currently owned by the Company.............................................. 8,523,162 7,500,000
Loan with Duke Energy Field Services, Inc., which provided for up to $9,000,000
to the Company for eighteen months pursuant to a decreasing facility. The
commitment reduces by $930,000 per quarter for five quarters beginning on
May 1, 1999, and reducing to zero on August 1, 2000. Total available as of
September 30, 1999 was $7,140,000. The interest rate is prime plus 4%. The
loan is secured by a mortgage on all properties
currently owned by the Company.............................................. 7,140,000 ---
---------------- -----------------
16,627,162 8,465,236
Less current portion............................................................ 11,013,162 101,236
---------------- -----------------
$ 5,614,000 $ 8,364,000
---------------- -----------------
---------------- -----------------
</TABLE>
On October 13, 1998, the Company amended and restated the credit
agreement dated January 3, 1996 with B of A to an amount equal to the lesser
of the Collateral Value, or $20,000,000. The amended agreement provided
for an immediate borrowing base of up to $9,000,000 ($8,250,000 if the
Company did a third party financing in which the third party lender would
share in certain collateral of B of A). In conjunction with this financing,
B of A received a 2% 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. As part of the credit agreement, the Company is subject to certain
covenants and restrictions, among which are the limitations on additional
borrowing, and sales of significant properties, working capital, cash,
and net worth maintenance requirements and a minimum debt to net worth
ratio. In July of 1999 the covenants were amended to decrease the
Tangible Net Worth requirement from a minimum of $45,000,000 to a
minimum of $25,000,000. The covenants regarding financial condition of
Company are as follows:
<TABLE>
<S> <C>
Tangible Net Worth............................ $25,000,000 + 50% of Consolidated Net Income + 100% of net
proceeds received from sale of any Non-Redeemable Stock
Current Ratio................................. 1.1:1.0
Debt to Capitalization........................ 0.5:1.0
Interest Coverage Ratio ...................... 1.0:1.0 -1st quarter 1999; 3.0:1.0 - 2nd quarter 1999 and any four
consecutive quarters after June 30, 1999
</TABLE>
8
<PAGE>
As of September 30, 1999, the Company's current ratio was 0.7251 and
the Company's interest coverage ratio was 5.4434 to 1 for the quarter but
(1.1475) to 1 for the four consecutive quarters ended September 30, both of
which were, therefore, in noncompliance. Although the Company has increased its
cash position as a direct result of sales of project interests completed during
the third quarter of 1999, its significant capital expenditures in the quarter
in the form of drilling costs caused it to be in non-compliance at September 30,
1999. B of A has waived said noncompliance at September 30, 1999. Although the
Company believes it can be in compliance with these covenants in the future,
there can be no assurance that it will be in compliance. As a result it is
possible that additional waivers may be needed in the future. In the event B of
A did not grant such waivers, if needed, the Company would be in noncompliance
of the covenants and would seek alternative financing arrangements.
The Company has entered into an interest rate swap guaranteeing a
fixed interest rate of 5.37% on the loan, and the Company will pay fees of
three-eighths of 1% (.0375%) on the unused portion of the commitment amount.
The unrealized loss on the interest rate swap agreement was $1,968 at
September 30, 1999. The actual rate for the Company is the fixed rate of 5.0%
plus 2% on Tranche A and the fixed rate of 5.0% plus 4% on Tranche B of the
loans from B of A.
On January 28, 1999, the Company closed a credit facility with Duke.
This facility provided for Duke to loan up to $9,000,000 to the Company for
eighteen months. The Company had $7,140,000 outstanding on said facility as
of September 30, 1999,which represented the total amount then available. The
commitment initially reduced by $930,000 per quarter until it reduces to zero
on August 1, 2000. Effective November 1, 1999, the Company and Duke amended
the credit agreement such that there was no reduction in the available amount
of $7,140,000 on November 1, 1999. As a result, the commitment amount
reduces by $1,860,000 in February of 2000, $930,000 in May of 2000, and
reduces to 0 in August of 2000. Principal outstanding cannot exceed the
commitment amount at any time. Duke is paid interest at a rate of prime plus
4%. It also received a right to gather and process, at fair market value,
gas and condensate from a designated area of interest, and a net revenue
interest in certain of the Company's future drilling activities not to exceed
0.49% of the Company's net interest. Proceeds primarily supplement
exploration costs.
On January 28, 1999, the Company, B of A, and Duke entered into an
intercreditor agreement which governs the collateral which is used to secure
the credit facility with B of A and the credit facility with Duke. Tranche A
of the B of A credit facility is secured by a first mortgage on most of the
Company's proven properties. Collateral securing amounts outstanding under
both the Duke credit facility and Tranche B of the B of A facility is
primarily comprised of mortgages taken on a significant proportion of the
Exploration Projects of the Company which have not been developed. At such
time as drilling is conducted on the Exploration Projects and proven reserves
are discovered, the Company has a right to seek increases in the available
amount to be drawn under Tranche A of its credit facility with B of A. In the
event B of A agrees to increase the amounts available pursuant to Tranche A,
then, subject to Duke's consent, security interests in proven reserves would
be used as additional primary collateral on Tranche A loans from B of A
supporting the borrowing availability increases.
3. ACQUISITION
On May 12, 1999, the Company announced that on May 11, 1999 it had
signed a Plan and Agreement of Merger with 3DX Technologies Inc. ("3DX") which
provided for the merger of 3DX into the Company (the "Acquisition"). The
shareholders of both companies approved the transaction at duly called
shareholders meetings on September 23, 1999 and the merger was consummated the
same day. The purchase price of the Acquisition was approximately $7.4
million of which $6.7 million was in the Company's common stock and $0.7
million was in the Company's preferred stock.
The terms of the merger provided for 3DX shareholders to receive, at
their election, either (i) the issuance of one share of Esenjay common stock
for 3.25 shares of 3DX common stock; or (ii) the issuance of a new Esenjay
convertible preferred stock at a ratio of one share of Esenjay convertible
preferred stock for each 2.75 shares of 3DX common stock. Approximately 91%
of the 3DX common shares converted into Esenjay common stock and
approximately 9% were converted into Esenjay convertible preferred stock. As
a result, Esenjay issued approximately 2,906,778 new shares of common stock
and approximately 356,999 shares of convertible preferred stock. The
convertible preferred stock may be redeemed at Esenjay's sole option until
September 23, 2000 at $1.925 per share. If not redeemed by that time, the
preferred will automatically convert into one share of Esenjay
9
<PAGE>
common stock on October 1, 2000 if the average closing price of Esenjay
common stock is greater than or equal to $1.875 during the month of September
2000. If the Esenjay common stock averages less than $1.875 in September of
2000, the preferred holder has the right, during the month of October of
2000, to "put" the shares to Esenjay. If put, Esenjay will then have the
right to retire the convertible preferred stock for $1.65 in cash or for
common stock with the number of shares of common stock adjusted based upon a
formula set out in the merger agreement. Under any scenario the convertible
preferred stock is scheduled to be converted or redeemed not later than
November 1, 2000.
3DX Technologies Inc. was a Houston-based exploration and production
company whose strategic business focus was the utilization of 3-D seismic
imaging and other advanced technologies in the search for natural gas and oil
principally in the onshore gulf coast of the United States. As a result of the
merger, the Company employed four members of the reservoir engineering and
geophysical staff of 3DX, plus one support person, increased its gas and oil
reserves, its monthly gas and oil revenues, and expanded its ownership of 3D
seismic data and projects.
The Acquisition has been accounted for using the purchase method of
accounting and, accordingly, the purchase price has been allocated to the assets
and liabilities acquired based on fair value at the date of acquisition. The
Acquisition included at fair value, current assets of $2.5 million, property
and equipment of $5.8 million, other assets of $0.1 million and liabilities
of $0.9 million. The operating results of the Acquisition has been included
in the Company's condensed consolidated financial statements from the date of
acquisition. The following unaudited pro forma information presents a summary
of the consolidated results of operations for the three and nine months ended
September 30, 1999 and 1998 as if the Acquisition had occurred on January 1,
1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------------------- ----------------------------------
1999 1998 1999 1998
----------------- ---------------- --------------- --------------
<S> <C> <C> <C> <C>
Revenues $ 5,045,186 $ 1,763,896 $ 8,468,917 $ 4,379,599
Total costs and expenses 6,422,017 7,973,500 22,066,198 22,493,931
----------------- ---------------- --------------- --------------
Net loss $ (1,376,831) $ (6,209,604) $ (13,597,281) $(18,114,332)
----------------- ---------------- --------------- --------------
----------------- ---------------- --------------- --------------
Preferred stock dividends $ --- $ --- $ --- $ 48,138
----------------- ---------------- --------------- --------------
----------------- ---------------- --------------- --------------
Basic and diluted loss
per common and common
equivalent share $ (0.07) $ (0.35) $ (0.73) $ (1.69)
----------------- ---------------- --------------- --------------
----------------- ---------------- --------------- --------------
</TABLE>
4. RELATED PARTY TRANSACTIONS
The Company's outstanding accounts receivable from employees and
affiliates of the Company at September 30, 1999 and December 31,1998 was
$258,278 and $963,700, respectively. The September 30, 1999 and December 31,
1998 receivables include approximately $47,787 from an affiliated partnership
for which the Company serves as the managing general partner. In addition, the
September 30, 1999 balance includes a net $108,642 receivable from EPC primarily
related to joint interest billings. In June 1999 the Company closed a sale to
Aspect of 12.5% (of 100%) interest in the Caney Creek Project, and a 12% (of
100%) interest in the Gillock Project, and all of the Company's undeveloped
interests in the West Beaumont project area for an aggregate of approximately
$2,700,000. Proceeds from the sale were used to help settle amounts due Aspect.
At September 30, 1999 the Company had a remaining net account payable to Aspect
in the amount of $684,988.
5. COMMITMENTS AND CONTINGENCIES
The Company markets its natural gas through monthly spot sales. Because
sales made under spot sales contracts result in fluctuating revenues to the
Company depending upon the market price of gas, the Company may enter into
various hedging agreements to minimize the fluctuations and the effect of price
declines or swings. During January 1999, the Company completed performance on a
1996 swap agreement on approximately 1,040 MMBtu's
10
<PAGE>
per day of Mid-Continent natural gas production for $1.566 per MMBtu for the
period beginning April 1, 1996 and ending January 31, 1999.
In October of 1998, the Company entered into two swap agreements, one
for 4,000 MMBtu's per day of its Gulf Coast natural gas production for $2.14 per
MMBtu for the period beginning November 1998 and ending in October 1999, and the
second one for 700 MMBtu's per day of its Gulf Coast natural gas production for
$2.13 per MMBtu for the period beginning November 1998 and ending in October
1999. Both of these swap agreements were supplemented in December 1998 when the
Company entered into additional swap agreements, one of which was for 4,000
MMBtu's per day of its Gulf Coast natural gas production for $2.07 per MMBtu for
the period beginning November 1999 and ending in October 2000, and the second
one was for 700 MMBtu's per day of its Gulf Coast natural gas production for
$2.07 per MMBtu for the period beginning November 1999 and ending in October
2000.
