SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934
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[ ] Confidential, for Use of the Commission only (as permitted by Rule
14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section
240.14a-12
3TEC ENERGY CORPORATION
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(Name of Registrant as Specified in Its Charter)
------------------------------------------------
(Name of Person(s) Filing Proxy Statement
if other than the Registrant)
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[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a(6)(i)(4) and
0-11.
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pursuant to Exchange Act Rule 0-11 (Set forth the amount on which
the filing fee is calculated and state how it was determined):
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
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paid previously. Identify the previous filing by registration statement
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3TEC ENERGY CORPORATION
Two Shell Plaza, 777 Walker Street
Suite 2400
Houston, Texas 77002
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD FRIDAY, JANUARY 28, 2000
To the Shareholders of 3TEC Energy Corporation:
A Special Meeting of Shareholders of 3TEC Energy Corporation, a Delaware
corporation ("3TEC" or the "Company"), formerly Middle Bay Oil Company, Inc.,
will be held at the principal office of the Company, Two Shell Plaza, 777 Walker
Street, Suite 2400, Houston, Texas, 77002 on January 28 , 2000 at 10:00 a.m.,
local time, for the purpose of acting on the following matter:
(1) To consider and approve the issuance of 3,300,000 shares of the
Company's common stock, $.02 par value, warrants to purchase up
To 1,000,000 shares of the Company's common stock, $.02 par value,
and 1,875,000 shares of a new series of the Company's preferred
stock, $.02 par value, to be designated as Series D Preferred
Stock, in connection with the merger of with Magellan Exploration,
LLC ("Magellan") with a wholly owned subsidiary of the Company;
(2) To transact such other business as may properly come before the
meeting or any adjournment thereof.
Only holders of record of the Company's common stock at the close of
business on December 9, 1999, will be entitled to notice of and to vote at the
Special Meeting or any adjournments thereof, notwithstanding the transfer of any
stock on the books of the Company after such record date. A list of the
shareholders will be open to the examination of any shareholder, for any purpose
relevant to the Special Meeting, for a period of ten (10) days prior to the
meeting during regular business hours at the principal office of the Company.
You are requested to forward your proxy to the Company whether or not you
expect to attend in person to ensure that you will be represented at the Special
Meeting. Any shareholder who submits the proxy enclosed with the proxy statement
has the power to revoke such proxy at any time prior to the exercise thereof by
filing with the Company a written revocation at or prior to the Special Meeting,
by executing a proxy bearing a later date, or by attending the Special Meeting
and voting in person the shares of stock that such shareholder is entitled to
vote.
YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, SIGN AND RETURN THE ACCOMPANYING PROXY
FORM IN THE ENVELOPE PROVIDED, WHICH REQUIRES NO POSTAGE IF MAILED IN THE UNITED
STATES.
By Order of the Board of Directors
/s/ Floyd C. Wilson
President and
Chief Executive Officer
Houston, Texas
January 7, 2000
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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
This Proxy Statement contains certain "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995 that are
based on the current beliefs of the Company and its management. When used in
this document, the words "anticipate," "believe," "estimate," "expect,"
"intend," "may," "should," and similar expressions are intended to identify
forward-looking statements. Such statements reflect the current view of the
Company with respect to future events and are subject to certain risks,
uncertainties and assumptions, including, but not limited to, the risk that the
Company may not be able to implement its business and operating strategy in the
intended manner including the integration of acquisitions, risks associated with
competitive pressures currently affecting participants in the oil and natural
gas industry and risks affecting the Company's industry, such as commodity price
risks, competition for quality reserves and technological changes. In addition,
the Company's business, operations and financial condition are subject to the
risks, uncertainties and assumptions which are described in the Company's
reports and statements filed from time to time with the Securities and Exchange
Commission (the "SEC"). Should one or more of those risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those described herein.
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3TEC ENERGY CORPORATION
Two Shell Plaza, 777 Walker Street
Suite 2400
Houston, Texas 77002
PROXY STATEMENT
FOR
SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD FRIDAY, JANUARY 28, 2000
INTRODUCTION
This proxy statement ("Proxy Statement") is furnished to shareholders of
3TEC Energy Corporation, a Delaware corporation ("3TEC" or the "Company"),
formerly Middle Bay Oil Company, Inc., in connection with the solicitation, on
behalf of the Board of Directors of 3TEC, of proxies to be used at a Special
Meeting of Shareholders to be held at 10:00 a.m., local time, on Friday,
January 28, 2000, and all adjournments thereof (the "Special Meeting") for the
purposes set forth in the accompanying Notice of Special Meeting of
Shareholders.
The approximate date on which this Proxy Statement and the enclosed form of
proxy will be first sent or given to shareholders is January 7, 2000. The
principal executive offices of the Company are located at Two Shell Plaza, 777
Walker Street, Suite 2400, Houston, Texas 77002, and the main phone number of
the Company is (713) 222-6725. If necessary, please contact the Company at this
address or phone number.
PROXY; RIGHT TO REVOKE PROXY
Proxies in the form enclosed will be voted at the Special Meeting if
properly executed, returned to 3TEC before the Special Meeting and not revoked.
Any shareholder giving a proxy may revoke it at any time before the vote by
delivering to 3TEC's Secretary at the above address a written revocation, by
voting in person at the Special Meeting, or by giving a later dated proxy.
Attendance at the meeting will not by itself constitute a revocation. The shares
represented by proxies solicited by the Board of Directors will be voted in
accordance with the recommendations of the Board of Directors unless otherwise
specified in the proxy. Whenever the person solicited specifies a choice with
respect to any matter to be acted upon, the shares will be voted in accordance
with the specification so made. Arrangements will be made with brokerage houses
and other custodians, nominees and fiduciaries for the forwarding of
solicitation material to the beneficial owners of the common stock. 3TEC may
reimburse such custodians, nominees and fiduciaries for reasonable out-of-pocket
expenses incurred in connection therewith.
The enclosed form of proxy grants discretionary authority to the persons
named to vote on any other matters that may properly come before the Special
Meeting. 3TEC is not aware of proposals planned to be made at the Special
Meeting which are not included in 3TEC's Notice of Special Meeting of
Shareholders accompanying this Proxy Statement and has no current intention of
making any additional proposals.
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BY WHOM AND THE MANNER IN WHICH PROXY IS BEING SOLICITED
The cost of solicitation will be paid by 3TEC. In addition to solicitation
of proxies by use of the mails, directors, officers or employees of 3TEC may,
without additional compensation, solicit proxies personally, by telephone or by
other appropriate means. 3TEC will request banks, brokerage houses and other
custodians, nominees or fiduciaries holding shares of Common Stock (defined
below) in their names for others to promptly send proxy materials to, and obtain
proxies from, their principals, and 3TEC will reimburse them for their
reasonable expenses in doing so. 3TEC has not and will not engage any
investment banking or brokerage firm or any professional proxy solicitation firm
to solicit proxies. No fees, commissions or other compensation will be paid to
anyone for proxy votes solicited by 3TEC.
SHARES OUTSTANDING
Voting rights regarding the matters to be considered at the Special Meeting
are vested exclusively in the holders of 3TEC's common stock, $ .02 par value
("Common Stock"). The record date ("Record Date") for the holders of Common
Stock entitled to vote at the Special Meeting is the close of business on
December 9, 1999. At the close of business on that date, 3TEC had issued,
outstanding and entitled to vote at the Special Meeting 15,993,092 shares of
Common Stock, each of which is entitled to one vote on all matters expected to
be voted upon at the Special Meeting.
QUORUM AND VOTING
The presence, in person or by proxy, of the holders of shares of Common
Stock entitled to vote at the Special Meeting representing a majority of the
shares of outstanding Common Stock is necessary to constitute a quorum at the
Special Meeting. Each holder of Common Stock is entitled to one vote, in person
or by proxy, for each share held in such holder's name on the Record Date.
Assuming the presence of a quorum, the affirmative votes of a majority of
the votes of holders of Common Stock cast at the Special Meeting, in person or
by proxy, are required for approval of the issuance of 3,300,000 shares of
Common Stock, warrants to purchase up to 1,000,000 shares of Common Stock, and
1,875,000 shares of 3TEC's Series D preferred stock (collectively, the "Merger
Securities") in connection with the merger (the "Merger") of Magellan
Exploration, LLC, a Delaware limited liability company ("Magellan") with a
wholly owned subsidiary of 3TEC. In addition, because of the significant
interest of certain entities affiliated with EnCap Investments L.L.C. ("EnCap")
in both Magellan and the Company, a Special Committee of the Company's Board,
having full authority to act in the matter, has recommended that approval should
also be given by the holders of a majority of Common Stock voting on the matter
who do not have a financial or beneficial interest in Magellan.
AS PART OF THE APPROVAL OF THE ISSUANCE OF THE MERGER SECURITIES IN
CONNECTION WITH THE MERGER, 3TEC, ALONG WITH TABULATING THE OVERALL VOTE, WILL
SEPARATELY TABULATE THE VOTE OF ITS SHAREHOLDERS WHO HAVE NO FINANCIAL OR
BENEFICIAL INTEREST IN MAGELLAN. THE INDIVIDUALS OR ENTITIES KNOWN TO THE
COMPANY TO HAVE A FINANCIAL OR BENEFICIAL INTEREST IN MAGELLAN ("INTERESTED
SHAREHOLDERS") ARE SET FORTH IN THE SECTION ENTITLED "INTEREST OF CERTAIN
PERSONS IN THE MERGER" UNDER PROPOSAL I. FOR THE PURPOSES OF THIS SPECIAL
TABULATION, THE JUDGE OF ELECTION AT THE SPECIAL MEETING, WILL COUNT ALL SHARES
OF COMMON STOCK VOTED BY SHAREHOLDERS OTHER THAN THE INTERESTED SHAREHOLDERS.
THE MERGER SECURITIES WILL NOT BE ISSUED UNLESS APPROVED BY A MAJORITY OF THE
DISINTERESTED SHAREHOLDERS REPRESENTED OR PRESENT AT THE MEETING AND VOTING ON
THIS MATTER.
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Abstentions will be included in vote totals and, as such, will have the
same effect on the matter voted upon as a negative vote. Where nominee
recordholders do not vote on proposals because they did not receive specific
instructions on such proposals from the beneficial owners of such shares
("broker nonvotes"), such broker nonvotes will not be included in vote totals
and, as such, will have no effect on the action taken at the Special Meeting.
GLOSSARY OF OIL AND GAS TERMS
To help clarify the descriptions in this Proxy Statement relating to 3TEC's
business, a glossary of Oil and Gas Terms has been attached to this Proxy
Statement as Exhibit "A."
PROPOSAL I
Approval of the Issuance of Shares
Pursuant to the Merger
GENERAL
The Common Stock of the Company is currently listed on the NASDAQ SmallCap
Market. The Company has called a separate Special Meeting of Shareholders to
be held on January 14, 2000, at which the holders of Common Stock are being
asked to vote on an Amendment to the Company's Certificate of Incorporation
which will effect a 1-for-3 reverse stock split of the Common Stock. Among the
reasons the Company has proposed the reverse stock split is an effort to
increase the trading price of the Common Stock to a level above $5 per share,
which is the minimum trading price for admission of the Common Stock for trading
on the NASDAQ National Market. All share and share related numbers in this
Proxy Statement have been prepared based on the current number of shares
outstanding, prior to any reverse split.
Pursuant to the Marketplace Rules for the NASDAQ Stock Market, the
Company is required to obtain shareholder approval prior to issuing Common Stock
(or securities convertible into or exercisable for Common Stock) in a
transaction other than a public offering when the amount of the Common Stock to
be issued (including shares issuable upon conversion or upon exercise of
warrants) is equal to or is greater than 20% of the Common Stock or voting power
of the Company outstanding prior to the issuance. Additionally, the Company is
required to obtain shareholder approval prior to issuing shares in a transaction
where a director, officer or substantial shareholder has more than a five
percent interest in the to be acquired business and where the Company issues
more than five percent of its Common Stock.
3TEC has negotiated a transaction to merge a wholly owned subsidiary of the
Company with Magellan, with Magellan being the survivor, in exchange for
3,300,000 shares of the Company's Common Stock, warrants to purchase up to
1,000,000 shares of the Company's Common Stock at an exercise price of $10.00
per share, and 1,875,000 shares of the Company's preferred stock, $.02 par
value, with a stated value of $8.00 per share to be designated as Series D
preferred stock ("Series D Preferred Stock"). For purposes of this Proposal I,
the securities described in the preceding sentence are collectively referred to
as the "Merger Securities." As additional consideration, certain of the owners
of Magellan will receive a contingent "back-in" working interest equal to 5% of
Magellan's interest in certain oil and gas exploration prospects as of the date
of closing of the merger transaction. The merger of the Company's wholly owned
subsidiary with Magellan is referred to herein as the "Merger."
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As of the Record Date, 15,993,092 shares of the Company's Common Stock were
outstanding. Therefore, the proposed issuance of the Merger Securities will
exceed the 20% level of the Company's presently outstanding shares of Common
Stock.
Additionally, certain shareholders and directors of the Company have
interests either directly or indirectly in Magellan and will receive Merger
Securities in connection with the Merger. The Interested Shareholders and
directors will not receive any additional benefit not received by the other
owners of Magellan. However, in the Merger, certain members of Magellan will
receive different consideration based on whether the member is considered a
"Prepayout Member," as described below under the caption "Merger Agreement". No
other person will receive any compensation as a result of the relationship
between the Interested Shareholders and directors and Magellan.
BUSINESS OF THE COMPANY
General
The Company is engaged in the acquisition, development, production and
exploration of oil and natural gas, with properties geographically concentrated
in East Texas and the Gulf Coast regions. 3TEC also owns significant properties
in the Permian and San Juan basins and in the Mid-Continent region. The
Company's management and technical staff have substantial experience in each of
these areas.
3TEC has grown its reserves and production through acquisitions focused on
properties having a substantial proved reserve component with attractive
exploitation potential. At October 1, 1999, the Company had estimated total
proved reserves of 227.8 Bcfe with a PV-10 value of $227.7 million using
constant gas and oil prices in effect on September 30, 1999, which averaged
$2.62 per Mcf for gas and $22.54 per barrel for oil. 3TEC's proved reserves are
74% gas on an equivalent basis with 79% of the reserves classified as proved
developed producing. The Company currently operates approximately 425 wells,
located primarily in Texas. These proved reserve and PV-10 estimates include
the recently acquired Floyd Oil Properties, described below.
The Company, until December 7, 1999, was named Middle Bay Oil Company, Inc.
("Middle Bay"), which was originally incorporated on November 30, 1992, under
the Alabama Business Corporation Code. Effective December 31, 1992, Middle Bay
purchased substantially all of the assets and liabilities of Bay City
Consolidated Partners, L.P., an Alabama limited partnership (the "Predecessor
Partnership"), in exchange for Common Stock of Middle Bay. The Predecessor
Partnership was then dissolved, and the shares of Common Stock owned by the
Predecessor Partnership were distributed to the partners pro rata in accordance
with their respective interests in the Predecessor Partnership.
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On August 27, 1999, Middle Bay issued Common Stock, warrants to purchase
Common Stock and senior subordinated convertible debt to 3TEC Energy Company
L.L.C. ("3TEC LLC"), an entity in which certain EnCap affiliated entities have a
controlling interest, in exchange for $20,525,000 in cash and $875,000 in oil
and gas properties. As a result of this transaction, 3TEC LLC became the
largest shareholder of Middle Bay with ownership of approximately 36% of the
then outstanding Common Stock. In connection with this transaction, five of the
seven members of Middle Bay's board of directors resigned, and the number of
directors was set at five. The two continuing directors were John J. Bassett,
replaced by Stephen W. Herod on September 30, 1999, and Gary R. Christopher.
Also, Floyd C. Wilson, an owner and the managing member of 3TEC LLC, became the
Chairman, President and Chief Executive Officer of the Company.
Under the terms of a shareholders' agreement executed in connection with
the above described transaction on August 27, 1999, by and among 3TEC LLC,
Kaiser-Francis Oil Company, C.J. Lett, III, Weskids, L.P., and Alvin V.
Shoemaker (the "Shareholders' Agreement"), 3TEC LLC has the right to designate
three members of the Company's five member board of directors and has caused Mr.
Wilson, D. Martin Phillips, and David B. Miller, both managing directors of
EnCap, to be appointed as the three designees. The remaining parties to the
Shareholders' Agreement have the right to appoint the remaining two designees
and have chosen Mr. Herod and Mr. Christopher as the two designees. The
Shareholders' Agreement relates only to the election of directors and is not
operative with respect to the proposal to be presented at the Special Meeting.
Approximately 10,875,421 shares representing approximately 68% of the
Company's Common Stock outstanding as of the Record Date are subject to this
Agreement, and thus, assuming no dilution, presently have the ability to elect
all the Company's directors.
3TEC, a Delaware corporation, was incorporated under the Delaware General
Corporation Law on November 24, 1999, as a wholly owned subsidiary of Middle
Bay. Effective December 7, 1999, Middle Bay was merged with and into 3TEC to
form 3TEC Energy Corporation, and each holder of the Common Stock of Middle Bay
received one share of 3TEC Common Stock in exchange for each share of Middle Bay
Common Stock.
Recent Acquisition of Floyd Oil Properties
On November 23, 1999, the Company purchased properties and interests owned
by a group of private sellers which were managed by Floyd Oil Company (the
"Floyd Oil Properties"). There is no relationship between Floyd C. Wilson,
President of the Company, and Floyd Oil Company. The majority of the Floyd Oil
Properties are located in Texas and Louisiana. The transaction had an adjusted
purchase price of approximately $87 million in cash and 1.5 million shares of
the Company's Common Stock. The effective date of the transaction was January
1, 1999. The source of the funds used to purchase the Floyd Oil Properties was
existing working capital and proceeds of a new credit facility.
The Floyd Oil Properties have estimated proved reserves at October 1, 1999,
of 174.2 Bcfe with a PV-10 value of $171.2 million using constant gas and oil
prices in effect on September 30, 1999, which averaged $2.64 per Mcf for gas and
$22.54 per barrel for oil. The acquired reserves are 76% natural gas, and 75% of
the reserves are classified as proved developed producing. Current net
production from the properties is approximately 28 Mmcf of natural gas and 2,300
Bbls of oil per day. The Company operates the majority of the properties.
Geographically, the reserves are located as follows: East Texas/North Louisiana
41%, Gulf Coast 26%, Permian Basin 12%, San Juan Basin 12% and Anadarko Basin
9%.
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On a pro forma basis at October 1, 1999, the Floyd Oil Properties
acquisition increased the Company's total proved reserves by 325% to 227.8 Bcfe
and increased net daily production by 260% to 38 Mmcf of natural gas and 3,300
Bbls of oil per day. Please refer to the financial statements and pro forma
financial statements relating to the Floyd Oil Properties below under the
heading "FINANCIAL STATEMENTS INCLUDED IN THIS PROXY STATEMENT." Please note
that in the financial statements regarding the acquisition of the Floyd Oil
Properties, the Floyd Oil Properties are referred to as the "Acquired
Properties."
BUSINESS OF MAGELLAN
General Description
Magellan is an independent energy company engaged in the exploration,
acquisition, development and production of oil and natural gas. Magellan was
formed in Delaware on December 18, 1998, as a limited liability company.
Magellan did not conduct any business activities from its inception through
March 5, 1999, when Pel-Tex Oil Company ("Pel-Tex") was merged into Magellan.
Magellan is majority owned and controlled by various affiliates of EnCap.
Magellan's properties are located in South Louisiana where it owns
interests in approximately 20,000 gross acres (11,650 net acres) in three
prospective areas. Magellan has estimated total net proved reserves of 26.9
Bcfe with a PV-10 value of $41.4 million as of October 1, 1999, using constant
NYMEX natural gas and oil prices of $2.70 per Mmbtu for gas and $20.00 per
barrel for oil with appropriate location and quality differentials resulting in
net commodity prices of $2.88 per Mcf for gas and $18.60 per barrel for oil.
The reserves are 66% gas on an equivalent basis with 80% of the reserves
classified as proved undeveloped. Magellan owns 90 square miles of proprietary
3-D seismic data over two of the prospect areas and licenses 35 square miles of
3-D seismic data over the third prospect area. In addition to the 3-D seismic
data, Magellan has licenses to over 200 miles of 2-D seismic data within its
regional focus area.
Magellan currently has six employees, including two geologist/geophysicists
and one drilling/production engineer. Magellan also is a party to a consulting
services agreement which provides Magellan with up to six additional regionally
experienced geological and geophysical personnel as well as additional
management for Magellan's exploration effort. The Company anticipates that the
current Magellan employees will continue with Magellan after the Merger;
however, there can be no assurance that all or any one of the employees will
remain.
Magellan's current inventory of drilling prospects includes five proved
undeveloped opportunities and over ten exploratory locations. Magellan also
owns interests in three producing wells, each with multiple proved non-producing
opportunities. Magellan's oil and gas properties are described below.
Oil & Gas Properties of Magellan
Breton Sound Area
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Magellan owns a 75% working interest (58.2% NRI) in 5,400 acres located in
Breton Sound Area Blocks 33, 34, and 35, which comprise the Olympus Project.
The Olympus Project is located approximately 60 miles southeast of New Orleans
in the state waters of Louisiana. There is one proved undeveloped drilling
location and several additional exploratory prospects within the Olympus
Project. All of these drilling locations have multiple pay sand objectives and
are supported by 3-D seismic interpretation and subsurface data gathered from
additional wells drilled in the immediate vicinity. The proved undeveloped
location has significant proved reserves with additional probable and possible
reserve potential. Management of the Company believes that the exploratory well
locations also have significant reserve potential.
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Bay de Chene Field
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Bay de Chene Field is located in southern Louisiana along the juncture of
Lafourche and Jefferson parishes, approximately 40 miles south of New Orleans.
The field lies in the inland waters of Hackberry Bay and was discovered by
Texaco in 1941. A total of 280 wells have been drilled in the field to date
yielding cumulative production of approximately 102 million barrels of oil and
230 Bcf of gas. The majority of these wells have been plugged and abandoned
leaving 57 wells either producing or temporarily abandoned.