In September of 1999, the Company entered into a series of swap
agreements on additional natural gas and oil production. It hedged 5,000 MMBtu's
per day of natural gas for the months of September through December 1999 at a
price of $3.055 per MMBtu, it hedged 3,000 MMBtu's per day for the period of
January through March of 2000, 2,400 MMBtu's per day for the period April
through June of 2000, and 1,700 MMBtu's per day for the period of July through
September of 2000, the latter three hedges of which were all at a price of $2.68
per MMBtu. In addition, the Company entered into a "collar" hedge arrangement on
certain of its oil production. This oil hedge was for a quantity equal to 300
barrels of oil per day in the fourth quarter of 1999, 280 barrels of oil per day
in the first quarter of 2000, 256 barrels of oil per day in the second quarter
of 2000, and 237 barrels of oil per day in the third quarter of 2000, all of
which transactions were structured with an $18.00 floor price and a $20.40 cap
price.
As a result of the above-referenced transactions, the Company has
hedged varying quantities of its natural gas and oil production through October
of 2000.
6. NEW ACCOUNTING PRONOUNCEMENTS
In June 1999, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferred of the Effective Date of FASB Statement No. 133" ("SFAS 137"). SFAS
137, which is effective for all fiscal quarters of fiscal years beginning after
June 15, 2000, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as "derivatives") and for hedging
activities. SFAS 137 requires that an entity recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at fair
value. The Company is currently evaluating the impact of the application of SFAS
137, which when adopted, could have a material effect on its consolidated
financial statements.
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, 1999 and 1998 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, 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 - INCEPTION THROUGH DECEMBER 31,
1998. In mid-1996, the Company refocused its activities from acquiring gas
reserves principally in the Mid-Continent region of the United
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States to concentrate on exploration and related development drilling
projects in Southern Louisiana and along the Gulf Coast region of Alabama,
Mississippi and Texas. 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, greatly reduced the Company's cash and
capital resources.
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, 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 a Special Meeting of Shareholders, the Company
closed the transactions provided for in the Acquisition Agreement, implemented
the Reverse Split, and completed the Reincorporation. 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 believed the Acquisitions would
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.
In connection with the Acquisitions, an affiliate of Enron Corp.
exercised an option to exchange $3.8 million of debt Aspect owed to such Enron
affiliate for 675,000 shares of the Company's Common Stock that would otherwise
have been issued to Aspect in the Acquisitions, at an effective conversion rate
of $5.63 per share.
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.
On Exploration Projects acquired in 1998 pursuant to the Acquisitions,
the Company participated in the drilling of twenty-four wells through December
31, 1998 with working interests, which range from 8% to 79%. Out of those
twenty-four wells drilled, thirteen wells have been completed and eleven were
dry holes. Several of the successful wells went into production late in the
third quarter of 1998, and in the fourth quarter of 1998.
OVERVIEW OF 1999 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, required several years 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 in 1999
and subsequent years.
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<PAGE>
In the first half of 1999, the Company completed a review of each of
its operating departments in order to identify areas where it could increase
efficiency and/or reduce costs. As a result, it has implemented personnel and
procedural changes in the accounting, land and operations departments. These
changes increased certain third quarter costs due to consultants fees,
employment severance packages, and new systems implementation. However, as a
result, the Company expects certain general and administrative cost decreases
and management and operational efficiencies to increase.
In 1999, the Company has participated in 25 new wells. Of the total
wells drilled in 1999, ten were producing as of September 30, six are scheduled
to commence production upon completion and pipeline connections, four were
dry holes, and five were drilling. Only two of the 1999 wells were producing
as of July 1, 1999, and as a result the Company's net daily oil and gas
production has been increasing substantially throughout the third and early
fourth quarters. Based upon estimated sustainable flow rates, the 1999 wells
helped to have increase the Company's net daily production to approximately
500 barrels of oil per day and 15.0 million cubic feet of natural gas per day
as of November 1, 1999.
The Company entered 1999 having gone from nominal third quarter 1998
gas and oil revenues of approximately $35,000 per month and large operating cash
flow deficits to a company which averaged $325,000 per month in net oil and gas
revenues and associated hedging revenues from commodity transactions in the
first six months of 1999. This number increased significantly as the wells
drilled in 1999 continued to come on line. The Company averaged $859,000 per
month in net oil and gas revenues in the third quarter. This allowed the Company
to achieve positive operating cash flow (before capital expenditures, and before
the costs of acquisition of new 3-D seismic data, and changes in working
capital) in the third quarter. It has six additional wells which have already
been drilled and are scheduled to commence production in 1999. In addition,
the Company has finalized the sale of additional project interests since
September 30, 1999, which sales resulted in increased availability of cash
resources and enhanced working capital. (See "Liquidity and Capital
Resources").
The Company will look to a variety of sources to fund its continuing
capital expenditures budget, including it's 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").
On May 12, 1999, the Company announced that on May 11, 1999 it had
entered into a Plan and Agreement of Merger with 3DX Technologies, Inc.
("3DX") which provides for the merger of 3DX into the Company. The
shareholders of both companies approved the transaction at their respective
meetings on September 23, 1999 and the merger was consummated the same day.
The terms of the merger provided for 3DX shareholders to receive, at their
election, either (i) the issuance of one share of Esenjay common stock for
3.25 shares of 3DX common stock; or (ii) the issuance of a new Esenjay
convertible preferred stock at a ratio of one share of Esenjay convertible
preferred stock for each 2.75 shares of 3DX common stock. Approximately 91%
of the 3DX common shares converted into Esenjay common stock and
approximately 9% were converted into Esenjay convertible preferred stock. As
a result, Esenjay issued approximately 2,906,778 new shares of common stock
and approximately 356,999 shares of convertible preferred stock. Esenjay has
approximately 18,775,227 total shares of common stock and 356,999 total
shares of preferred stock outstanding.
The convertible preferred stock may be redeemed at Esenjay's sole
option until September 23, 2000 at $1.925 per share. If not redeemed by that
time, the preferred will automatically convert into one share of Esenjay common
stock on October 1, 2000 if the average closing price of Esenjay common stock is
greater than or equal to $1.875 during the month of September 2000. If the
Esenjay common stock averages less than $1.875 in September of 2000, the
preferred holder has the right, during the month of October of 2000, to "put"
the shares to Esenjay. If put, Esenjay will then have the right to retire the
convertible preferred stock for $1.65 in cash or for common stock with the
number of shares of common stock adjusted based upon a formula set out in the
merger agreement. The convertible preferred stock is scheduled to be converted
or redeemed not later than November 1, 2000.
3DX Technologies Inc. was a Houston-based exploration and production
company whose strategic business focus was the utilization of 3-D seismic
imaging and other advanced technologies in the search for natural gas and oil
principally in the onshore gulf coast of the United States. (See also Part II,
Item 4 "Submission of Matters to a Vote of Security Holders" and Item 5 "Other
Information").
SUCCESSFUL EFFORTS ACCOUNTING AND RELATED MATTERS. The Company utilizes
the successful efforts
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<PAGE>
method of accounting. Under this method it expenses its exploratory dry hole
costs and the field acquisition costs of 3-D seismic data as incurred. The
undeveloped properties which were acquired pursuant to the Acquisitions, and
which were comprised primarily of interests in unproven 3-D seismic based
projects, recorded in May of 1998 at an independently estimated fair market
value of $54.2 million as determined by Cornerstone Ventures, L.P., a
Houston, Texas based investment banking firm. Pursuant to the successful
efforts method of accounting, the Company is amortizing such initial costs of
unproved properties on a straight-line basis over a period not to exceed
forty-eight months, as well as recognizing property specific impairments.
Hence significant non-cash charges will likely depress reported earnings of
the Company over the next several years, but will not affect cash flows
provided by operating activities nor the ultimate realized value of the
Company's natural gas and oil properties.
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 is exposed to the risk that the Year 2000 issue could cause
system failures or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send joint
interest billings, or engage in similar normal business activities. During 1998,
the Company undertook a corporate-wide initiative designed to assess the impact
of the Year 2000 issue on software and hardware utilized in the Company's
operations.
The Company's initiative is to be conducted in these phases:
assessment, implementation and testing. During the assessment phase, the Company
completed a comprehensive inventory of all "mission critical" systems and
equipment. Many of the Company's systems include hardware and packaged software
purchased from large vendors who have represented that these systems are already
Year 2000 compliant.
The Company relies on other producers and transmission companies to
conduct its basic operations. Should any third party with which the Company has
a material relationship fail, the impact could impair the Company's ability to
perform its basic operation. Examples of such changes are an inability to
transport production to market or an inability to continue drilling activities.
Key third party vendors, producers and transmission companies have been
contacted and have indicated Year 2000 compliance.
The majority of the Company's technical applications are not date
sensitive. Of those applications that are date sensitive, most have recently
been, or are currently being, upgraded. The Company has completed the testing of
Year 2000 modifications during the third quarter of 1999 and has determined that
its primary systems performed correctly. However, if such modifications are not
adequate or do not operate properly, the Year 2000 issue could have a material
impact on the Company. Based upon its overall assessment of the impact of the
Year 2000 issue and the results of inquiries made and testing performed, the
Company does not plan to develop a contingency plan at this time. The Company
will, however, continue to monitor its systems as they approach the Year 2000
and, if any unexpected developments arise that would require a contingency plan,
the Company will develop such a plan.
The Company's efforts with respect to the Year 2000 issue have been
handled internally by management and other Company personnel. Costs of
developing and carrying out this initiative are being funded from the Company's
operations and have not represented a material expense to the Company. The
Company has completed its cost assessment and currently believes that the costs
of addressing the Year 2000 issue should not be significant and should not have
a material adverse impact on the Company's financial condition.
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<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain operating information of the
Company during the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
1999 1998 1999 1998
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
PRODUCTION:
Gas (MMcf)....................... 851.7 126.7 2078.4 183.0
Oil and condensate (MBbls)....... 33.4 2.7 50.2 6.2
Total equivalent (Mmcfe)......... 1052.1 142.9 2379.6 220.2
AVERAGE SALES PRICE:
Gas (per Mcf).................... 2.45 1.82 1.81 2.07
Oil and condensate (per Bbl)..... 14.66 12.33 11.22 12.79
AVERAGE EXPENSES (PER MCFE):
Lease operating (1).............. 0.10 0.31 0.20 0.45
Depletion of oil and gas properties: 1.01 1.38 0.94 1.52
</TABLE>
(1) Includes all direct expenses of operating the Company's properties, as
well as production and ad valorem taxes.
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1998
All comparative discussions should be considered in the context of the
Acquisitions closed on May 14, 1998, which, together with related changes
significantly modified the scope, focus and the method of doing business of the
Company. As a result, the comparisons may be of more limited value when
analyzing relevant trends.
REVENUE. Total revenue increased 1,335.75% from $321,466 for the
quarter ended September 30, 1998 to $4,615,442 for the quarter ended September
30, 1999. This is primarily attributable to the continuing growth of the
Company's net gas and oil production as wells drilled in the first six months of
1999 began to come on line, which factors are further described below.
It was also significantly impacted by a $1,924,273 gain on the sale of
certain unproven, undeveloped project interests to industry partners.
Total gas and oil revenues increased 815.87% from $281,408 to
$2,577,335. The increase in gas and oil revenue was attributed to the increase
of properties placed in production during the quarter ended September 30, 1999,
resulting from drilling activity during the first half of 1999, and the accrued
revenues from properties acquired in the 3DX merger, closed on September 23,
1999. There was an increase in gain on sale of assets of $1,922,326 from $1,947
for the quarter ended September 30, 1998 to $1,924,273 for the quarter ended
September 30, 1999. This increase was due to recorded gains on the sale of
unproven, undeveloped project interests in the quarter.