On November 1, 1996, Magellan (then Pel-Tex) entered into an exploration
agreement with Texaco which allowed Magellan to earn an undivided 50% working
interest in the then existing Texaco leases which comprised Bay de Chene Field,
subject to completion by Magellan of a single well exploratory drilling
commitment. Texaco reserved from the assignment specific portions of reservoirs
for described intervals which could be produced from existing wellbores and
three wells to be drilled or sidetracked at a later date. Texaco also retained
plugging and abandonment obligations of all existing wells.
During 1997, a proprietary 3-D seismic survey was shot across Bay de Chene
Field covering 72 square miles. In 1998, Magellan drilled an exploratory well
which satisfied the earning requirements of the exploration agreement and
subsequently received an assignment of a 50% working interest (38.9% NRI) in the
14,200 acres encompassing the Bay de Chene Field. As a result of extensive
analysis of the 3-D seismic data and subsurface technical data, together with an
extensive regional geologic study, three proved undeveloped locations and
several exploration prospects have been identified.
Garden City Prospect Area
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The Garden City Prospect Area is located onshore in St. Mary Parish,
Louisiana within the Garden City Field. The field produces from 22 different
sand horizons and has been on production since 1959. To date, the Garden City
Field has produced over 1,800 Bcf of gas and 21 million barrels of oil. Magellan
owns a 100% working interest (72.2% NRI) in 486 acres underlying a proved
undeveloped location. This proved location also has significant probable and
possible reserves. Magellan also has two deep, high potential exploration
prospects in the Garden City Prospect Area.
Magellan Summary Unaudited Historical Selected Financial Information
In evaluating the consideration to be received from and paid to Magellan in
the Merger, because (i) the Magellan properties are primarily proved undeveloped
reserves and (ii) Magellan has no debt other than trade payables, neither the
Company nor the Special Committee placed any special significance on the
financial statements of Magellan, which have not been audited. Instead,
principal reliance was placed on the reserve and oil and gas property
information provided by Magellan and as prepared by independent petroleum
engineers. Magellan's unaudited financial statements indicated total assets of
approximately $19 million and no long-term debt at October 31, 1999. The
Company does not believe that the operating results as reported by Magellan,
including revenues of approximately $664,000 and a net loss for the ten months
ended October 31, 1999, of approximately $1,385,000 are indicative of results
Magellan would achieve as a part of the Company following the Merger.
Subsequent to the Merger, 3TEC plans to fund a development program of Magellan's
proved undeveloped reserves, which management of the Company believes could
significantly increase future production and revenues from Magellan's
properties. As a flow-through entity for tax purposes, Magellan does not pay
taxes, but rather any tax liability or tax loss is passed through to the members
of Magellan. Financial statements for Magellan are not presented herein as
Magellan will not constitute a significant subsidiary of the Company for such
purposes.
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REQUIRED VOTE TO APPROVE THE ISSUANCE OF THE MERGER SECURITIES
The issuance of the Merger Securities must be approved by the affirmative
vote of a majority of the total votes cast on this Proposal I, in person or by
proxy, at the Special Meeting. Abstentions will be counted toward the
tabulation of votes cast for determination of a quorum and will have the same
effect as a vote against this Proposal I. Broker non-votes will be counted
toward the tabulation of votes cast for the determination of a quorum but will
not be counted for or against Proposal I.
ADDITIONALLY, THE JUDGE OF ELECTION WILL SEPARATELY TABULATE THE TOTAL
VOTES OF THE COMPANY'S SHAREHOLDERS WHO ARE NOT INTERESTED SHAREHOLDERS. THE
MERGER SECURITIES WILL NOT ISSUED UNLESS APPROVED BY A MAJORITY OF THE
DISINTERESTED SHAREHOLDERS VOTING AT THE MEETING. BECAUSE OF THIS SPECIAL
TABULATION, THE BOARD URGES ALL SHAREHOLDERS TO CAST A VOTE REGARDING THE
ISSUANCE OF THE MERGER SECURITIES EITHER IN PERSON OR BY THE PROXY WHICH
ACCOMPANIES THIS PROXY STATEMENT.
The Special Committee, as described below, believes that approval of the
issuance of the Merger Securities in connection with the Merger is in the best
interest of the Company and recommends a vote "FOR" the approval of Proposal I.
All proxies will be voted to approve Proposal I unless a contrary vote is
indicated on the proxy card.
THE SPECIAL COMMITTEE UNANIMOUSLY RECOMMENDS THAT THE SHAREHOLDERS VOTE "FOR"
APPROVAL OF THE ISSUANCE OF THE COMPANY'S COMMON STOCK, WARRANTS TO PURCHASE
COMMON STOCK, AND PREFERRED STOCK IN CONNECTION WITH THE MERGER.
BACKGROUND OF THE MERGER
In early November 1999, Floyd C. Wilson and Stephen W. Herod, both
officers and directors of the Company, met to discuss the due diligence which
Mr. Wilson and the Company's technical personnel had performed on Magellan as a
possible target for the Company to acquire or merge with in order to expand the
Company's oil and gas reserves, prospects and production. Initial meetings had
taken place at Magellan's offices on September 21, 1999, and October 13, 1999.
3TEC was represented at these meetings primarily by Mr. Wilson while Magellan
was represented primarily by Wynne M. Snoots, the President of Magellan. Also
present at the September 21 meeting were representatives of EnCap. The due
diligence included a review of the geological, geophysical and engineering data
provided by Magellan and reserve reports prepared by Ryder Scott Company ("Ryder
Scott"), a petroleum engineering firm, and a meeting at the offices of Ryder
Scott to review the technical support for Magellan's properties. As of November
1, 1999, the technical due diligence of Magellan was substantially complete.
On November 10, 1999, Mr. Herod, Mr. Wilson, and Gary R. Christopher, a
member of the Company's Board, attended a presentation of Magellan's operations
and assets, including its proved, probable, and possible reserves and
exploration prospects, at the offices of Magellan. Magellan was represented at
the meeting primarily by Mr. Snoots. The Board members representing the Company
requested that Magellan and certain 3TEC personnel provide the Board with
certain financial and technical information to facilitate a more focused
analysis of the combined companies on a pro forma basis. On November 15, 1999,
the Board members received the requested information.
-8-
<PAGE>
On November 18, 1999, the Board of Directors of the Company approved the
continued negotiations with Magellan. The Board discussed the fact that 3TEC
LLC, the Company's largest shareholder, is controlled by EnCap affiliated
entities, which own a majority of Magellan. The Board determined that it was in
the best interest of 3TEC to form a special committee of the Board ("Special
Committee") to continue the discussions with Magellan. The Board, by
resolution, appointed Mr. Herod and Mr. Christopher as the members of the
Special Committee and granted the Special Committee full authority to act in the
matter and to take all actions necessary, including the hiring of such experts
to advise the Special Committee as the Special Committee deemed appropriate, to
carry out the due diligence, negotiation, and ultimate approval or termination
of the Magellan transaction. Neither Mr. Herod nor Mr. Christopher has any
financial or beneficial interest in Magellan.
The Special Committee convened on November 19, 1999, to discuss and comment
on the proposed letter of intent for the transaction. At the time of this
discussion, the parties had not agreed on the structure of the transaction,
which later was agreed to be a merger. Additionally, the Special Committee
determined that it would engage an independent financial advisor to evaluate and
prepare a fairness opinion to be presented to the Special Committee with regard
to the fairness of the Merger to the Company's public common shareholders from
a financial point of view. The Special Committee met again on November 22,
1999, to discuss the letter of intent as agreed to by Magellan's counsel and the
Company's counsel. On this date, the Special Committee authorized an officer of
3TEC to execute a non-binding letter of intent to acquire Magellan, and Mr.
Wilson executed the letter of intent for the transaction along with the
following owners of Magellan: ECIC Corporation, EnCap Energy Capital Fund III,
L.P., EnCap Energy Acquisition III-B, Inc., BOCP Energy Partners, L.P., and
Pel-Tex Partners, L.L.C.
The Special Committee reconvened on November 29, 1999, to discuss the
proposed fairness opinion and the potential candidates to provide the opinion.
Also, on November 30, 1999, Mr. Herod and Mr. Wilson met with Mr. Snoots to
discuss the financial statements of Magellan as well as the time line of events
to close the transaction. On December 1, 1999, the Special Committee engaged
Harris, Webb & Garrison, Inc. ("Harris Webb & Garrison"), an investment banking
firm, to consider and advise the Special Committee as to the fairness of the
Merger to the Company's public common shareholders from a financial point of
view.
On December 6, 1999, Mr. Herod received a first draft of the acquisition
agreement from counsel for the Company. Also on the same day, Mr. Herod along
with certain of 3TEC's technical personnel and representatives of Harris Webb &
Garrison met at Magellan's offices with Magellan's management and technical
staff to review Magellan's operations and assets.
On December 8, 1999, the Special Committee approved the transaction based
on the conditions that the Special Committee receive a satisfactory opinion from
Harris Webb & Garrison as to the fairness of the Merger to the Company's public
common shareholders from a financial point of view and the execution of a
satisfactory definitive agreement.
Mr. Herod met with representatives of Harris Webb & Garrison on several
occasions beginning December 10, 1999, and continuing through the date the
opinion was delivered to the Special Committee. Mr. Herod and the
representatives of Harris Webb & Garrison discussed in detail the documentation
and support for the fairness opinion.
-9-
<PAGE>
On December 20, 1999, the Special Committee received and reviewed the
definitive agreement and authorized the Company's President, Mr. Wilson, to
execute the definitive agreement on behalf of the Company subject to receipt of
the fairness opinion of Harris Webb & Garrison. On December 21, 1999, the
Special Committee received the fairness opinion from Harris Webb & Garrison
which stated that the Merger was fair to the Company's public common
shareholders from a financial point of view, and Mr. Wilson executed the
definitive agreement.
SPECIAL COMMITTEE'S REASONS FOR APPROVING MERGER
In making its decision to approve the Merger the Special Committee
considered, among other factors, the following:
(i) Magellan's business, its current financial position and results of
operations, its future prospects and the current and anticipated
developments in Magellan's business plan;
(ii) The potential of the Magellan properties to increase the Company's
production and revenues by adding Magellan's proved reserves and
exploration prospects to the Company's existing producing properties and
development projects;
(iii) The complementary nature of Magellan's operations, which the
Company believes to have attractive exploration potential, with that of the
Company's;
(iv) The terms of the Merger and its legal and tax implications and
considered them to be fair and standard for transactions of this nature;
(v) The possible addition of Magellan's technical personnel to increase
the Company's geological and geophysical and engineering expertise; and
(vi) The opinion of Harris Webb & Garrison which stated that the Merger
is fair to the Company's public common shareholders from a financial point
of view;
In view of the wide variety of factors considered, the Special Committee
did not find it practicable to, and did not, quantify or otherwise attempt to
assign relative weights to the specific factors considered or to determine that
any factor was of particular importance in reaching its determination that the
potential benefits of the Merger and the issuance of the Merger consideration
outweighed the potential risks and is fair to and in the best interests of the
shareholders. The members of the Special Committee may have assigned different
weights to different factors. As structured, for the transaction to proceed,
the favorable vote of both members of the Special Committee was required and was
received.