The Company also realized a loss from various commodity transactions
totaling $30,376 for the third quarter of 1998. 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. The Company recognized
gains of $33,557 for the third quarter of 1999. These recognized gains were
largely due to the average hedging prices received by the Company exceeding
those spot market prices during the same period. The Company accrued unrealized
gains of $10,817 for the third quarter of 1998; however, during 1999 the
Company's production volumes have exceeded hedged volumes and, as a result,
unrealized gains or losses are not realized. Operating fees decreased from
$97,923 for the quarter ended September 30, 1998 to $69,803 for the quarter
ended September 30, 1999. These decreases are attributed to the transfer of some
operational activities to an affiliate. Other revenues increased $50,727 from a
loss of $40,253 for the quarter ended September 30, 1998 to $10,474 for the
quarter ended September 30, 1999.
COSTS AND EXPENSES. Total costs and expenses increased 44.61% from
$3,911,096 in the quarter ended September 30, 1998 to $5,655,816 in the quarter
ended September 30, 1999. The increase in costs and expenses was primarily due
to a combination of increases in amortization of unproved properties, depletion,
depreciation and amortization, impairment of assets, exploration costs - dry
hole costs, interest expense, production taxes, delay rentals,
15
<PAGE>
and lease operating expenses, and partially offset by a significant decrease
in exploration costs--geological and geophysical.
LEASE OPERATING EXPENSE increased 143.79% from $44,966 for the quarter
ended September 30, 1998 to $109,622 for the quarter ended September 30, 1999.
This was primarily attributed to operational cost from wells placed in
production during late 1998 and the first nine months of 1999.
PRODUCTION TAXES increased 687.90% from $20,084 for the quarter ended
September 30, 1998 to $158,241 for the quarter ended September 30, 1999. The
increase in production taxes was largely due to revenues of wells placed in
production in late 1998 and during the first nine months of 1999. Also
contributing was accrued taxes associated with accrued revenues from wells
acquired with the 3DX merger.
DEPRECIATION, DEPLETION AND AMORTIZATION ("DD&A") increased 441.68%
from $196,729 for the quarter ended September 30, 1998 to $1,065,641 for the
quarter ended September 30, 1999. This increase to DD&A was attributed to wells
placed in production late 1998 and during the first nine months of 1999. Of the
total, $206,815 was associated with wells placed in production during the third
quarter of 1999.
AMORTIZATION OF UNPROVED PROPERTIES was $1,692,600 for the third
quarter of 1999 (none in 1998). The Company will amortize the undeveloped and
unevaluated value of the properties acquired pursuant to the acquisitions over a
period not to exceed forty-eight months. (See "Overview - Successful Efforts
Accounting and Related Matters").
IMPAIRMENT OF ASSETS increased from $0 for the quarter ended September
30, 1998 to $358,106 for the quarter ended September 30, 1999. This increase was
entirely attributed to an impairment charge taken by the Company against the
book value of certain unproven, undeveloped project costs.
EXPLORATION COSTS - GEOLOGICAL AND GEOPHYSICAL decreased 87.46% from
$2,240,281 for the quarter ended September 30, 1998 to $280,896 for the quarter
ended September 30, 1999. 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.
EXPLORATION COSTS - DRY HOLE increased 148.99% from $133,666 for the
quarter ended September 30, 1998 to $332,820 for the quarter ended September 30,
1999.
INTEREST EXPENSE increased from 0 dollars for the quarter ended
September 30, 1998 to $212,538 for the quarter ended September 30, 1999 due to
increased loans outstanding. The Company capitalizes a large portion of its
interest associated with its ongoing projects, of which capitalized amounts
totaled $139,102 for the quarter ended September 30, 1998 and $324,142 for the
quarter ended September 30, 1999.
GENERAL AND ADMINISTRATIVE EXPENSES increased 2.62% from $1,234,414 for
the quarter ended September 30, 1998 to $1,266,805 for the quarter ended
September 30, 1999. Approximately $90,000 were costs associated with
departmental reorganization during the third quarter of 1999, partially offset
by $102,591 of prior period adjustments.
DELAY RENTALS increased 335.95% from $40,956 for the quarter ended
September 30, 1998 to $178,547 for the quarter ended September 30, 1999. The
increase was attributed to rentals paid in connection with ongoing projects from
the Company's project inventory.
NET LOSS PER COMMON SHARE decreased from a net loss of $0.24 per share
for the third quarter of 1998 to a net loss of $0.06 for the third quarter ended
September 30, 1999. This was attributed to the factors enumerated above. There
was a decrease in the net loss applicable to common stockholders of $2,549,256
from the third quarter of 1998 as compared to the third quarter of 1999.
Approximately 16,062,000 weighted average common equivalent shares were
outstanding at September 30, 1999 as compared with approximately 14,899,000 at
September 30, 1998, which further influenced the decrease in net loss per share
in 1999.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1998
16
<PAGE>
All comparative discussions should be considered in the context of the
Acquisitions closed on May 14, 1998 which, together with related changes,
significantly modified the scope, focus, and method of doing business of the
Company. As a result, the comparisons may be of more limited value when
analyzing relevant trends.
REVENUE. Total revenues increased 922.83% from $670,589 for the nine
months ended September 30, 1998 to $6,858,991 for the nine months ended
September 30, 1999. The Company's increasing net oil and gas production is the
primary factor.
Total gas and oil revenues increased 893.52% from $436,272 for the nine
months ended September 30, 1998 to $4,334,441 for the nine months ended
September 30, 1999. The increase in gas and oil revenues was primarily
attributed to the effect of the onset of production from drilled project
inventories. In addition, to the increase in gas and oil revenues for the
nine months ended September 30, 1998, there was an increase in gain on sale
of assets of $2,029,530 from $5,375 for the nine months ended September 30,
1998 to $2,034,905 for the nine months ended September 30, 1999. This
increase was due to the closing of various sales of unproven, undeveloped
project interests to third parties which resulted in an aggregate gain for
the period. Increases from operations from both exploratory and developmental
drilling have resulted in the increase of operating fees of 13.06% from
$197,384 for the nine months ended September 30, 1998 to $223,154 for the
nine months ended September 30, 1999. The Company realized a loss from
various commodity hedges of $128,938 for the nine months ended September 30,
1998. These losses were attributed to various transactions in which the
Company hedged future gas delivery obligations as a requirement of its bank
loan facility. The Company realized net gains of $231,580 for the nine months
ended September 30, 1999. This was due to the Company's average hedge pricing
exceeding the spot market prices for the period. The Company recognized an
unrealized gain on commodity transactions for the nine months ended September
30, 1998 of $97,888 as compared to none for the nine months ended September
30, 1999. This was due to the fact that 1999 oil and gas production volumes
exceeded those of the hedged volumes and as a result the Company no longer
recognizes unrealized gains or losses in its hedge accounts. In addition to
the foregoing, the Company had other revenues of $62,608 for the nine months
ended September 30, 1998, as compared to $34,911 for the nine months ended
September 30, 1999. This decrease was primarily attributed to the reduction
in interest income for trade and affiliate receivables.
COSTS AND EXPENSES. Total costs and expenses increased 66.87% from
$9,880,937 for the nine months ended September 30, 1998 to $16,488,765 for the
nine months ended September 30, 1999. The increase primarily relates to the
Company's change in scope, focus and method of doing business, which occurred
upon the closing of the Acquisition Agreement among the Company, EPC and Aspect.
As a direct result, staffing, departmental reorganization and activity volumes
have greatly increased. The increase in costs and expenses was attributed to a
combination of increases in amortization of unproved properties, depletion,
depreciation and amortization, general and administrative costs, lease operating
expense, impairment of assets, interest expense, production taxes, and delay
rentals. Partially offsetting the aforementioned increases were decreases in
exploration costs - geological and geophysical, exploration costs - dry hole,
and transportation and gathering costs.
LEASE OPERATING EXPENSES increased 378.86% from $100,699 for the nine
months ended September 30, 1998 to $482,210 for the nine months ended September
30, 1999. The increase in lease operating expenses relates primarily to the
operational cost for the Company's wells placed in production during late 1998
and during the first nine months of 1999. In addition, the Company incurred
$149,067 of costs associated with the installation of compressors and road
repairs.
PRODUCTION TAXES increased 992.33% from $25,036 for the nine months
ended September 30, 1998 to $273,475 for the nine months ended September 30,
1999. This increase was attributed to a combination of revenues of wells placed
into production late 1998 and during the first nine months of 1999 and the
accrued production taxes associated with accrued revenues obtained by the
Company from the 3DX merger which closed on September 23, 1999.
DEPLETION, DEPRECIATION AND AMORTIZATION ("DD&A") increased 568.91%
from $335,095 for the nine months ended September 30, 1998 to $2,241,468 for the
nine months ended September 30, 1999. The increase was attributable to wells
placed in production during late 1998 and the first nine months of 1999, of
which $530,902 was associated with wells placed into production during the first
nine months of 1999.
17
<PAGE>
AMORTIZATION OF UNPROVED PROPERTIES was $6,050,600 for the nine months
ended September 30, 1999 (none in 1998). The Company has adopted a policy to
amortize the undeveloped and unevaluated value of the properties acquired
pursuant to the Acquisition Agreement between the Company and EPC and Aspect
over a period not to exceed forty-eight months. (See - "Overview - Successful
Efforts Accounting and Related Matters").
IMPAIRMENT OF ASSETS was $358,106 for the nine months ended September
30, 1999 (none in 1998). This was an impairment charge on certain unproven,
undeveloped project costs. The Company from time to time will elect to impair
certain individual projects, prospects or properties based on the estimated
economic value of those assets.
EXPLORATION COSTS - GEOLOGICAL AND GEOPHYSICAL decreased 68.87% from
$5,028,381 for the nine months ended September 30, 1998 to $1,565,374 for the
nine months ended September 30, 1999. The decrease resulted from a decreased
volume of new 3-D data acquisitions during the nine months ended September 30,
1999. These exploration costs reflect 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
technology enhanced exploration program on the Exploration Projects has required
the acquisition and interpretations of substantial quantities of data. 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.
EXPLORATION COSTS - DRY HOLE decreased 66.08% from $1,173,767 for the
nine months ended September 30, 1998 to $398,098 for the nine months ended
September 30, 1999. The reduction can be attributed to the Company's high
percentage of drilling success from late 1998 continuing through the nine months
ended September 30, 1999.
INTEREST EXPENSE increased 139.09% from $217,899 for the nine months
ended September 30, 1998 to $520,977 for the nine months ended September 30,
1999. The increase in interest expense was attributable to the credit facility
with Duke Energy Financial Services, Inc., which closed in February of 1999 and
an increased borrowing base pursuant to the Company's credit facility with Bank
of America NT&SA in October 1998. The Company capitalizes a large portion of its
interest associated with ongoing projects, of which capitalized amounts totaled
$898,261 for the nine months ended September 30, 1999 and $300,321 for the nine
months ended September 30, 1998.
GENERAL AND ADMINISTRATIVE EXPENSES increased 47.22% from $2,954,021
for the nine months ended September 30, 1998 to $4,348,901 for the nine months
ended September 30, 1999. This was primarily due to increases in operational
expenses incurred after May 14, 1998, the effective date of the Acquisition
Agreement with Aspect and EPC. After such time, the Company's scope, focus and
method of business increased greatly. Approximately $281,323 in costs for the
nine months ended September 30, 1999 were costs associated with departmental
reorganization, information systems conversions and implementation.