OPINION OF FINANCIAL ADVISOR
The Special Committee retained Harris Webb & Garrison to act as its
financial advisor in connection with the Merger and to render an opinion as to
the fairness of the financial terms of the Merger to the Company's public common
shareholders from a financial point of view. Harris Webb & Garrison is an
independent investment banking firm that has no ownership interest in the
Company and is not an affiliate of the Company. On December 21, 1999, Harris
Webb & Garrison rendered its opinion to the Special Committee to the effect
that, as of such date and based upon and subject to the various considerations
described in the opinion, the Merger was fair to the Company's public common
shareholders from a financial point of view. Neither the Special Committee nor
the Company imposed any limitations upon Harris Webb & Garrison with respect to
the investigations made or procedures followed by Harris Webb & Garrison in
rendering an opinion.
-10-
<PAGE>
Harris Webb & Garrison has consented to the use of its name and its opinion
in this proxy statement. The full text of the opinion, dated December 21, 1999,
which describes the assumptions made, general procedures followed, matters
considered and limitations on the scope of review undertaken by Harris Webb &
Garrison in rendering its opinion, is attached as Exhibit "B". The Company's
shareholders should read the entire opinion carefully. Harris Webb & Garrison
provided its opinion to the Special Committee for its information, and its
opinion is directed to the fairness of the Merger to the Company's public common
shareholders from a financial point of view. Harris Webb & Garrison's opinion
does not address the relative merits of the Merger and any other potential
transactions or business strategies considered by 3TEC's Board or the Special
Committee, and does not constitute a recommendation to any shareholder as to how
that shareholder should vote at the Company's Special Meeting.
In arriving at its opinion, Harris Webb & Garrison, among other things:
(i) Reviewed a letter of intent outlining the proposed acquisition of
Magellan by the Company dated November 22, 1999;
(ii) Reviewed the merger agreement;
(iii) Reviewed Magellan's unaudited balance sheet and income statement
for the ten month interim period ended October 31, 1999;
(iv) Reviewed the Company's 10-KSB report for the year ended December
31, 1998;
(v) Reviewed the Company's 10-QSB reports for the quarters ended March
31, 1999; June 30, 1999 and September 30, 1999;
(vi) Reviewed summary pages of the Company's reserve report prepared by
Cawley, Gillespie & Associates, Inc. as of August 1, 1999;
(vii) Reviewed summary pages of the Floyd Oil Properties reserve report
prepared by Cawley, Gillespie & Associates, Inc. as of August 1,
1999;
(viii) Reviewed summary pages of the Company's reserve report prepared by
Ryder Scott Company as of October 1, 1999;
(ix) Reviewed summary pages of Magellan's reserve report prepared by
Ryder Scott Company as of October 1, 1999;
-11-
<PAGE>
(x) Reviewed certain analyses prepared by the Company's management and
certain consultants of Magellan's reserves and prospects;
(xi) Reviewed confidential financial forecasts for the Company prepared
by the Company's management;
(xii) Reviewed the Company's proxy statements for its August 10, 1999
and November 18, 1999 shareholder meetings;
(xiii) Reviewed the Company's Bank One credit agreement executed November
23, 1999;
(xiv) Reviewed various confidential schedules and discounted cash flow
analyses prepared by Magellan regarding Magellan's assets being
acquired through the Merger;
(xv) Discussed with management of the Company and Magellan the outlook
for future operating results, the assets and liabilities of both
companies, materials in the foregoing documents, and other matters
it considered to be relevant to its inquiry;
(xvi) Considered other information, financial studies, analyses and
investigations as it deemed relevant.
Harris Webb & Garrison held discussions with officers and representatives
of 3TEC and Magellan concerning the historical and current financial condition
and operating results as well as the future prospects of the Company and
Magellan. In addition, Harris Webb & Garrison talked with representatives of
Cawley, Gillespie & Associates, Inc. and Ryder Scott, petroleum engineering
firms that prepared reserve reports for the Floyd Oil Properties, Magellan, and
the Company. Harris Webb & Garrison also considered financial, economic and
market criteria which Harris Webb & Garrison deemed relevant for the preparation
of its opinion.
In arriving at its opinion, Harris Webb & Garrison assumed and relied upon
the accuracy and completeness of the financial and other information that was
publicly available or provided to it by 3TEC, Magellan, Cawley, Gillespie &
Associates, Inc. or Ryder Scott Company. Harris Webb & Garrison did not
independently verify any of this information. Harris Webb & Garrison further
relied upon the assurances of the management of the Company and Magellan that
they were unaware of any facts that would make the information provided to
Harris Webb & Garrison incomplete or misleading in any material respect. With
respect to non-historical financial and operating data, Harris Webb & Garrison
assumed that they had been reasonably prepared on bases reflecting the best
currently available estimates and judgment of the management of the Company and
Magellan, relating to the future financial and operational performance of 3TEC
and Magellan. With respect to the estimates of oil and gas reserves, Harris
Webb & Garrison assumed that they had been reasonably prepared on bases
reflecting the best available estimates and judgments of the Company and
Magellan or their engineering consultants relating to the oil and gas properties
of the Company and Magellan. Harris Webb & Garrison did not make an independent
evaluation or appraisal of the assets or liabilities of the Company or Magellan
nor, except for the estimates of oil and gas reserves referred to above, was
Harris Webb & Garrison furnished with such an evaluation or appraisal.
-12-
<PAGE>
The opinion is based on economic, market, financial and other conditions as
they existed on, and on the information made available to Harris Webb & Garrison
as of, the date of the opinion. It should be understood that, although
subsequent developments may affect its opinion, Harris Webb & Garrison does not
have any obligation to update, revise or reaffirm its opinion.
The following is a summary of the material financial analyses performed by
Harris Webb & Garrison in connection with the preparation of its opinion dated
December 21, 1999.
Value Range Comparison. Harris Webb & Garrison's fairness analysis was
primarily that the estimated fair market value range of "items given up" by the
Company's shareholders was within a range of value reasonably equivalent to the
estimated fair market value range of "value received" by the Company's
shareholders. Harris Webb & Garrison's fair market value range for "items given
up" was estimated to be $17.6 - $21.4 million for the issuance of Common Stock,
Series D Preferred Stock, warrants and the contingent 5% "back-in" working
interest, and "items received" was estimated to be $18.9 - $24.6 million for
Magellan's oil and gas properties and working capital. The following table
summarizes Harris Webb & Garrison's indicated value range comparison:
<TABLE>
<CAPTION>
Dollar Value
Indicated Value Range Comparison In Millions
- ------------------------------------------ -------------
<S> <C>
3.3 million Shares of 3TEC Common. . . . . $ 10.5 - 12.5
($3.18 - $3.79 per share)
1.875 million Shares of 3TEC D Pfd.. . . . 6.8 - 8.3
"Back-In" 5% Working Interest. . . . . . . 0.1 - 0.2
1.0 million Warrants at $10.00 . . . . . . 0.2 - 0.4
-------------
Total Consideration from 3TEC. . . . . . . $ 17.6 - 21.4
=============
Approximate Mid-point of "items given up". $ 19.5
Magellan's Oil and Gas Properties. . . . . $ 18.5 - 24.0
Working Capital and Other Assets . . . . . 0.4 - 0.6
-------------
Range of Magellan Value. . . . . . . . . . $ 18.9 - 24.6
=============
Approximate Mid-point of "items received". $ 21.8
Range of Overlap . . . . . . . . . . . . . $ 18.9 - 21.4
</TABLE>
Discounted Cash Flow Analysis of Magellan Contained in the Ryder Scott
Reserve Report. Harris Webb & Garrison considered the present value of the
future cash flows that the proved oil and gas reserves of Magellan could be
expected to generate after approximately October 1, 1999, the date of the Ryder
Scott report, based on the reserve report.
Harris Webb & Garrison's analysis of 100% of Magellan's net asset value
began with the reserve report prepared by Ryder Scott Company as of October 1,
1999, and Magellan's unaudited balance sheet as of October 31, 1999. The
reserve report indicated a total proved reserve present value of $41.4 million
for Magellan's oil and gas assets. Assumptions included a 10% per annum
discount rate and constant pricing and costs. The prices for oil and natural
gas were $20.00 per barrel and $2.70 per mcf. Using a 20% discount rate, the
present value was $31.3 million.
-13-
<PAGE>
Magellan's proved reserves are heavily concentrated in the undeveloped
category (approximately 80%), which is unusual for an oil and gas exploration
and production company. In discussions with oil and gas executives currently
considering acquisitions comparable to Magellan's primary assets, Harris Webb &
Garrison was told that a reasonable fair market value calculation for reserves
by a buyer might assume:
- 100% of the present value of proved producing reserves assuming
current prices and costs held constant and using a 15 - 20% discount
rate, and
- a 25 - 75% "haircut" (or discount) for proved non-producing and
proved undeveloped reserves, depending on the quality and risk of
those assets.
It was also suggested to Harris Webb & Garrison that the value of proved
developed non-producing reserves would be "haircut" by a buyer by roughly 25% in
average or normal circumstances and up to 50% for higher risk plays; and that
proved undeveloped reserves would be haircut 50 - 75%, depending on the quality
of these undeveloped reserves and the likelihood that they would be developed at
current prices for oil and gas.
Harris Webb & Garrison's investigation revealed that many industry buyers
are currently looking at 15% present values and in some cases 20% present values
(i.e., present values for oil and gas based on discounting estimated future cash
flows by 15% per annum and 20% per annum in order to achieve a rate of return of
15-20% on a higher risk investment). Buyers are currently not willing to
escalate prices of oil because they perceive current prices of oil to be high.
Some buyers report that they are assuming a slight decline in oil prices over
the next two years.
Since approximately 80% of the Ryder Scott value for Magellan's proved
reserves rests with the proved undeveloped reserves and only 3% with proved
developed producing reserves, Harris Webb & Garrison believed that a buyer would
pay significantly less than the 10% present value and 15% present value
calculated in the Ryder Scott report. Based on Harris Webb & Garrison's current
analysis of the market for proved reserves and giving some credit to Magellan's
probable reserves, Harris Webb & Garrison believed that the fair market value
for Magellan's oil and gas properties ranged from $18.5 million to $24.0
million.
Harris Webb & Garrison then added $0.4 - $0.6 million for the fair market
value of Magellan's net working capital and other assets and arrived at a range
of $18.9 million to $24.6 million for the value of 100% of Magellan's equity.
Analysis of value for 3TEC common stock. In valuing 3TEC's common stock,
Harris Webb & Garrison believed the current stock market price and recent
historical stock prices were the best indicators of fair market value.
Nevertheless, Harris Webb & Garrison also conducted "break-up analyses" based
primarily on the present value of future cash flows from proved reserves and
compared those values to 3TEC's current stock market price. Based on the
Company's December 20, 1999 stock market price of $3.50 per share, the Company's
past trading history and the average of Harris Webb & Garrison's "break-up"
values for 3TEC of $2.99 per share, Harris Webb & Garrison believed the range of
fair market value for 3TEC's common stock was between $3.18 and $3.79 per share.
This gave the 3.3 million shares to be issued a total value range of $10.5 to
$12.5 million.