DELAY RENTALS increased 442.05% from $46,039 for the nine months ended
September 30, 1998 to $249,556 for the nine months ended September 30, 1999.
These increased rentals were costs associated with maintaining the Company's
position in its ongoing project inventory.
NET LOSS PER COMMON SHARE decreased from a net loss of $1.18 per share
for the third quarter of 1998 to a net loss of $0.61 per share for the third
quarter of 1999. Due to factors discussed above, there was a decrease in net
loss applicable to common stockholders of $419,426 from the third quarter of
1998 as compared to the third quarter of 1999, and the combination of the
increased number of weighted average shares of common equivalent shares at
September 30, 1999 resulting from the merger of 3DX. Approximately 15,881,000
weighted average common equivalent shares were outstanding at September 30, 1999
as compared with approximately 7,857,000 at September 30, 1998.
KNOWN AND ANTICIPATED TRENDS, CONTINGENCIES AND DEVELOPMENTS IMPACTING FUTURE
OPERATING RESULTS.
The Company's future operating results will continue to be
substantially dependent upon the success of the Company's efforts to develop the
projects acquired in the Acquisitions and the acquisition of 3DX, as well as its
other prospects.
Management continues to believe these projects represent the most
promising prospects in the Company's history. The wells drilled on projects
acquired pursuant to the Acquisitions in 1998 and 1999 continue to
18
<PAGE>
substantially increase the Company's revenues. Conversely, the capital
expenditures planned in the remainder of 1999 and into 2000 will continue to
require substantial outlays of capital to explore, develop and produce.
Drilling results for 1998 resulted in substantial revenue increases. Drilling
results in the first ten months of 1999 have resulted in rapidly expanding
revenues in 1999. The Company anticipates certain general and administrative
cost decreases in the fourth quarter and in 2000 due to personnel and systems
changes which have been implemented, which are intended to increase
efficiency and/or reduce costs. However, pursuant to the acquisition of 3DX
Technologies, Inc., certain of the planned savings have been offset by staff
additions pursuant to the merger. The cost additions should be more than
offset by revenue increases from producing properties acquired in the merger
and the additions expand the Company's ability to manage and create value
from its broad project inventory. However, because of the Company's expanded
1999 drilling budget, capital from sources other than cash flow from
operations will continue to be required for funding planned exploration
activities. The Company's 1999 and 2000 budgets continue to include the sales
of certain project interests to industry partners, which have not
materialized in the first nine months of 1999 as rapidly as planned. The
Company's drilling program will have to be reduced if the Company does not
execute such sales in the fourth quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred approximately $13,639,586 in drilling, completion,
land and seismic costs net to its account in the first nine months of 1999. It
has currently budgeted over $6,000,000 in such costs in the fourth quarter of
1999, and plans a $26,000,000 budget for 2000. These budgeted amounts are based
upon exploration opportunities and may be adjusted based upon available capital.
The Company's sources of financing include borrowing capacity under its existing
and potential new credit facilities, the sale of promoted interests in the
Exploration Projects to industry partners and cash provided from operations. The
Company's budget includes the sales of certain project interests to industry
partners, which did not materialize as rapidly as planned in the first nine
months of 1999. The Company expects said sales will continue to be consummated
but may have to delay the drilling of certain wells pending such sales. The
Company's drilling program may have to be reduced if the Company does not
execute such sales in the fourth quarter of 1999.
The Company entered 1999 having gone from nominal second quarter
1998 gas and oil production of approximately $35,000 per month and large
operating cash flow deficits to a company which averaged $870,000 per month
in oil and gas revenues and in realized revenue from hedges on production in
the third quarter of 1999, most which is attributable to wells which
commenced production in quarter. Gas and oil production is expected to
continue to increase as new gas and oil production from wells drilled in 1999
continue to come on line. Of the total wells drilled in 1999, ten were
producing as of September 30, six are scheduled to commence production upon
completion and/or pipeline connections, four were dry holes, and five were
drilling. Only two of the 1999 wells were producing as of July 1, 1999, and
as a result the Company's net daily oil and gas production has been
increasing substantially throughout the third and early fourth quarters.
Based upon estimated sustainable flow rates, the 1999 wells have increased
the Company's net daily production to approximately 500 barrels of oil per
day and 15.0 million cubic feet of natural gas per day as of November 1,
1999. This represents an increase from the 150 barrels of oil per day and
4,250,000 cubic feet of natural gas per day being produced at the end of the
second quarter of 1999. Additional success in 1999 on wells currently
drilling is expected to continue the trend. This should allow the Company to
achieve steadily increasing operating cash flow (prior to capital
expenditures 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 the quarter ended September 30, 1999, the Company closed one
significant sale of project interests for a total of approximately $4,800,000.
It has also closed the sale of two additional sales of project interests in the
fourth quarter of 1999. The transaction which closed in the third quarter was a
sale to Helmerich & Payne, Inc., ("H&P"). The sale was a sale of non-producing
undeveloped interests comprised of a 20.8% interest in the Company's Lovells
Lake project, in which the Company retains a 12.5% interest, a 33.3% in the
Company's Bauer Ranch project, which represented the Company's entire interest
in said project, and the Company's interest in deep rights in its Gillock
project. The deep rights in the Gillock project were rights below the Nodosaria
Sands, and the Company retained all of its rights in depths above the Nodosaria
Sands. All of its ownership in locations and reserves proven by prior drilling
in the areas involved were exempt from the sale and retained by the Company. H&P
also received certain interests in three project areas which have not presently
been evaluated by 3-D seismic data.
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<PAGE>
In October of 1999, the Company sold 50% of its interest in a 3-D
project it has assembled and calls the Papalote project. The sale is also to H&P
for a total cash consideration of $3,000,000. Of this amount, $2,000,000 was
paid upon closing with the remainder deferred until completion of a 3-D seismic
survey over the Papalote project anticipated to be completed in the first
quarter of 2000. The Company sold interests in the project ranging from 20%
to 30% (depending upon geographical location within the area). As a result,
the Company retains ownership interests which range from 34% to 48%
(depending upon geographical location within the area) in the Papalote
project. As a part of the sale, the Company is responsible for contracting
and delivering a 3-D seismic survey over the project area at no additional
cost to H&P.
Project interests closed in October also included a transaction with
Seagull Energy E&P, Inc. ("Seagull"), a subsidiary of Ocean Energy, Inc.
Pursuant to this transaction, the Company will be paid a total of approximately
$1.5 million to sell 50% of its net interest in four distinct drilling
prospects located within the Company's Mikeska and Hall Ranch 3-D seismic
projects. All four wells are scheduled to commence and/or complete drilling in
the fourth quarter of 1999. After drilling of the four wells, Seagull will have
earned a 45-day option to acquire 50% of the Company's net interest in the
remaining drilled exploratory prospects within the Mikeska and Hall Ranch 3-D
seismic projects for an additional $6.5 million, and a 45-day option to purchase
50% of the Company's net interest in four additional Wilcox trend 3-D seismic
projects for an additional $2 million. After the initial four exploratory
prospects are drilled, Seagull may defer exercising its option by electing to
drill two additional exploratory wells. In such case, Seagull must pay the
Company an additional cash consideration of from approximately $700,000 to
$1,000,000. In the event Seagull does not exercise either of said options, it
must pay the Company an additional $500,000 and grant the Company a 12.5%
back-in after payout on the wells drilling pursuant to the initial phase of the
exploration agreement.
On September 23, 1999, at the meeting of its shareholders the Company
approved the previously announced acquisition of 3DX Technologies Inc. ("3DX").
The shareholders of 3DX approved the merger on the same date and the merger was
consummated on September 23, 1999. (See Part II, Item 4 "Submission of Matters
to a Vote of Security Holders"). As part of the transaction the Company
increased its working capital by approximately $2,340,283 and its long-term debt
by $750,000.
On October 23, 1998, the Company amended and restated its credit
agreement dated January 3, 1996 with B of A. The amended agreement is in a total
amount of $20,000,000 and provided for an immediate borrowing base of up to
$9,000,000. The Company had drawn $8,350,000 pursuant to the B of A loan
facility as of September 30, 1999. The loan is in two tranches. $4,750,000 is
outstanding under Tranche A and $3,773,162 under Tranche B. Tranche A is a
revolving facility with no required principal payments until 2000, after which
it converts into a thirty-six month term loan. Tranche B is payable in interest
only until maturity on April 13, 2000. 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 London Interbank rate plus 2% for Tranche A
and 4% for Tranche B. All undrawn funds will be available for future drilling
activities of the Company, subject to the approval of the bank. The Tranche A
loan is secured by a mortgage on most proven properties currently owned by the
Company. In addition, certain mortgages on the Company's exploration project
inventory secure Tranche B of the credit facility with B of A as well as the
entire credit facility with Duke discussed below. All such shared collateral is
governed by an intercreditor agreement between B of A and Duke in which B of A
serves as the collateral agent. In addition to the foregoing, B of A received a
2.0% overriding royalty interest, proportionately reduced to the Company's net
interest, in the properties classified as 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 credit agreement
does not provide for any additional overriding interests in favor of B of A.
Proceeds of the loan primarily supplement working capital and exploration costs.
The Company expects further increases as recently drilled wells are engineered
and come on line. The Company also assumed $750,000 in long term debt pursuant
to the acquisition of 3DX Technologies Inc. which was payable to B of A. This
amount was rolled into Tranche A of the Company's credit facility with B of A.
On January 28, 1999, the Company closed a credit facility with Duke.
This facility provided for Duke to loan up to $9,000,000 to the Company for
eighteen months pursuant to a decreasing facility. The commitment reduces by
$930,000 per quarter and reduces to zero on August 1, 2000. The Company has
fully drawn the facility and had $7,140,000 on said facility outstanding as of
September 30, 1999. Principal outstanding cannot exceed the commitment amount at
any time. Duke is paid interest at a rate of prime plus 4%. The facility reduces
by $1,860,000 in February of 2000, $930,000 in May of 2000, and is to be fully
paid in August of 2000.
20
<PAGE>
Duke also received a right to gather and process, at fair market
value, gas and condensate from a designated area of interest, and a net revenue
interest in certain of the Company's future drilling activities not to exceed
0.49% of the Company's net interest. Proceeds primarily supplement exploration
costs.
On January 28, 1999, the Company, B of A, and Duke entered into an
intercreditor agreement which governs the collateral which is used to secure the
credit facility with B of A and the credit facility with Duke. Tranche A of the
B of A credit facility is secured by a first mortgage on most of the Company's
proven properties. Collateral securing amounts outstanding under both the Duke
credit facility and Tranche B of the B of A facility is primarily comprised of
mortgages taken on a significant proportion of the Exploration Projects of the
Company which have not been developed. At such time as drilling is conducted on
the Exploration Projects and proven reserves are discovered, the Company has a
right to seek increases in the available amount to be drawn under Tranche A of
its credit facility with B of A. In the event B of A agrees to increase the
amounts available pursuant to Tranche A, then, subject to Duke's consent,
security interests in proven reserves would be used as additional primary
collateral on Tranche A loans from B of A supporting the borrowing availability
increases.
At September 30, 1999, the Company's current ratio was in noncompliance
with the covenants of the B of A credit agreement and the Company's interest
coverage ratio was in compliance for the quarter ended September 30, 1999 but
not for the one year period ended September 30, 1999, and as such was also in
noncompliance. B of A has waived said noncompliance at September 30, 1999.