-14-
<PAGE>
Comparable Convertible Preferred Stocks. Harris Webb & Garrison reviewed 12
publicly traded convertible preferred stocks and compared yield and conversion
premiums to 3TEC's new Series D convertible preferred stock. The 12 convertible
preferred stocks were issued by:
- Apache Corporation - Howell Corporation
- Belco Oil & Gas Corp. - MCN Energy Group, Inc.
- Callon Petroleum Company - Newfield Exploration Company
- Cross Timbers Oil Company - Nuevo Energy Company
- Devon Energy Corporation - Patina Oil & Gas Corporation
- Goodrich Petroleum Corporation - The Williams Companies, Inc.
Harris Webb & Garrison believed that the most comparable preferred stocks
(based on company size, stock rating, conversion premium, etc.) indicated a
reasonable range of current yield between 9% and 11%. At its 5% stated yield
and its $0.40 per share annual dividend, 3TEC's Series D convertible preferred
stock would need to trade between $3.63 and $4.44 to yield 9 - 11%. This gave
the 1.875 million shares to be issued a total value range of $6.8 - $8.3
million.
Warrant Analysis. Harris Webb & Garrison reviewed certain ratios for
comparable publicly-traded warrants, calculated a "Black-Scholes" valuation and
conducted an internal rate of return analysis to arrive at a range of fair
market value for 3TEC's warrants. The average of the three methods was $0.30
per warrant, and Harris Webb & Garrison believed the total range of value for
1.0 million warrants was $0.2 - $0.4 million.
Analysis of Certain Other Publicly Held Oil and Gas Entities. Harris Webb &
Garrison compared selected operating and financial ratios for 3TEC and Magellan
to corresponding data and ratios for selected oil and gas entities whose
securities are publicly held and which Harris Webb & Garrison believed were
comparable in some respects to the Company. These entities were selected for
comparison because they are oil and gas entities with similar properties and
business characteristics to 3TEC. Harris Webb & Garrison calculated the market
capitalization and market value for each of the following publicly traded
companies: Bellwether Exploration Company; Callon Petroleum Company; Comstock
Resources, Inc.; Magnum Hunter Resources, Inc.; and Texoil, Inc.
For this purpose, Harris Webb & Garrison defined "market value of
capitalization" as market value of the relevant company's common equity plus
total debt less excess cash and cash equivalents. Harris Webb & Garrison
calculated the enterprise value of each of these comparable companies as a
multiple of each company's December 31, 1998 proved reserves, the latest twelve
months earnings (as of September 30, 1999) before interest, taxes, depreciation,
depletion, amortization, impairments and exploration costs or "EBITDX" and the
present value of future net revenues of proved reserves, before taxes,
discounted at 10%, assuming no escalation in oil and gas prices. Harris Webb &
Garrison's analysis of the exploration and production companies yielded the
following ranges:
-15-
<PAGE>
<TABLE>
<CAPTION>
Discounted
Proved Present Value of
Reserves EBITDX Proved Reserves
--------------------- -------- ----------------
(per thousand cubic
feet equivalent)
<S> <C> <C> <C>
High $ 1.08 7.5x 156%
Low. $ 0.71 5.4x 107%
</TABLE>
Applying these multiples to 3TEC yielded an enterprise value range of
$178.3 - $318.0 million for 100% of 3TEC, or an equity value range for 100% of
3TEC of $80.6 - $220.3 million. This would be a value per common share of $5.04
- - $13.77 based on 3TEC's 16.0 million primary common shares currently
outstanding and a value per share of $3.25 - $8.87 on a fully diluted basis.
Applying these multiples to Magellan yielded a value range of $19.1 - $64.7
million for 100% of Magellan's equity.
Because of the inherent differences between the businesses, operations and
the prospects of 3TEC and Magellan, and the businesses, operations and prospects
of these comparable companies and the recent significant changes in the oil and
gas markets, Harris Webb & Garrison believed that it was inappropriate to, and
therefore did not, give significant weight to the quantitative results of this
analysis of comparable companies.
Comparable Transactions. Harris Webb & Garrison reviewed eight selected
transactions involving oil and gas exploration and production companies:
- Goodrich Petroleum Corporation's sale of convertible notes, preferred
stock and warrants.
- Carrizo Oil and Gas, Inc.'s repurchase of its Series A Preferred
Stock and warrants from affiliates of Enron Corp.
- Fidelity Oil Holdings, Inc.'s, a subsidiary of MDU Resources Group,
Inc., acquisition of properties from American Resources Offshore,
Inc.
- Cross Timbers Oil Company's acquisition of properties from Ocean
Energy, Inc.
- Bargo Energy Company's acquisition of properties from Atlantic
Richfield Company.
- Harken Energy's acquisition of Xplor Energy, Inc.
- St. Mary Land & Exploration Co.'s acquisition of King Ranch Energy,
Inc.
- Castle Energy Corp.'s acquisition of properties from AmBrit Energy
Corp.
Harris Webb & Garrison did not consider the reserves in any of these
acquisitions to be comparable to 3TEC or Magellan. Moreover, up-to-date reserve
information was not available with respect to these transactions. Consequently,
Harris Webb & Garrison did not make any calculations of ratios involved in these
transactions, and Harris Webb & Garrison did not believe that a buyer of
Magellan's assets would have given any significant weight to such an analysis.
-16-
<PAGE>
In addition to the financial analyses set forth above, Harris Webb &
Garrison considered a number of qualitative factors in arriving at its opinion,
including, the following:
- the potential capital appreciation of the 3TEC's common stock and the
potential for new proved reserves for 3TEC and Magellan;
- the greater number and diversity of properties and prospects of
3TEC resulting from the proposed merger; and
- the possible addition of Magellan's management team and exploration
staff to 3TEC.
The summary set forth above is not a complete description of the analyses
performed by Harris Webb & Garrison. Preparation of the opinion involved
various determinations as to the most appropriate and relevant methods of
financial analysis and the application of these methods to the particular
circumstances. Notwithstanding the separate factors summarized above, Harris
Webb & Garrison believes that its analyses must be considered as a whole and
that selecting portions of its analyses and the factors considered by it,
without considering all analyses and factors, would create an incomplete view of
the evaluation process underlying its opinion. In performing its analyses,
Harris Webb & Garrison made numerous assumptions with respect to oil and gas
industry performance, market prices for oil and gas and economic conditions and
other matters. Harris Webb & Garrison did not attribute any particular weight
to any analysis considered by it, but rather made qualitative judgements as to
the significance and relevance of each analysis. The analyses performed by
Harris Webb & Garrison are not necessarily indicative of actual values or future
results, which may be significantly more or less favorable than suggested by
these analyses.
The Special Committee of the Company's board selected Harris Webb &
Garrison as its financial advisor because Harris Webb & Garrison is a regionally
recognized investment banking firm with substantial experience in transactions
similar to the Merger. As part of its investment banking business, Harris Webb
& Garrison is regularly engaged in the valuation of businesses and securities in
connection with mergers, acquisitions, underwritings, sales and distributions of
listed and unlisted securities, private placements and valuations for corporate
and other purposes.
Pursuant to an engagement letter between the Company and Harris Webb &
Garrison, the Company agreed to pay Harris Webb & Garrison a fee of $75,000,
payable upon delivery of its opinion, regardless of the conclusions reached by
Harris Webb & Garrison in its opinion. 3TEC has also agreed to reimburse Harris
Webb & Garrison for its reasonable out-of-pocket expenses. The Company has also
agreed to indemnify Harris Webb & Garrison, and certain related persons against
certain liabilities relating to or arising out of its engagement, including
liabilities under the federal securities laws. To the extent that this
indemnification includes liabilities arising out of the federal securities laws,
it may not be enforceable as it may be determined to be against public policy.
-17-
<PAGE>
INTEREST OF CERTAIN PERSONS IN THE MERGER
EnCap affiliated entities own a controlling interest in 3TEC LLC, which
currently owns 4,755,556 shares of Common Stock representing 29.74% of the
Company's outstanding shares as of the Record Date. In addition, 3TEC LLC owns
warrants to purchase Common Stock and securities convertible into Common Stock,
which if added to the shares of Common Stock it presently owns (and assuming the
Company does not issue any additional securities and no holder of convertible or
exercisable securities converts or exercises), would represent 48.26% of the
Company's then outstanding Common Stock. Floyd C. Wilson, President, Chief
Executive Officer and Chairman of the Company, is also the managing director and
a member of 3TEC LLC. Also, D. Martin Phillips and David B. Miller, both
directors of the Company, are managing directors of EnCap. EnCap affiliated
entities are also members of Magellan currently holding in the aggregate an
approximate 76% prepayout interest in Magellan, as discussed below.
EnCap affiliated entities will receive Merger Securities in the Merger
because of their ownership positions in Magellan but will not receive any
special consideration. Also, no party will receive any compensation as a result
of the Merger based solely on EnCap's relationship with the Company. EnCap's,
Mr. Wilson's, Mr. Phillips', and Mr. Miller's interest in the Merger was
disclosed fully to the Company's Board and the Special Committee prior to any
decision to enter into negotiations for a business agreement with Magellan.
MERGER AGREEMENT
The following is a summary of the principal terms of the Agreement and Plan
of Merger (the "Merger Agreement"). Attached as Exhibit "C" to this Proxy
Statement is a copy of the Merger Agreement dated December 21, 1999, executed by
and among the Company, 3TM Acquisition L.L.C., Magellan and the following
members of Magellan (the "Prepayout Members"): ECIC Corporation, EnCap Energy
Capital Fund III, L.P., EnCap Energy Acquisition III-B, Inc., BOCP Energy
Partners, L.P., and Pel-Tex Partners, L.L.C. The summary of the Merger
Agreement set forth below is qualified in its entirety by reference to the full
text of the Merger Agreement attached to this Proxy Statement as Exhibit "C".
Shareholders are urged to read the Merger Agreement carefully in its entirety.
GENERAL TERMS
The management of the Company has structured the transaction as a Merger of
a wholly owned subsidiary of the Company with and into Magellan with Magellan
being the surviving entity. The Merger will be accomplished by exchanging 100%
of the membership interests of Magellan for the Merger consideration described
below. After the Merger, Magellan will be a wholly owned subsidiary of the
Company. The Merger will be completed as soon as possible after approval of the
shareholders at the Special Meeting and no later than February 29, 2000. The
Merger will be accounted for under the "purchase" method of accounting in
accordance with generally accepted accounting principles. The Company is not
aware of any material governmental regulatory approvals required for completion
of the Merger.
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<PAGE>
The Company, as the sole member of Magellan after the Merger is completed,
will have the right to replace Magellan's board of managers with individuals
selected by 3TEC. The Company plans to elect Mr. Wilson as the sole manager and
President of Magellan, and intends promptly to integrate the operations of
Magellan with those of the Company.
Delaware law does not afford appraisal rights or the right to receive cash
for shares of Common Stock to the Company's shareholders who vote against or
abstain from voting in favor of the Merger, and the Company does not intend to
make available any such rights.
MERGER CONSIDERATION
Common Stock and Warrants
The Company will issue (i) 3,300,000 shares of its Common Stock to the
Prepayout Members and (ii) warrants to purchase up to 1,000,000 shares of the
Company's Common Stock to the Prepayout Members and the other members of
Magellan. The Common Stock will have identical rights and privileges to the
currently outstanding shares of Common Stock. The effect of this issuance will
be to decrease each existing shareholder's percentage ownership in 3TEC because
the Company will have increased the total number of shares of Common Stock
outstanding.
The warrants being issued will be exercisable at a price of $10.00 per
share and may be exercised at any time on or before four years after the closing
date of the Merger. In the event of a stock split, reserve stock split, stock
dividend, recapitalization or similar transaction, appropriate adjustments will
be made to the exercise price and number of shares received on exercise to
maintain the correct exercise ratio. The effect of any exercise of the warrants
will be to decrease each existing shareholder's percentage ownership of 3TEC
because the Company will have increased the total number of shares of Common
Stock outstanding.
Series D Preferred Stock
Additionally, the Company will issue to the Prepayout Members 1,875,000
shares of the Company's Series D Preferred Stock, which has a redemption value
of $8.00 per share. The Series D Preferred Stock has dividend and liquidation
payment rights equal to the Company's existing Series B preferred stock, $.02
par value having a stated value of $7.50 per share, and Series C preferred
stock, $.02 par value having a stated value of $5.00 per share. The Series D
Preferred Stock will pay dividends at 5% per annum cumulative, payable
semi-annually when, as and if authorized and declared by the Board of Directors.
For a period of three years from the closing date of the Merger, the Company may
pay the dividends in additional shares of Series D Preferred Stock with a stated
value of $8.00 per share.
Holders of Series D Preferred Stock will have the right, at any time, to
convert one share of Series D Preferred Stock into one share of Common Stock.
The Company shall have the right, upon 30 days written notice, to redeem any or
all shares of Series D Preferred Stock for $8.00 per share plus any accrued and
unpaid dividends. However, the holders of the Series D Preferred Stock do not
have the right, under any event or circumstances, to cause or require the
Company to redeem or purchase the Series D Preferred Stock.
-19-
<PAGE>
In the event of a liquidation, dissolution, winding-up or merger of the
Company, the holders of Series D Preferred Stock are entitled to receive
distributions equal to $8.00 per share of Series D Preferred Stock plus any
accrued but unpaid dividends before any holders of Common Stock or junior
preferred stock receive any distributions.
In the event of any stock split, reverse stock split, stock dividend,
recapitalization or similar transaction, appropriate adjustments will be made to
the Series D Preferred Stock to maintain the rate of conversion, redemption, or
distributions upon liquidation existing at the closing date of the Merger.
A majority of the holders of Series D Preferred Stock must consent to
certain actions by 3TEC, including any which (i) adversely alters or changes the
rights, preferences or privileges of the Series D Preferred Stock holders by
merger, consolidation or otherwise, (ii) increases the authorized number of
shares of Series D Preferred Stock, or (iii) authorizes or issues any securities
with rights senior to the Series D Preferred Stock. Other than these described
consents or as required by law or any provision of the Company's Certificate of
Incorporation, the holders of Series D Preferred Stock will have no other voting
rights.
Back-In Working Interest
At closing, the Company has agreed to cause Magellan to assign to the
Prepayout Members a contingent "back-in" working interest equal to 5% of
Magellan's interest as of such date in certain designated exploration prospects
(the "Prospects") on the terms generally described below. An assignment of a
back-in working interest will be made only when Magellan has recouped from all
revenues received by it and attributable to its interest in the Prospects at
closing the sum of (i) its third party costs attributable to its interest at
closing of the Merger in drilling and completing wells on such prospects and
(ii) an 8% per annum return on the monthly cumulative difference between such
costs and revenues ("Initial Payout"). When made, an assignment will cover only
those Prospects on which are located wells either producing or capable of
producing. If after Initial Payout, drilling activities are conducted by
Magellan on previously undrilled Prospects, the payout procedure described above
will be repeated as to such previously undrilled Prospects.
Registration Rights
None of the Merger Securities has been registered under the Securities Act
of 1933, as amended, or any state securities law in connection with the Merger.
In addition, none of the Merger Securities has been registered for resale under
the federal securities laws or the laws of any state and, therefore, the Merger
Securities are restricted from being resold, except pursuant to a registration
statement filed with the Securities and Exchange Commission by the Company
subsequent to the Merger or pursuant to an exemption from the registration
requirements of the federal and state securities laws.
The Company has agreed to file two registration statements to register the
Common Stock received as consideration for the Merger either directly or as a
result of a conversion of the Series D Preferred Stock when requested by the
holders of the Common Stock, and, if necessary, to keep the registration
statement effective for up to two years. 3TEC also has agreed to give notice to
the holders of Common Stock, Series D Preferred Stock and warrants of any
proposed registration statement to be filed by the Company. The holders of
Common Stock, Series D Preferred Stock upon converting into Common Stock, and
warrants, upon exercising the warrants for Common Stock, have the right to
include the Common Stock in such registration statement. The effect of any
registration of the Common Stock will be to allow the owners of the Common Stock
to sell in accordance with the federal and state securities laws.
-20-
<PAGE>
MATERIAL FEDERAL TAX CONSEQUENCES OF THE MERGER
The following general discussion summarizes certain material federal income
tax consequences of the Merger to the shareholders of the Company. This section
does not purport to address any federal tax consequences of the Merger as it
relates to the members of Magellan. This discussion is based on the Internal
Revenue Code of 1986, as amended (the "Code"), the related treasury regulations,
existing administrative interpretations and court decisions, all of which are
subject to change, possibly with retroactive effect. The Company has not sought
and will not seek an opinion of counsel or ruling from the Internal Revenue
Service regarding the Federal Income Tax consequences of the Merger.
Based on the above premise, the Board believes that the shareholders of the
Company will have no federal income tax effect from the Merger and will
recognize no gain or loss based on the Merger. Additionally, the Company will
recognize no gain or loss based on the Merger. The Internal Revenue Service may
adopt a contrary position to that taken by the Board.
This tax discussion is included for general information only and is based
on present law. Each shareholder should consult their own tax advisor to
determine the specific federal income tax consequences of the Merger as it
relates to the shareholder.
REPRESENTATIONS AND WARRANTIES
The Merger Agreement contains customary representations and warranties by
Magellan, the Prepayout Members and the Company including representations and
warranties as to: (a) due organization, valid existence, and good standing; (b)
authorization to execute, deliver, and perform the Merger Agreement; (c) the
binding effect of the Merger Agreement without causing a default or violation of
any material agreement or organizational document; (d) capital structure; (e)
financial statements and financial instruments owned; (f) material agreements;
(g) outstanding debt; (h) investments; (i) employees and employment
arrangements; (j) litigation or proceeding pending or threatened; (k) pension
plans or other ERISA plans; (l) the filing of tax returns and payment of taxes;
(m) title to and nature of assets; (n) possession of necessary permits to carry
on business; (o) ownership of intellectual property used in its business; (p)
environmental matters; (q) investor representations; (r) insurance; (s) the
absence of brokers or finders engaged; (t) oil and gas operations; (u) books and
records; (v) Magellan's reserve report as of October 1, 1999; (w) the veracity
of information; and (x) Year 2000 compliance.
-21-
<PAGE>
CERTAIN COVENANTS
The Merger Agreement contains customary covenants by Magellan, the
Prepayout Members and by the Company. Prior to the effective date of the
Merger, which will be as soon as practicable after the shareholders approve the
issuance of the Merger Securities at the Special Meeting, the Prepayout Members
of Magellan and Magellan agree to maintain Magellan's business as currently
operated and agree not to take any action that would cause a material change in
Magellan's current business or operations.
The Board of Directors of the Company, after meeting their fiduciary
obligations, is required to make a recommendation to the shareholders to vote in
favor of the issuance of the Merger Securities in exchange for the membership
interests of Magellan. The Board has discharged this obligation through its
Special Committee which has recommended that the shareholders approve the
issuance of the Merger Securities.
INDEMNIFICATION OF THE COMPANY
The Prepayout Members have agreed to indemnify the Company, its
shareholders, directors, officers, employees, agents, successors and assigns
(the "Company Indemnified Parties") under certain circumstances as generally
described below:
(i) The Prepayout Members will indemnify the Company Indemnified
Parties against liabilities, losses, damages, costs and expenses ("Damages")
relating to or arising out of any breach by the Prepayout Members of any of
their representations, warranties, covenants and agreements contained in the
Merger Agreement or related documents;
(ii) The Prepayout Members will indemnify the Company for all or a
portion (depending on the circumstances) of its documented out-of-pocket costs
and expenses in connection with the investigation and negotiation of the
transactions contemplated in the Merger Agreement in the event the Merger
Agreement is terminated under certain circumstances, including if a member of
Magellan, not a Prepayout Member, exercises a "preferential right" to purchase
the membership interests of the Prepayout Members in Magellan proposed to be
transferred to the Company; and
(iii) The Prepayout Members will indemnify the Company Indemnified
Parties against Damages relating to or arising out of any actions or proceedings
brought by members of Magellan (other than the Prepayout Members) against the
Company or Magellan in connection with the Merger or any preferential rights to
purchase under Magellan's governing documents.
The indemnification obligations of the Prepayout Members under the Merger
Agreement are subject to certain qualifications and limitations as follows:
(i) The liability of the Prepayout Members will be several (and not
joint and several), and each Prepayout Member's share of any indemnification
claim will not exceed the percentage specified for such member in the Merger
Agreement.
-22-
<PAGE>
(ii) The Prepayout Members will have liability for Damages resulting
from a breach of any of their representations and warranties (exclusive of the
representations and warranties relating to the environment) only to the extent
that the amount of such Damages exceeds $100,000, and only if the Company
requests indemnification within one year of the closing.
(iii) The Prepayout Members will have liability for Damages resulting
from a breach of any of their representations and warranties relating to the
environment only to the extent that the amount of such Damages exceeds $100,000
and only if the Company requests indemnification within three years of the
closing.
(iv) The maximum aggregate liability of the Prepayout Members for their
indemnification obligations under the Merger Agreement (excluding, however,
liability for claims arising out of any actions or proceedings brought by
members of Magellan, other than the Prepayout Members, against the Company or
Magellan in connection with the Merger or any preferential rights to purchase
under Magellan's governing documents), will not exceed $19,500,000; and
(v) The Prepayout Members may satisfy their indemnification obligations
in certain circumstances by tendering the Merger Securities to the Company.
The Company has agreed to indemnify the members of Magellan, their
respective partners, shareholders, members, directors, officers, managers,
employees, agents, successors and assigns against any liabilities, losses,
damages, costs and expenses which may arise out of the Merger Agreement or
related documents.
CONDITIONS TO CLOSING
Prior to closing the Merger, certain conditions must be met by both the
members of Magellan, the Prepayout Members and by the Company. The Prepayout
Members and the Company are required to deliver customary closing certificates
which certify that the representations and warranties of the Merger Agreement
are true and correct and that all covenants have been complied with prior to
closing. The parties are required to deliver legal opinions as well.