Although the Company believes it can be in compliance with these covenants
throughout the remainder of 1999 and 2000, there can be no assurance that it
will be in compliance. As a result it is possible that additional waivers may be
needed in the future. In the event B of A did not grant such waivers, if needed,
the Company would be in noncompliance of the covenants and would seek
alternative financing arrangements.
The Company will require additional sources of capital to fund its
exploration budget over the remainder of 1999 and the first half of 2000. It
will also have to retire and/or refinance the current portion of its long term
debt. It anticipates substantial growth of its bank credit facility based upon
proven reserves of gas and oil added by its exploration program. B of A is the
survivor of the recent merger of NationsBank of Texas, N.A., and Bank of America
NT&SA and changed its name of B of A. The staff of the small-cap oil and gas
loan department of B of A has been released and the commitment of B of A to
serve any small cap oil and gas company in the industry is in doubt. The Company
intends to continue to work with B of A, but is prepared to change its banking
relationship to a lender more committed to the small cap oil and gas area, if
necessary, to receive competitive debt capital availability. Management believes
satisfactory credit facilities will be available from alternative sources at
competitive rates secured by the Company's expanding portfolio of proven,
producing oil and gas properties. It also plans to continue to sell promoted
interests in certain of its Exploration Projects to fund its exploration program
in 1999 and 2000. In the fourth quarter of 1999, its capital expenditures budget
will be significantly dependent upon sales of additional interests in the
Exploration Projects. Said sales have not materialized as rapidly as expected
and the Company may delay the drilling of certain wells if such sales are not
timely under contract. The Company is actively marketing certain project
interests and management anticipates sufficient sales will be timely
consummated.
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, sales of project interests to industry partners and
with cash provided by operating activities. Its major obligations at November
12, 1999, consisted principally of (i) servicing loans under the credit
facilities with B of A and with Duke and other loans, (ii) funding of the
Company's exploration activities, and (iii) funding of the day-to-day
operating costs.
The Company has an ambitious capital expenditure plan for the balance
of 1999 and 2000, which includes approximately $4,600,000 in drilling and
completion costs in the fourth quarter of 1999 and $18,000,000 in 2000, and an
additional $1,900,000 and $8,000,000, respectively, in geological, geophysical
and land costs for said periods. Cash flow from operations will contribute
significantly to said budgets, but substantial additional funds in the form of
sales of project interests and/or long term debt will be needed. In addition,
the Company must restructure and/or retire $11,013,162 in current portion of
long term debt in 2000. It believes a substantial source of capital will be oil
and gas production loans secured by reserves discovered to date pursuant to its
exploratory drilling activities, but it does not currently have additional
lending commitments for such debt.
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<PAGE>
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 the acquisition of a company with producing properties for common
stock or other equity securities, and also 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 has entered into hedging transactions with Bank of America's
Financial Engineering and Risk Management Group.
The Company markets its natural gas through monthly spot sales. Because
sales made under spot sales contracts result in fluctuating revenues to the
Company depending upon the market price of gas, the Company may enter into
various hedging agreements to minimize the fluctuations and the effect of price
declines or swings. In October of 1998, the Company entered into two swap
agreements, one for 4,000 MMBtu's per day of its Gulf Coast natural gas
production for $2.14 per MMBtu for the period beginning November 1998 and ending
in October 1999, and the second one for 700 MMBtu's per day of its Gulf Coast
natural gas production for $2.13 per MMBtu for the period beginning November
1998 and ending in October 1999. Both of these swap agreements were supplemented
in December 1998 when the Company entered into additional swap agreements, one
of which was for 4,000 MMBtu's per day of its Gulf Coast natural gas production
for $2.07 per MMBtu for the period beginning November 1999 and ending in October
2000, and the second one was for 700 MMBtu's per day of its Gulf Coast natural
gas production for $2.07 per MMBtu for the period beginning November 1999 and
ending in October 2000. In September of 1999, the Company entered into a series
of swap agreements on additional natural gas and oil production. It hedged 5,000
MMBtu's per day of natural gas for the months of September through December 1999
at a price of $3.055 per MMBtu, it hedged 3,000 MMBtu's per day for the period
of January through March of 2000, 2,400 MMBtu's per day for the period April
through June of 2000, and 1,700 MMBtu's per day for the period of July through
September of 2000, the latter three hedges of which were all at a price of $2.68
per MMBtu. In addition, the Company entered into a "collar" hedge arrangement on
certain of its oil production. It also entered into an oil hedge for a quantity
equal to 300 barrels of oil per day in the fourth quarter of 1999, 280 barrels
of oil per day in the first quarter of 2000, 256 barrels of oil per day in the
second quarter of 2000, and 237 barrels of oil per day in the third quarter of
2000, all of which transactions were structured with an $18.00 floor price and a
$20.40 cap price. As a result of the above-referenced transactions, the Company
has hedged varying quantities of its natural gas and oil production through
October of 2000.
WORKING CAPITAL. At September 30, 1999, the Company a cash balance of
$1,060,615, total current assets of $8,441,234, and total current liabilities of
$22,653,884. This resulted in a working capital deficit of $14,212,650. The
largest component of the working capital deficit was the current portion of long
term debt which totaled $11,013,162, which is due in varying amounts from the
time frame February through August of 2000. The Company believes that its
rapidly increasing portfolio of proven and, in particular, proven developed oil
and gas reserves, when combined with its existing large inventory of unproven
projects will allow it to effectively restructure the current portion of long
term debt into longer maturities in the next 90 to 120 days. As part of its plan
to do so, the Company has retained outside consulting engineers to prepare third
party evaluations of its proven reserve base, which independent evaluations will
be utilized in conjunction with the financial restructuring. Management believes
that this restructuring can be accomplished with competitive financing in a
timely manner. The factors which contribute to this conclusion include the
Company's consistently increasing net oil and gas production and associated
revenues. The revenues will now enable it to fund significant portions of its
capital expenditures budget from cash generated by operations. The Company's net
working capital deficit, not including the current portion of long term debt,
was $3,199,488 at September 30, 1999. Its cash position was enhanced in October
of 1999 by its previously referenced sale of 50% of its interest in its recently
assembled Papalote project for a cash consideration of $2,000,000 plus an
additional $1,000,000 due in the future, and its previously referenced sale of
project interests to Seagull generating total cash proceeds net to the Company
in the fourth
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<PAGE>
quarter of approximately $890,000. The Company expects its trend of
increasing gas and oil revenues and associated hedging revenues from
commodity transactions will continue the growth in revenues in excess of the
ongoing costs of operations throughout the fourth quarter and beyond, which
will also enhance the Company's working capital position. The net working
capital can be negatively effected by the Company's continuing aggressive
capital expenditures program on its exploration projects to the extent said
capital expenditures exceed cash generated from the sale of interests to
industry partners. The Company is currently marketing certain project
interests which, if closed prior to December 31, 1999, could result in the
Company having positive working capital at year end other than the current
portion of its long term debt. As indicated above, the Company anticipates
restructuring said current portion of long term debt in the next 90 to 120
days.
SUMMARY. The Company believes it is positioned to continue to expand
its 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 throughout the balance of 1999 and 2000.
As evidence of this activity the Company has participated in the
drilling of 25 wells on its exploration projects in the first ten months of
1999. Of the total wells drilled in 1999, ten were producing as of September
30, six are scheduled to commence production upon completion and pipeline
connections, four were dry holes, and five were drilling. The addition of
wells drilled in 1999 to producing status in the third quarter has increased
the Company's net daily production to approximately 500 barrels of oil per
day and 15.0 million cubic feet of natural gas per day as of November 1,
1999. The Company expects that these revenues will not only provide positive
operating cash flow in the balance of the year (prior to capital expenditures
and new 3-D seismic data acquisition costs, which costs the successful
efforts accounting method utilized by the Company mandates to be expensed
rather than capitalized), but begin to contribute significantly to future
drilling expenditures in 2000. The Company's recent drilling results have
further served to increase its confidence in its future drilling on the
technology enhanced Exploration Projects. Additional exploration success
would continue this positive trend. Pending the expected sale of project
interests to industry partners in the fourth quarter, the Company could,
however, have to delay certain of its drilling activities.
The Company expects to fund significant portions of its drilling and
completion costs in 2000 from operating cash flow (prior to capital expenditures
and new 3-D seismic data acquisition costs); however, its exploration plan
includes large portions of its fourth quarter 1999 and 2000 capital
expenditure budgets which will not be funded 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. Management believes expanded credit facilities will be available
to it throughout the next year, and that strategic sales of prospect interests
will be contracted and closed which will allow it to continue its planned
exploration activities throughout 1999 and 2000.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS. In June 1999, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferred of the Effective Date
of FASB Statement No. 133" ("SFAS 137"). SFAS 137, which is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
"derivatives") and for hedging activities. SFAS 137 requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. The Company is currently evaluating
the impact of the application of SFAS 137, which when adopted, could have a
material effect on its consolidated financial statements.
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<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
EPC was a defendant in a lawsuit regarding injuries to a oil field
worker not employed by the Company 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 in exchange for approximately
$6.0 million in punitive damages that otherwise would have been payable to the
plaintiff. 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 in the District Court, 28th Judicial District, State
of Texas against both EPC and the Company. The action style "Juan Ramon
Caballero vs. EPC and Frontier Natural Gas Corporation, alleged, in part, that
EPC has failed and refused to implement an appropriate safety plan and entered
into 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 has in fact implemented a safety plan as part of its
business strategy, which it believes equals or exceeds the one EPC agreed to
implement. It took this action as part of its business activities and not due to
any obligation it believes exists to the Plaintiff.
In the third quarter, the Company and EPC agreed with counsel for the
plaintiff on a procedure for verification of the Company's ongoing safety plan,
and as a result the lawsuit has been dismissed with prejudice at no cost to the
Company or EPC.
ITEM 2. CHANGES IN SECURITIES.
In the quarter ended September 30, 1999, the Company issued 42,304
shares of its common stock pursuant to its employees' 401-K plan. The shares
represent the employer's pro rata match of employee contributions. The shares
are presently unregistered but are intended to be registered in 1999.
Effective September 30, 1999, Esenjay Exploration, Inc. completed
the acquisition of 3DX Technologies Inc. via merger. The terms of the merger
provided for 3DX shareholders to receive, at their election, either (i) the
issuance of one share of Esenjay common stock for 3.25 shares of 3DX common
stock; or (ii) the issuance of a new Esenjay convertible preferred stock at a
ratio of one share of Esenjay convertible preferred stock for each 2.75 shares
of 3DX common stock. Approximately 91% of the 3DX common shares converted into
Esenjay common stock and approximately 9% were converted into Esenjay
convertible preferred stock. As a result, Esenjay issued approximately 2,906,778
new shares of common stock and approximately 356,999 shares of convertible
preferred stock.
The convertible preferred stock may be redeemed at Esenjay's sole
option until September 23, 2000 at $1.925 per share. If not redeemed by that
time, the preferred will automatically convert into one share of Esenjay common
stock on October 1, 2000 if the average closing price of Esenjay common stock is
greater than or equal to $1.875 during the month of September 2000. If the
Esenjay common stock averages less than $1.875 in September of 2000, the
preferred holder has the right, during the month of October of 2000, to "put"
the shares to Esenjay. If put, Esenjay will then have the right to retire the
convertible preferred stock for $1.65 in cash or for common stock with the
number of shares of common stock adjusted based upon a formula set out in the
merger agreement. Under any scenario the convertible preferred stock is
scheduled to be converted or redeemed not later than November 1, 2000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On September 23, 1999, the annual meeting of shareholders of Esenjay
Exploration, Inc. was held. At that meeting the shareholders voted as
follows:
24
<PAGE>
<TABLE>
<S> <C> <C> <C>
a) To approve the Plan and
Agreement of Merger with
3DX whereby the Company
would acquire 3DX. For 12,666,663 Against 14,681 Abstain 10,805
---------- ------ ------
</TABLE>
b) The following directors were elected (by the vote indicated) at such
meeting:
<TABLE>
<CAPTION>
Name of Nominee Number of Number of Number of
Shares Voted For Shares Voted Against Shares Abstained
<S> <C> <C> <C>
David W. Berry 14,766,574 0 36,163
Alex B. Campbell 14,771,148 0 31,589
Charles J. Smith 14,739,904 0 62,831
</TABLE>
25
<PAGE>
ITEM 5. OTHER INFORMATION.
Immediately after the shareholders meetings on September 23,
1999 of the Company and the shareholders meeting of 3DX, at which
shareholders meetings the Plan and Agreement of Merger with 3DX was
approved by the shareholders of both companies, the merger was consummated.
The Company believes the consummation of the merger is in its best interest
for an array of reasons, in particular, including the following:
- The Company and 3DX had interests in a number of the same
exploration projects, including interests in seismic data in those
exploration projects; therefore, the Company believes the merger
increased its interest in these projects giving it greater control
of the operation and development of such projects;
- 3DX owned interests in exploration projects in which the Company
did not have an interest, but which the Company believed had been
valuable additions to its project inventory;
- The acquisition of 3DX has resulted in the acquisition by the
Company of interests in additional exploration assets, including
interests in proven developed natural gas and oil properties;
- Certain key professional technical personnel previously employed
by 3DX have remained on the staff of the Company, thereby
expanding its array of professional exploration personnel;
- The elimination of duplicate overhead and regulatory burdens and
costs associated with operating two separate entities can allow
for increased efficiencies and operating cash flow out of the
consolidated reserves.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
<TABLE>
<S> <C> <C>
(a) Exhibits
(2) Plan and Agreement of Merger of Esenjay Exploration,
Inc. and 3DX Technologies Inc. is incorporated by
reference to the Company's Quarterly Report on Form
10-QSB for the quarter ended March 31, 1999 dated May
19, 1999 wherein the same appears as Exhibit 2.
(4) Certificate Of Designations Of Esenjay Exploration, Inc.
Establishing The Designations, Preferences, Limitations
And Relative Rights Of Its Series A. Convertible Preferred
Stock
(11) Computation of Earnings Per Common Share
(27.1) Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K, filed October 8, 1999, is incorporated herein by reference.
</TABLE>
26
<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 , 1999 By: /s/ MICHAEL E. JOHNSON
----------------- ---------------------------
MICHAEL E. JOHNSON, President,
Chief Executive Officer and Director
Date: November , 1999 By: /s/ DAVID B CHRISTOFFERSON
----------------- --------------------------
DAVID B. CHRISTOFFERSON,
Senior Vice President, General Counsel,
Principal Financial Officer
Date: November , 1999 By: /s/ ANGELA CONWAY
----------------- ----------------------------
ANGELA CONWAY
Controller and
Principal Accounting Officer
27
<PAGE>
STATE OF DELAWARE PAGE 1
OFFICE OF THE SECRETARY OF STATE
--------------------------------
I, EDWARD J. FREEL, SECRETARY OF STATE OF THE STATE OF DELAWARE, DO
HEREBY CERTIFY THE ATTACHED IS A TRUE AND CORRECT COPY OF THE CERTIFICATE OF
DESIGNATION OF "ESENJAY EXPLORATION, INC.", FILED IN THIS OFFICE ON THE
TWENTY-THIRD DAY OF SEPTEMBER, A.D. 1999, AT 3:45 O'CLOCK P.M.
A FILED COPY OF THIS CERTIFICATE HAS BEEN FORWARDED TO THE NEW CASTLE
COUNTY RECORDER OF DEEDS.
/s/Edward J. Freel
2890068 8100 [SEAL] ------------------------------------
EDWARD J. FREEL, SECRETARY OF STATE
991401103
AUTHENTICATION: 9989075
DATE: 09-24-99
<PAGE>
CERTIFICATE OF DESIGNATIONS
OF
ESENJAY EXPLORATION, INC.
ESTABLISHING THE DESIGNATIONS, PREFERENCES,
LIMITATIONS AND RELATIVE RIGHTS OF ITS
SERIES A CONVERTIBLE PREFERRED STOCK
Pursuant to Section 151 of the Delaware General Corporation Law, Esenjay
Exploration, Inc., a corporation organized and existing under the Delaware
General Corporation Law (the "Company"),
DOES HEREBY CERTIFY that pursuant to the authority conferred upon the
Board of Directors by the Certificate of Incorporation, as amended, of the
Company, and pursuant to Section 151 of the Delaware General Corporation Law,
the Board of Directors, by unanimous written consent of all members of the
Board of Directors on September 23, 1999, duly adopted a resolution providing
for the issuance of a series of 400,000 shares of Series A Convertible
Preferred Stock, which resolution is and reads as follows:
RESOLVED, that pursuant to the authority expressly granted to and
invested in the Board of Directors of Esenjay Exploration, Inc. (the
"Company") by the provisions of the Certificate of Incorporation of the
Company, as amended, a series of the preferred stock, par value $.01 per
share, of the Company be, and it hereby is, established; and
FURTHER RESOLVED, that the series of preferred stock of the
Company be, and it hereby is, given the distinctive designation of
"Series A Convertible Preferred Stock"; and
FURTHER RESOLVED, that the Series A Convertible Preferred Stock
shall consist of 400,000 shares; and
FURTHER RESOLVED, that the Series A Convertible Preferred Stock
shall have the powers and preferences, and the relative, participating,
optional and other rights, and the qualifications, limitations, and
restrictions thereon set forth below:
<PAGE>
Section 1. DESIGNATION OF SERIES; RANK. The shares of such series shall
be designated as the "Series A Convertible Preferred Stock" (the "Convertible
Preferred Stock") and the number of shares initially constituting such series
shall be up to 400,000. The Convertible Preferred Stock, with respect to
distributions upon liquidation, dissolution or winding up, ranks (i) junior
to any series of preferred stock of the Company the terms of which
specifically provide that such series ranks senior to the Convertible
Preferred Stock (the "Senior Stock"), (ii) PARI PASSU with any other series
of preferred stock of the Company the terms of which specifically provide
that such series ranks PARI PASSU with the Convertible Preferred Stock (the
"Parity Stock") and (iii) senior to the common stock, par value $.01 per
share, of the Company ("Common Stock") and any series of preferred stock the
terms of which specifically provide that such series ranks junior and
subordinate to the Convertible Preferred Stock (the "Junior Stock"). So long
as any shares of Convertible Preferred Stock remain outstanding, the
Company's Certificate of Incorporation shall specify that any other class or
series of stock issued, other than Common Stock, is either Senior Stock,
Parity Stock or Junior Stock. The Convertible Preferred Stock shall be
subject to the creation of Senior Stock, Parity Stock and Junior Stock;
PROVIDED, HOWEVER, that the Company shall not issue any Senior Stock or Parity
Stock to Aspect Resources LLC or its affiliates or Esenjay Petroleum
Corporation or its affiliates without the affirmative vote of two-thirds of
the Company's then existing board of directors who cast votes on the issuance
of such Senior Stock or Parity Stock.
Section 2. DIVIDENDS The holders of Convertible Preferred Stock shall
be entitled to receive dividends paid on the Common Stock as if each share
of Convertible Preferred Stock held by such holders had been fully converted
into one share of Common Stock (the number of shares of Common Stock into
which each share of Convertible Preferred Stock is deemed to be convertible
is referred to herein as the "Conversion Price").
Section 3. LIQUIDATION PREFERENCE
3.1 DISTRIBUTION AMOUNT. In the event of a voluntary or
involuntary liquidation, dissolution or winding up of the Company, the
holders of shares of the Convertible Preferred Stock are entitled to receive
out of the assets of the Company available for distribution to shareholders,
before any distribution of assets is made to holders of Common Stock or any
other stock ranking junior to the Convertible Preferred Stock as to
liquidation, a liquidating distribution as to each share in an amount equal
to the greater of (i) $1.875 or (ii) an amount equal to the liquidating
distribution paid to the holders of the number of shares of Common Stock into
which such share of Convertible Preferred Stock is deemed to be convertible
at the Conversion Price, plus accumulated and unpaid dividends, if any. The
holders of Convertible Preferred Stock and any Parity Stock hereafter issued
that rank on a parity as to liquidation rights with the Convertible Preferred
Stock will be entitled to share ratably, in accordance with the respective
preferential amounts payable on such stock, in any liquidating distribution
that is not sufficient to pay in full the aggregate of the amounts payable
thereon. Neither a consolidation, merger or other business combination of
the Company with or into another corporation or other entity nor a sale,
lease, or exchange or transfer of all or part of the Company's assets for
cash, securities or other property will be considered a liquidation,
dissolution or winding up of the Company.
2
<PAGE>
3.2 NON-CASH DISTRIBUTIONS. If any of the assets of the
Company are to be distributed other than in cash under this Section 3, then
the Board of Directors of the Company shall promptly engage independent
competent appraisers to determine the value of the assets to be distributed
to the holders of shares of the Convertible Preferred Stock. The Company
shall, upon receipt of such appraiser's valuation, give prompt written notice
to each holder of shares of Convertible Preferred Stock of the appraiser's
valuation.
Section 4. VOTING.
4.1 VOTING RIGHTS. The holders of the Convertible Preferred
Stock will have no voting rights except as described in this Section 4 or as
required by law. In exercising any such vote, each outstanding share of
Convertible Preferred Stock will be entitled to one vote, excluding shares
held by the Company or any entity controlled by the Company, which shares
shall have no voting rights.
4.2 ELECTION OF DIRECTORS. For so long as any shares of the
Convertible Preferred Stock remain issued and outstanding, the holders
thereof, voting separately as a class, shall have the right to elect one
director to serve on the Company's Board of Directors. The Company shall
cause to be nominated as a candidate for such director position any person
that, at least 60 calendar days before any meeting (i) is designated in
writing by a holder of Convertible Preferred Stock, (ii) who agrees in
writing to serve if elected and (iii) who provides the Company with a
reasonable description of his personal and business background and
qualifications to serve as a director of the Company; PROVIDED, HOWEVER, that
the Company may refuse to cause any person to be so nominated if, based on a
review of such person's qualifications, the Board of Directors reasonably
concludes that such person is unfit to serve as director of the Company.
From and after such appointment (i) such director shall serve until the next
annual meeting of the shareholders of the Company and until his successor has
been elected and qualifies and (ii) at each annual meeting of the
shareholders of the Company, the Convertible Preferred Stock, voting as a
single class, shall be entitled to elect one director of the Company.
Cumulative voting by holders of Convertible Preferred Stock is prohibited.
Any vacancy on the Board of Directors caused by the death or resignation of a
director so elected or appointed shall be filled at the next annual meeting
of the shareholders of the Company, PROVIDED, HOWEVER, that the Board of
Directors shall promptly appoint to fill such vacancy any qualified person
designated in writing by the holders of more than 50% of the then outstanding
Convertible Preferred Stock. The term of office of the director designated
by the holders of the Convertible Preferred Stock will terminate immediately
upon there being no shares of Convertible Preferred Stock remaining
outstanding.