TERMINATION OF MERGER
The Merger Agreement may be terminated upon the mutual agreement of the
Company and the Prepayout Members or by either party if the merger has not been
completed by February 29, 2000. Additionally, the Company may terminate the
Merger Agreement (i) if there is a breach of a representation or warranty in the
Merger Agreement, (ii) if Magellan or the members of Magellan have failed to
comply with a covenant in the Agreement, or (iii) if the Company is not
satisfied with its due diligence and gives notice of its election to terminate
by no later than January 14, 2000. The Merger Agreement also may be terminated
by the members of Magellan if (i) the Company has breached a representation or
warranty or (ii) the Company has failed to comply with a covenant in the
Agreement.
-23-
<PAGE>
STOCK INFORMATION
STOCK PRICE
The Company's Common Stock is traded under the symbol "TTEN" and is quoted
on the NASDAQ SmallCap Market. On December __, 1999, the day previous to the
first public announcement of the Merger, the high and low sales prices of 3TEC's
Common Stock was $ ___ per share and $ ____ per share, respectively.
DIVIDEND POLICY
To the date of this Proxy Statement, the Company has not declared or paid
any dividends on its outstanding Common Stock.
The Company currently is required to pay dividends of $.50 per share per
annum in cash when, as and if authorized and declared by the Board on its
existing Series C convertible preferred stock, $.02 par value with a $5.00 per
share stated value. The Company currently is not in arrears in its obligations
to pay dividends to the holders of Series C preferred stock. Nothing in the
Merger affects the dividend rights or payments with regard to 3TEC's existing
preferred stock. The Company's outstanding shares of Series B convertible
preferred stock carry no stated dividend obligation.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth the shares of 3TEC's Common Stock
beneficially owned by those persons known by 3TEC to be the beneficial owner of
more than five percent of 3TEC's issued and outstanding Common Stock. All
percentages are based on 15,993,092 shares of Common Stock issued and
outstanding on December 9, 1999.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF AMOUNT AND NATURE OF PERCENT OF
BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS
- -------------------------- --------------------- -----------
<S> <C> <C>
3TEC Energy Company L.L.C. 10,482,222(1), (2) 48.26%
5910 N. Central Expressway
Suite 1150
Dallas, TX 75206
EnCap Investments L.L.C. . 10,482,222(3), (2) 48.26%
1100 Louisiana
Suite 3150
Houston, TX 77002
Kaiser-Francis Oil Company 3,337,734 20.87%
6733 South Yale
Tulsa, OK 74136
Prudential Capital Group . 2,325,487(6) 13.47%
751 Broad Street
Newark, NJ 07102
-24-
<PAGE>
C. J. Lett, III. . . . . . 1,187,556 7.43%
9320 East Central
Wichita, KS 67206
Weskids, L.P . . . . . . . 961,154(4) 5.97%
310 South Street
Morristown, NJ 07960
Alvin V. Shoemaker . . . . 948,634(5) 5.86%
8800 First Avenue
Stone Harbor, NJ 08247
<FN>
(1) As disclosed in a joint filing on Schedule 13D filed with the Securities
and Exchange Commission on September 10, 1999, 3TEC LLC is the
beneficial owner and has sole voting and dispositive power with respect
to 10,482,222 shares of Common Stock.
(2) Includes 3,566,666 shares represented by subordinated notes convertible
into Common Stock and 2,160,000 shares represented by warrants to
purchase Common Stock exercisable within 60 days of this Proxy
Statement.
(3) EnCap may be deemed to share voting and dispositive power with respect
to the shares of Common Stock owned by 3TEC LLC; however, EnCap
disclaims any beneficial ownership of these shares.
(4) As disclosed in a filing on Schedule 13D filed with the Securities and
Exchange Commission on November 7, 1997; Weskids, L.P. is presently the
beneficial owner and has sole voting and disposition power of 843,687
shares of Common Stock and 117,467 shares of Series B Preferred Stock
immediately convertible into not less than 117,467 shares of 3TEC's
Common Stock. Weskids, Inc. is the general partner of Weskids, L.P. and
effectively controls Weskids, L.P.
(5) As disclosed in a filing on Schedule 13D filed with the Securities and
Exchange Commission on December 23, 1997; includes 117,466 shares of
Series B Preferred Stock immediately convertible into not less than
117,466 shares of 3TEC's Common Stock. This figure also includes 66,666
shares of Common Stock, subordinated notes convertible into 50,000
shares of Common Stock, and warrants immediately exercisable for
30,280 shares of Common Stock, all of which Mr. Shoemaker may be deemed
to share the power to vote or direct the vote and dispose or direct the
disposition of with Shoemaker Family Partners, L.P. and Shoeinvest II,
L.P.
(6) This figure includes subordinated notes convertible into 791,281 shares
of Common Stock and warrants which are immediately exercisable for
479,206 shares of Common Stock.
</TABLE>
-25-
<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth the shares of 3TEC's Common Stock
beneficially owned by each director and executive officer and all directors and
executive officers as a group, all as of December 9, 1999.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF AMOUNT AND NATURE OF PERCENT OF
BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS
- ------------------------------------ --------------------- -----------
<S> <C> <C>
Floyd C. Wilson. . . . . . . . . . . 0 (1) *
Two Shell Plaza, Suite 2400
Houston, TX 77002
David B. Miller. . . . . . . . . . . 0 (2) *
3811 Turtle Creek Blvd., Suite 1080
Dallas, TX 75219
D. Martin Phillips . . . . . . . . . 0 (3) *
1100 Louisiana, Suite 3150
Houston, TX 77002
Frank C. Turner, II. . . . . . . . . 156,522(4) *
Two Shell Plaza, Suite 2400
Houston, TX 77002
Robert W. Hammons. . . . . . . . . . 163,546(5) *
915 Kentbury Court
Katy, TX 77450
Gary R. Christopher. . . . . . . . . 28,000(6) *
6733 South Yale
Tulsa, OK 74136
Stephen W. Herod . . . . . . . . . . 180,683(7) 1.13%
Two Shell Plaza, Suite 2400
Houston, TX 77002
Directors and executive officers . . 528,751 3.31%
of the company as a group
(7 persons)
-26-
<PAGE>
<FN>
* Represents less than 1%.
(1) Mr. Wilson is the managing director and a member of 3TEC LLC which is
the beneficial owner of 10,482,222 of 3TEC's Common Stock.
(2) Mr. Miller is a Managing Director of EnCap, which is a member of 3TEC
LLC. EnCap may be deemed to be the beneficial owner of the 10,482,222
shares of 3TEC's Common Stock directly owned by 3TEC LLC; however, EnCap
disclaims beneficial ownership of these shares.
(3) Mr. Phillips is a Managing Director of EnCap, which is a member of 3TEC
LLC. EnCap may be deemed to be the beneficial owner of the 10,482,222
shares of 3TEC's Common Stock directly owned by 3TEC LLC; however EnCap
disclaims beneficial ownership of these shares.
(4) Represents 20,092 shares of Common Stock and 136,500 shares issuable
upon exercise of options granted to Mr. Turner.
(5) Represents 7,046 shares of Common Stock and 156,500 shares issuable upon
exercise of options granted to Mr. Hammons.
(6) Represents 13,000 shares of Common Stock and 15,000 shares issuable upon
exercise of options granted to Mr. Christopher. Mr. Christopher is an
officer of Kaiser-Francis Oil Company which is the beneficial owner of
3,337,734 shares of 3TEC's Common Stock.
(7) Represents 109,816 shares of Common Stock and 55,000 shares issuable
upon exercise of options granted to Mr. Herod and 15,867 shares of
Series B preferred stock convertible into 15,867 shares of Common Stock.
</TABLE>
WHOM TO CONTACT FOR ADDITIONAL INFORMATION
The Company files annual, quarterly and special reports, proxy statements
and other information with the SEC. You may read and copy any reports,
statements or other information that the Company files with the SEC at the SEC's
public reference rooms in Washington, D.C., New York, New York and Chicago,
Illinois. Please call the SEC at 1-800-SEC-0330 for further information on the
public reference rooms. These SEC filings are also available to the public from
commercial document retrieval services and at the Internet web site maintained
by the SEC at "http://www.sec.gov."
You should rely only on the information contained in this Proxy Statement
in making your decision to approve Proposal I . We have not authorized anyone
to provide you with information that is different from the information contained
in this Proxy Statement. This Proxy Statement is dated January 7, 2000. You
should not assume that the information contained in this Proxy Statement is
accurate as of any date other than that date. Neither the mailing of this Proxy
Statement to shareholders nor the issuance of the Company's Common Stock and
other securities in the Merger creates any implication to the contrary.
-27-
<PAGE>
The Company will provide without charge to each person to whom a Proxy
Statement is delivered upon written or oral request to such person, within one
business day of receipt of such Request, a copy of the Company's Form 10-KSB for
the fiscal year ended December 31, 1998. Requests for such copies should be
directed to Floyd L. Wilson, the Company's President at Two Shell Plaza, 777
Walker Street, Suite 2400, Houston, Texas 77002.
ACCOUNTANTS
One or more representatives of KPMG LLP, the principal accountants of the
Company for the current year and for the most recently completed fiscal year,
(i) will attend the Special Meeting; (ii) will have the opportunity to make a
statement if they desire to do so; and (iii) will be available to respond to
appropriate questions.
OTHER BUSINESS
The Company does not intend to bring any business before the Special
Meeting other than matters referred to in the accompanying notice and at this
date has not been informed of any matters that may be presented to the Special
Meeting by others.
DISCRETIONARY AUTHORITY
At the time of mailing this Proxy Statement, the Board of Directors was not
aware of any other matters which might be presented at the meeting. If any
matter not described in this Proxy Statement should properly be presented, the
persons named in the accompanying form of proxy will vote such proxy in
accordance with their judgment.