4.3 AMENDMENTS TO ARTICLES AND BYLAWS. So long as Convertible
Preferred Stock is outstanding, the Company shall not, without the
affirmative vote of the holders of at least 66-2/3% of all outstanding shares
of Convertible Preferred Stock, voting separately as a class (i) amend, alter
or repeal any provision of the certificate of incorporation or the bylaws of
the Company so as to adversely affect the designations, preferences,
limitations and relative rights of the Convertible Preferred Stock or (ii)
effect any reclassification of the Convertible Preferred Stock.
3
<PAGE>
4.4 AMENDMENT OF RIGHTS OF CONVERTIBLE PREFERRED STOCK. The
Company shall not, without the affirmative vote of the holders of at least
66-2/3% of all outstanding shares of Convertible Preferred Stock, amend,
alter or repeal any provision of this Statement of Designations, PROVIDED,
HOWEVER, that the Company may, by any means authorized by law and without any
vote of the holders of shares of Convertible Preferred Stock, make technical,
corrective, administrative or similar changes in this Statement of
Designations that do not, individually or in the aggregate, adversely affect
the rights or preferences of the holders of shares of Convertible Preferred
Stock.
Section 5. REDEMPTION
5.1 OPTIONAL REDEMPTION.
(a) For a period of one year from the Effective Date (as
defined in Paragraph 1.3 of the Plan and Agreement of Merger of Esenjay
Exploration, Inc. and 3DX Technologies, Inc. dated May ___ 1999), the Company
shall have the right to redeem any or all of the outstanding shares of
Convertible Preferred Stock at a per share redemption price (the "Redemption
Price") equal to $1.925, plus all accumulated but unpaid dividends, if any.
(b) No sinking fund shall be established for the Convertible
Preferred Stock.
(c) Notice of any proposed redemption of shares of Convertible
Preferred Stock shall be mailed by means of first class mail, postage
prepaid, addressed to the holders of record of the shares of Convertible
Preferred Stock to be redeemed, at their respective addresses then appearing
on the books of the Company, at least 20, but not more then 60 days before
the date fixed for such redemption (herein referred to as the "Redemption
Date"). Each such notice shall specify (i) the Redemption Date, (ii) the
Redemption Price, (iii) the place for payment and for delivering the stock
certificate(s) and transfer instrument(s) in order to collect the Redemption
Price and (iv) the number of shares, and the class or series of, Convertible
Preferred Stock to be redeemed. Any notice mailed in such manner shall be
conclusively deemed to have been duly given when mailed whether or not such
notice is in fact received. If less than all the outstanding shares of
Convertible Preferred Stock are to be redeemed, the Company will select those
to be redeemed PRO RATA, by lot or in such other manner determined by the
Board of Directors. In order to facilitate the redemption of the shares of
Convertible Preferred Stock, the Board of Directors may fix a record date
for determination of holders of Convertible Preferred Stock to be redeemed,
which date shall not be more than 60 and less than 10 days before the
Redemption Date with respect thereto.
(d) The holder of any shares of Convertible Preferred Stock
that are redeemed shall not be entitled to receive payment of the Redemption
Price for such shares until such holder shall cause to be delivered to the
place specified in the notice given with respect to such redemption (i) the
certificate(s) representing such shares of Convertible Preferred Stock, and
(ii) transfer instrument(s) satisfactory to the Company and sufficient to
transfer such shares of Convertible Preferred Stock to the Company free of
any adverse interest. No interest shall accrue on the Redemption Price of
any share of Convertible Preferred Stock after its Redemption Date.
4
<PAGE>
(e) At the close of business on the Redemption Date for any
share of Convertible Preferred Stock to be redeemed, such share shall
(provided the Redemption Price of such share has been paid or properly
provided for) be deemed to cease to be outstanding and all rights of any
person other than the Company in such share shall be extinguished on the
Redemption Date for such share except for the right to receive the Redemption
Price, without interest, for such share in accordance with the provisions of
this Section 5, subject to applicable escheat laws.
(f) If any shares of Convertible Preferred Stock shall be
converted into Common Stock pursuant to Section 6, then (i) the Company shall
not have the right to redeem such shares, and (ii) any funds that shall be
been deposited for the payment of the Redemption Price for such shares shall
be returned to the Company immediately after such conversion.
5.2 NO MANDATORY REDEMPTION. Except as expressly set forth
herein, no holder of Convertible Preferred Stock shall have any right to
require the Company to redeem any or all of the shares of Convertible
Preferred Stock.
Section 6. CONVERSION RIGHTS
6.1 OPTIONAL CONVERSION.
(a) If the average Closing Price (defined in Section 6.4(e))
of the Common Stock for each trading day beginning on the first day of the
twelfth calendar month following the Effective Date and ending on the last
day of the twelfth calendar month following the Effective Date (the "Average
Closing Price") is less than $1.875 (the "Base Conversion Price") per share,
then at any time during the period beginning the first day of the thirteenth
calendar month following the Effective Date and ending on the last day of the
thirteenth calendar month following the Effective Date, a holder of
Convertible Preferred Stock may cause the Company to convert all or any
portion of his Convertible Preferred Stock into the consideration described
below. The conversion price per share (the "Optional Conversion Price") for
all such shares of Convertible Preferred Stock shall be, at the Company's
option, either (i) a number of shares of Common Stock determined by dividing
$1.875 by the Average Closing Price, to a maximum of 3.75 shares of Common
Stock (the "Maximum Optional Conversion Shares") for each share of
Convertible Preferred Stock converted, with the total shares of Common Stock
to be issued to any holder of Convertible Preferred Stock to be rounded to
the nearest whole share; or (ii) $1.65 in cash (the "Cash Conversion Amount")
for each share of Convertible Preferred Stock converted.
(b) If the Average Closing Price is less than $1.875 per
share, then the Company shall, no later than the third business day following
the first day of the thirteenth calendar month following the Effective Date,
mail to each holder of Convertible Preferred Stock, at its expense, a notice
setting forth (i) the Average Closing Price, (ii) whether the Company has
elected to issue Common Stock or cash to any holder exercising its rights
under Section 6.1(a), and (iii) a statement that the shares of Convertible
Preferred Stock will automatically convert to Common Stock without
5
<PAGE>
further notice on the first day of the fourteenth calendar month following
the Effective Date unless converted before that time.
6.2 AUTOMATIC CONVERSION. On (i) the first day of the thirteenth
calendar month following the Effective Date, if the Average Closing Price is
greater than or equal to the Base Conversion Price; or (ii) the first day of
the fourteenth calendar month following the Effective Date if the Average
Closing Price is less than the Base Conversion Price and the holder has not
elected to convert under Section 6.1(a), each share of Convertible Preferred
Stock then outstanding shall, immediately and automatically, without further
notice, be converted into one share of Common Stock, as adjusted pursuant to
Section 6.4; provided, however, that such automatic conversion shall not be
made during the occurance and continuance of an Event of Bankruptcy or any
liquidation thereunder. As used herein, "Event of Bankruptcy" shall have
occurred if the Company shall have commenced a voluntary case or other
proceeding seeking liquidation, reorganization or other relief with respect
to itself or its debts under any bankruptcy, insolvency or other similar law
not or hereafter in effect or seeking the appointment of a trustee, receiver,
liquidator, custodian or other similar official of it or any substantial part
of its property, or shall have consented to any such relief or to the
appointment of or taking possession by any such official in an involuntary
case or other proceeding commenced against it; or if an involuntary case or
other proceeding shall have been commenced against the Company seeking
liquidation, reorganization or other relief with respect to it or its debts
under any bankruptcy, insolvency or other similar law now or hereafter in
effect or seeking the appointment of a trustee, receiver, liquidator,
custodian or other similar official of it or any substantial part of its
property (PROVIDED, HOWEVER, the Event of Bankruptcy shall not be deemed to
be continuing if such involuntary case or other proceeding shall have been
dismissed); or if an order for relief shall be entered against the Company
under the federal bankruptcy laws as now or hereafter in effect.
6.3 MECHANICS OF CONVERSION.
(a) No fractional share of Common Stock shall be issued upon
conversion of shares of Convertible Preferred Stock, and in lieu thereof, the
holder shall receive, at the Company's option, either a number of whole
shares of Common Stock determined by rounding the number of shares of Common
Stock so issuable to the nearest whole share or an amount of cash equal to
the value of such fractional share of Common Stock based on the Closing Price
of the Common Stock on the day before the conversion. Before any holder of
shares of Convertible Preferred Stock shall be entitled to convert his
Convertible Preferred Stock into shares of Common Stock (or if Section
6.1(a)(ii) applies, cash), he shall surrender the certificate or certificates
therefor, duly endorsed for each share of Convertible Preferred Stock to be
converted, at the office of the Company or of any transfer agent for the
Company, and he shall give at least three business days' prior written notice
to the Company at such office (i) that he elects to convert his Convertible
Preferred Stock, and (ii) shall state therein his name or the name or names
of his nominees in which he wishes the certificate or certificates for shares
of Common Stock to be issued and, if the conversion is pursuant to Section
6.1(a)(ii), the person or persons he wishes to receive any cash. The Company
shall, as soon as practicable thereafter, but not later three business days,
issue and deliver at such office to
6
<PAGE>
such holder of shares, or to his nominee or nominees, a certificate or
certificates for the number of shares of Common Stock to which he shall be
entitled, or the cash to which he is entitled, as the case may be. Except as
set forth in this Section 6, such conversion shall be deemed to have been
made immediately before the close of business on the day of the delivery of
the certificate for the shares of Convertible Preferred Stock and the person
or persons entitled to receive the shares of Common Stock issuable upon such
conversion shall be treated for all purposes as the record holder or holders
of such shares of Common Stock on such date. Upon conversion of only a
portion of the number of shares of Convertible Preferred Stock represented by
a certificate so surrendered for conversion, the Company shall issue and
deliver to the holder a balance certificate representing the number of
unconverted shares of Convertible Preferred Stock.
(b) If more than one certificate representing shares of
Convertible Preferred Stock shall be surrendered for conversion at one time
by the same holder, the number of full shares issuable or the amount of cash
payable upon conversion thereof shall be computed on the basis of the
aggregate number of shares of Convertible Preferred Stock represented by such
certificates, or the specified portions thereof to be converted, so
surrendered.
6.4 ADJUSTMENTS TO REDEMPTION PRICE, CONVERSION PRICE AND OPTIONAL
CONVERSION PRICE. The Redemption Price, Conversion Price and Optional
Conversion Price shall be adjusted from time to time as follows:
(a) In case the Company shall hereafter (i) pay a dividend or make
a distribution on its Common Stock in shares of Common Stock, (ii) subdivide
its outstanding shares of Common Stock into a greater number of shares, or
(iii) combine its outstanding shares of Common Stock into a smaller number of
shares, the Redemption Price and Conversion Price in effect immediately
before such action shall be adjusted so that the holder of any share
thereafter surrendered for conversion shall be entitled to receive the number
of shares of Common Stock or other capital stock of the Company that he would
have owned immediately following such action had such share been redeemed or
converted immediately prior thereto. An adjustment made pursuant to this
subsection (a) shall become effective immediately after the record date in
the case of a dividend or distribution and shall become effective immediately
after the effective date of a subdivision or combination.
(b) In case the Company shall hereafter issue rights or warrants
to holders of its outstanding shares of Common Stock generally entitling them
(for a period expiring within 45 days after the record date mentioned below)
to subscribe for or purchase shares of Common Stock at a price per share less
than the Closing Price per share of the Common Stock on the record date
mentioned below, the Redemption Price and Conversion Price shall be adjusted
so that the Redemption Price and Conversion Price shall equal the price
determined by multiplying the Redemption Price and Conversion Price in effect
immediately before the date of issuance of such rights or warrants by a
fraction of which the denominator shall be the Closing Price on such record
date minus the discount to such Closing Price with respect to the exercise of
such rights or warrants, and of which the numerator shall be the Closing
Price on such record date. Such adjustment shall
7
<PAGE>
become effective immediately after the record date for the determination of
shareholders entitled to receive such rights or warrants.
(c) In case the Company shall hereafter distribute to holders
of its outstanding Common Stock generally evidences of its indebtedness or
assets (excluding any cash dividend paid from retained earnings of the
Company and dividends or distributions payable in stock for which adjustment
is made pursuant to subsection (a) above) or rights or warrants to subscribe
to securities of the Company (excluding those referred to in subsection (b)
above), then in each such case the Conversion Price of the shares of Common
Stock shall be adjusted so that the Conversion Price shall equal the price
determined by multiplying the Conversion Price in effect immediately before
the date of such distribution by a fraction of which the denominator shall be
the current market price per share (determined as provided below) of the
Common Stock on the record date mentioned below less the then fair market
value (as determined by the Board of Directors, whose determination shall be
conclusive and shall be described in a statement filed with any conversion
agent) of the portion of the evidences of indebtedness or assets so
distributed to the holder of one share of Common Stock or of such
subscription rights or warrants applicable to one share of Common
Stock, and of which the numerator shall be such current market price per
share of Common Stock. Such adjustment shall become effective immediately
after the record date for the determination of shareholders entitled to
receive such distribution.
(d) In the case of any optional conversion pursuant to Section
6.1(a), the calculation of the number of shares of Common Stock issuable or
the amount of cash payable upon such conversion, shall be made after
adjusting the Base Conversion Price, the Maximum Optional Conversion Shares
and the Cash Conversion Amount pursuant to the provisions of paragraphs
6.4(a), (b) and (c).
(e) For the purpose of any computation under subsection (b),
(c) and (d) above, the current market price per share of the Common Stock on
any date shall be deemed to be the Closing Price.
(f) The term "Closing Price," means (i) the last sale price of
the Common Stock reported on the NASDAQ Small-Cap Market, (ii) the last sale
price regular way for the Common Stock as reported in the consolidated
transaction reporting system of any stock exchange on which the Common Stock
may then be listed for trading, or (iii) if the Common Stock is not quoted
on the NASDAQ Small-Cap Market or is not listed for trading on a national
securities exchange, the closing bid price is published by NASDAQ (or, if
such prices are not so published by NASDAQ, the average of the high and low
bid prices for the Common Stock each trading day, as furnished by any New
York Stock Exchange member firm selected from time to time by the Company for
such purpose).
(g) In the case of any reclassification of the Common Stock
(other then a change in par value or a change from par value to no par
value or from no par value to par value), any consolidation of the Company
with, or merger of the Company with or into, any other person, any merger of
any person into the Company (other than a merger that does not result in any
8
<PAGE>
reclassification of, or change in, the outstanding shares of Common Stock),
any sale or transfer of all or substantially all of the assets of the Company
(other than a sale-leaseback, collateral assignment, mortgage or other
similar financing transaction), or any compulsory share exchange whereby the
Common Stock is converted into other securities, cash or other properties,
then each share of Convertible Preferred Stock shall thereafter be
convertible into the number of shares of stock or other securities, cash or
other property to which a holder of the number of shares of Common Stock into
which such share of Convertible Preferred Stock might have been converted
immediately before such merger or conveyance would have been entitled upon
such merger or conveyance; PROVIDED, HOWEVER, that if the Company and another
entity consummate a merger in which the Company is not the surviving entity
and the holders of the Convertible Preferred Stock would receive securities
as consideration in such merger, then the Company will redeem all issued and
outstanding shares of Convertible Preferred Stock unless such securities to
be received by the holders thereof as merger consideration contain the same
rights and preferences as the Convertible Preferred Stock.
(h) Notwithstanding the foregoing provisions, no adjustment in the
Conversion Price will be made until all accumulated adjustments to the
Conversion Price are equal to 1% or more of the Conversion Price immediately
preceding the date of the most recent prior adjustment. Any adjustments to
the Conversion Price not made effective shall be carried forward and added to
the next adjustment to the Conversion Price. All calculations shall be made
to the nearest cent or to the nearest 1/100th of a share, as the case may be.
Anything in this Section to the contrary notwithstanding, the Company shall
be entitled to make such increases in the Conversion Price, in addition to
those required hereby, as the Company in its discretion shall determine to
be advisable in order that any stock dividend, subdivision of shares,
distribution or rights to purchase stock or securities, or distribution of
securities convertible into or exchangeable for stock hereafter made by the
Company to its shareholders shall not be taxable.
(i) The Company may from time to time increase the Conversion Price by
any amount for any period of not fewer than 20 consecutive days, in which
case the Company shall give at least 15 days advance written notice of such
increase to all holders of the shares of Convertible Preferred Stock. The
Company may, in its sole discretion, make such increases in the Conversion
Price, in addition to those set forth in this Section 6, as the Board of
Directors of the Company deems advisable to avoid or diminish any income tax
to holders of shares of the Common Stock as a result of any cash distribution
of stock or issuance or rights or warrants to purchase shares of the Common
Stock or as a result of any other event which results in increased income tax
to the holders of shares of the Common Stock.
6.5 TRANSFER COSTS. The Company shall pay any and all documentary stamp
and other transaction taxes attributable to the issuance or delivery of
shares of Common Stock upon conversion of any shares of Convertible Preferred
Stock; PROVIDED, HOWEVER, that the Company shall not be required to pay any
tax that may be payable in respect of any transfer involved in the issue or
delivery of shares of Common Stock in a name other than that of the holder of
the Convertible Preferred Stock to be converted and no such issue or delivery
shall be made unless and until the
9
<PAGE>
person requesting such issue or delivery had paid to the Company the amount
of any such tax or has established, to the satisfaction of the Company, that
such tax has been paid.
6.6 CERTIFICATE AS TO ADJUSTMENTS. Upon the occurrence of each adjustment
or readjustment of the Redemption Price, Conversion Price or Optional
Conversion Price pursuant to this Section 6, the Company at its expense,
shall promptly compute such adjustment or readjustment in accordance with the
terms hereof and furnish to each holder of shares of Convertible Preferred
Stock, a certificate setting forth such adjustment or readjustment and
showing in detail the facts upon which such adjustment or readjustment is
based. The Company shall, upon the written request at any time of any holder
of shares of Convertible Preferred Stock, furnish or cause to be furnished to
such holder a like certificate setting forth (i) such adjustments and
readjustments, (ii) the Conversion Price in effect and (iii) the number of
shares of Common Stock that would be received by the holder upon conversion
of shares of Convertible Preferred Stock.
6.7 COMMON RESERVED. The Company shall reserve and keep available out of
its authorized but unissued shares of Common Stock such number of shares of
Common Stock as shall from time to time be sufficient to effect conversion of
the shares of Convertible Preferred Stock.
6.8 STATUS OF SHARES. All shares of Common Stock that may be issued
upon conversion of the shares of Convertible Preferred Stock will, upon
issuance by the Company, be validly issued, fully paid and nonassessable and
free from all taxes, liens and charges with respect to the issuance thereof
and free from preemptive rights.
Section 7. STATUS OF REACQUIRED SHARES OF CONVERTIBLE PREFERRED STOCK.
Shares of Convertible Preferred Stock issued and reacquired by the Company
(including, without limitation, shares of Convertible Preferred Stock that
have been converted into shares of Common Stock) shall not be reissued by the
Company as shares of Convertible Preferred Stock but shall have the status of
authorized and unissued shares of Preferred stock, undesignated as to series,
subject to later issuance.
Section 8. PREEMPTIVE RIGHTS. The holders of shares of Convertible
Preferred Stock are not entitled to any preemptive or subscription rights in
respect of any securities of the Company.
Section 9. NOTICES. Any notice required hereby to be given to the holders
of shares of Convertible Preferred Stock shall be deemed given if deposited
in the United States mail, postage prepaid, and addressed to each holder of
record at his address appearing on the books of the Company.
10
<PAGE>
IN WITNESS WHEREOF, the Company has caused this statement to be duly
executed by its President this23rd day of September, 1999.
ESENJAY EXPLORATION, INC.
By: /s/ Michael E. Johnson
-----------------------------
Michael E. Johnson, PRESIDENT
11
<PAGE>
EXHIBIT 11 TO FORM 10QSB
ESENJAY EXPLORATION, INC.
COMPUTATION OF EARNINGS PER COMMON SHARE
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
--------------------------- ------------------------
1999 1998 1999 1998
----------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
BASIC EARNINGS (LOSS) PER SHARE
Weighted average common shares Outstanding......... 16,062,302 14,898,728 15,881,590 7,856,842
=========== ============ =========== ===========
Basic loss per share......................... $ (0.06) $ (0.24) $ (0.61) $ (1.18)
=========== ============ =========== ===========
DILUTED EARNINGS (LOSS) PER SHARE
Weighted Average Common Shares Outstanding......... 16,062,302 14,898,728 15,881,590 7,856,842
Shares issuable from assumed conversion of
Common share options and warrants............ 7,500 9,015 7,500 39,731
Convertible preferred stock.................. 27,163 --- 9,154 ---
----------- ------------ ----------- -----------
Weighted average common shares
Outstanding, as adjusted....................... 16,096,965 14,907,743 15,898,244 7,896,573
=========== ============ =========== ===========
Diluted loss per share....................... $ (0.06) $ (0.24) $ (0.61) $ (1.17)
=========== ============ =========== ===========
EARNINGS FOR BASIC AND DILUTED
COMPUTATION
Net loss........................................... $(1,040,374) $ (3,589,630) $(9,629,774) $(9,258,486)
Preferred share dividend........................... --- --- --- ---
----------- ------------ ----------- -----------
Net income to common shareholders
(Basic earnings per share computation)........ $(1,040,374) $ (3,589,630) $(9,629,774) $(9,258,486)
----------- ------------ ----------- -----------
Net loss to common shareholders
(Basic and diluted earnings per share
computation.............................. $(1,040,374) $ (3,589,630) $(9,629,774) $(9,258,486)
=========== ============ =========== ===========
</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.
28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,060,615
<SECURITIES> 0
<RECEIVABLES> 6,687,382
<ALLOWANCES> (519,137)
<INVENTORY> 0
<CURRENT-ASSETS> 8,441,234
<PP&E> 76,337,880
<DEPRECIATION> (23,906,269)
<TOTAL-ASSETS> 61,672,873
<CURRENT-LIABILITIES> 22,653,884
<BONDS> 4,750,000
0
3,570
<COMMON> 187,752
<OTHER-SE> 32,974,715
<TOTAL-LIABILITY-AND-EQUITY> 61,672,873
<SALES> 4,334,441
<TOTAL-REVENUES> 6,858,991
<CGS> 0
<TOTAL-COSTS> 16,488,765
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 520,977
<INCOME-PRETAX> (9,629,774)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,629,774)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,629,774)
<EPS-BASIC> (0.61)
<EPS-DILUTED> (0.61)
</TABLE>