By Order of the Board of Directors
/s/ Floyd C. Wilson
President and
Chief Executive Officer
Houston, Texas
January 7, 2000
-28-
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS INCLUDED IN THIS PROXY STATEMENT
<S> <C>
I. CONSOLIDATED FINANCIAL STATEMENTS OF 3TEC ENERGY CORPORATION AND SUBSIDIARIES
(FORMERLY MIDDLE BAY OIL COMPANY, INC.), AS REPORTED BY THE COMPANY IN
ITS ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998:
Reports of Independent Auditors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 . . . . . . . . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Operations for the years ended December 31, 1998 and 1997 . . . . . . . . . . . F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1997 . . . . . . . . . . . F-6
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998 and 1997. F-7
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-8
Management's Discussion and Analysis from its Quarterly Report on Form 10-QSB/A for Quarter Ended
September 30, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Q1999 MDA-1
II. CONSOLIDATED FINANCIAL STATEMENTS OF 3TEC ENERGY CORPORATION AND SUBSIDIARIES
(FORMERLY MIDDLE BAY OIL COMPANY, INC.), AS REPORTED BY THE COMPANY IN
ITS QUARTERLY REPORT ON FORM 10-Q\A FOR THE QUARTER ENDED SEPTEMBER 30, 1999:
Consolidated Balance Sheets as of September 30, 1999 (unaudited) and December 31, 1998 . . . . . . . . . . F-28
Consolidated Statements of Operations for the three months and nine months ended
September 30, 1999 and 1998 (unaudited). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-29
Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 and 1998 (unaudited). . F-30
Notes to Consolidated Financial Statements at and as of September 30, 1999 (unaudited) . . . . . . . . . . F-31
Management's Discussion and Analysis from its Annual Report on Form 10-KSB for 1998. . . . . . . . . . . . 1998 MDA-1
III. STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES WITH RESPECT TO THE
RECENTLY ACQUIRED FLOYD OIL PROPERTIES (THE "ACQUIRED PROPERTIES" )
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-40
Statements of Revenues and Direct Operating Expenses for the Years ended
December 31, 1998 and 1997 (audited) and the periods ended September 30, 1999 and 1998 (unaudited),
with respect to the Acquired Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-41
Notes to Statements of Revenues and Direct Operating Expenses. . . . . . . . . . . . . . . . . . . . . . . F-42
IV. 3TEC ENERGY CORPORATION UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
Unaudited Pro Forma Condensed Consolidated Balance Sheet at September 30, 1999 . . . . . . . . . . . . . . F-46
Unaudited Pro Forma Condensed Consolidated Statement of Operations
for the year ended December 31, 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-47
Unaudited Pro Forma Condensed Consolidated Statement of Operations
for the nine months ended September 30, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-48
Notes to Unaudited Pro Forma Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . F-49
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
3TEC Energy Corporation
We have audited the accompanying consolidated balance sheet of 3TEC Energy
Corporation (formerly Middle Bay Oil Company, Inc.) and subsidiaries as of
December 31, 1998, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of 3TEC Energy
Corporation and subsidiaries as of December 31, 1998, and the results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
KPMG LLP
Houston, Texas
March 26, 1999
F-2
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
3TEC Energy Corporation
We have audited the accompanying consolidated balance sheet of 3TEC Energy
Corporation (formerly Middle Bay Oil Company, Inc.) and subsidiaries as of
December 31, 1997, and the related statements of operations, changes in
stockholders' equity and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We have conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of 3TEC Energy
Corporation and subsidiaries as of December 31, 1997, and the results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
SCHULTZ, WATKINS & COMPANY
Jackson, Mississippi
February 27, 1998
F-3
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
ASSETS
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
CURRENT ASSETS...........................................................................
Cash and cash equivalents.............................................................. $ 1,040,096 $ 1,587,184
Accounts receivable.................................................................... 3,309,043 2,352,679
Accounts receivable--Insurance Claim................................................... 448,083 --
Other current assets................................................................... 141,364 89,021
Assets held for resale................................................................. -- 206,464
------------ ------------
Total current assets................................................................. 4,938,586 4,235,348
NON-CURRENT ASSETS
Accounts receivable--stockholder....................................................... 173,115 166,165
PROPERTY (at cost)
Oil and gas (successful efforts method) 90,849,439 62,654,328
Other.................................................................................. 795,323 822,806
------------ ------------
91,644,762 63,477,134
Less accumulated depletion, depreciation and amortization.............................. (39,073,584) (30,636,202)
------------ ------------
52,571,178 32,840,932
OTHER ASSETS............................................................................. 257,938 10,127
------------ ------------
TOTAL ASSETS............................................................................. $ 57,940,817 $ 37,252,572
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long term debt................................................... $ -- $ 1,375,537
Accounts payable--Trade................................................................ 3,643,241 1,176,680
Accounts payable--Enex, LP Dissenters and Fractional Shares............................ 538,750 --
Accounts payable--Revenue.............................................................. 342,931 308,981
Other current liabilities.............................................................. 275,010 29,737
------------ ------------
Total current liabilities............................................................ 4,799,932 2,890,935
LONG TERM DEBT........................................................................... 27,454,567 9,714,713
DEFERRED INCOME TAXES.................................................................... 1,733,167 4,780,528
OTHER LIABILITIES........................................................................ 437,949 --
MINORITY INTEREST........................................................................ 957,369 --
STOCKHOLDERS' EQUITY..................................................................... -- --
Preferred stock, $.02 par, 5,000,000 shares authorized with 266,667 shares designated
Series B and 2,177,481 designated Series C, none other issued........................ -- --
Cumulative convertible Series A 8% preferred stock, $6 stated value, No shares
outstanding at 12/31/98 and 1,666,667 shares issued and outstanding at 12/31/97,
$10,000,000 aggregate liquidation preference......................................... -- 10,000,000
Convertible preferred stock Series B, $7.50 stated value, 266,667 shares issued and
outstanding at 12/31/98 and 12/31/97. $2,000,000 aggregate liquidation preference.... 3,627,000 3,627,000
Convertible preferred stock Series C, $5.00 stated value, 1,142,663 shares issued and
outstanding at 12/31/98. $5,713,317 aggregate liquidation preference................. 5,281,937 --
Common stock, $.02 par value, 10,000,000 authorized, 8,552,365 and 4,519,206 shares
issued and outstanding at 12/31/98 and 12/31/97, respectively........................ 171,055 90,392
Additional paid-in capital............................................................. 36,947,588 23,029,299
Unearned stock compensation............................................................ -- (67,500)
Accumulated deficit.................................................................... (23,401,707) (16,744,755)
Treasury stock; 21,773 shares at 12/31/98 and 12/31/97................................. (68,040) (68,040)
------------ ------------
Total stockholders' equity........................................................... 22,557,833 19,866,396
------------ ------------
COMMITMENTS AND CONTINGENCIES
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................................... $ 57,940,817 $ 37,252,572
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1998 1997
------------- --------------
<S> <C> <C>
REVENUES
Oil and gas sales and plant income.............................................. $ 15,011,354 $ 10,213,047
Gain on sale of properties...................................................... 1,953,362 7,018
Delay rental and lease bonus income............................................. 217,404 975,347
Other........................................................................... 520,458 237,583
------------- --------------
Total revenues................................................................ 17,702,578 11,432,995
COSTS AND EXPENSES
Lease operating, production taxes and plant costs............................... 7,801,249 3,848,627
Geological and geophysical...................................................... 877,643 222,608
Dryhole......................................................................... 503,444 1,118,838
Impairments..................................................................... 4,164,184 21,147,823
Depletion, depreciation and amortization........................................ 7,116,116 4,567,063
Interest........................................................................ 1,971,595 671,081
Stock compensation.............................................................. 266,445 202,500
General and administrative...................................................... 4,266,727 2,361,124
Other........................................................................... 138,855 317,469
------------- --------------
Total costs and expenses...................................................... 27,106,258 34,457,133
LOSS BEFORE INCOME TAX BENEFIT AND MINORITY INTEREST.............................. (9,403,680) (23,024,138)
INCOME TAX EXPENSE (BENEFIT)
Current......................................................................... -- 6,451
Deferred........................................................................ (2,829,762) (7,451,249)
------------- --------------
(2,829,762) (7,444,798)
MINORITY INTEREST................................................................. 15,089 --
------------- --------------
NET LOSS.......................................................................... $ (6,589,007) $ (15,579,340)
Dividends to preferred stockholders............................................... (67,945) (604,712)
------------- --------------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS...................................... $ (6,656,952) $ (16,184,052)
============= ==============
NET LOSS PER SHARE
Basic........................................................................... $ (0.83) $ (4.76)
============= ==============
Diluted......................................................................... $ (0.83) $ (4.76)
============= ==============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic........................................................................... 8,050,108 3,397,117
============= ==============
Diluted......................................................................... 8,050,108 3,397,117
============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss............................................................................ $(6,589,007) $(15,579,340)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depletion, depreciation and amortization.......................................... 7,070,916 4,567,063
Impairments....................................................................... 4,164,184 21,147,823
Deferred income tax benefit....................................................... (2,829,762) (7,451,249)
Bad debt expense.................................................................. 20,000 45,000
Abandonment expense............................................................... 45,200 --
Dryhole costs..................................................................... 503,444 1,118,838
Stock compensation................................................................ 266,445 202,500
Gain on sale of assets............................................................ (1,953,362) (7,018)
Minority interest................................................................. 15,089 --
Changes in operating assets and liabilities, net of acquisition effects:
(Increase) Decrease in receivables................................................ (108,892) 243,779
Increase (Decrease) in payables................................................... 1,541,025 (438,355)
(Increase) Decrease in other assets............................................... (76,995) (147,928)
----------- -----------
Net cash provided by operating activities........................................... 2,068,285 3,701,113
CASH FLOWS FROM INVESTING ACTIVITIES
Payment for acquisition of Bison Energy Corp., net of cash acquired of $994,367... -- (7,139,914)
Payment for acquisition of Shore Oil Company net of cash acquired of $2,057,467... -- (514,299)
Payment for acquisition of 80% of Enex Resources Corp., net of cash acquired of
$4,698,211....................................................................... (11,403,189) --
Payment for acquisition of assets of Service Drilling Co., LLC.................... (6,328,208) --
Capital expenditures:
Oil and gas properties.......................................................... (4,100,252) (8,175,051)
Other assets.................................................................... (322,816) (246,735)
Proceeds from sale of:
Oil and gas properties.......................................................... 4,812,326 103,872
Other assets.................................................................... 390,927 1,445,890
Advances to stockholder........................................................... (6,950) (6,950)
----------- -----------
Net cash used in investing activities......................................... (16,958,162) (14,533,187)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds of bank loans.............................................................. 32,469,604 5,769,705
Principal payments on loans......................................................... (16,105,287) (2,497,533)
Proceeds from issuance of preferred stock........................................... -- 9,000,000
Preferred stock dividends........................................................... (67,945) (604,712)
Partnership distributions........................................................... (1,348,098) --
Proceeds from common stock.......................................................... -- 195,772
Registration costs of Series C preferred stock...................................... (431,380) --
Other............................................................................... (174,105) --
----------- -----------
Net cash provided by financing activities..................................... 14,342,789 11,863,232
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS FOR THE YEAR..................... (547,088) 1,031,158
Cash and cash equivalents--Beginning of year........................................ 1,587,184 556,026
----------- -----------
Cash and cash equivalents--End of year.............................................. $ 1,040,096 $ 1,587,184
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR FOR:
Interest.......................................................................... $ 1,657,362 $ 601,582
=========== ===========
Income Taxes...................................................................... $ -- $ 6,451
=========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common stock issued as finders' fee in Enex Resources Corp. tender offer............ $ 245,232 $ --
=========== ===========
Present value of consulting agreement of former president of Enex Resources Corp.... $ 788,563 $ --
=========== ===========
Common stock issued in asset acquisition from Service Drilling Corp. LLC............ $ 3,554,774 $ --
=========== ===========
Preferred stock issued in acquisition of Enex Consolidated Partners, LP............. $ 5,713,317 $ --
=========== ===========
Conversion of redeemable common stock to common stock (net of treasury shares
acquired)......................................................................... $ -- $ 421,179
=========== ===========
Common stock issued in acquisition of Bison Energy Corp............................. $ -- $ 3,330,558
=========== ===========
Common stock issued in acquisition of Shore Oil Company............................. $ -- $12,976,165
=========== ===========
Preferred stock Series B issued in acquisition of Shore Oil Company................. $ -- $ 3,627,000
=========== ===========
Debt assumed in acquisition of Shore Oil Company.................................... $ -- $ 2,105,000
=========== ===========
Common stock issued in property acquisition......................................... $ -- $ 260,130
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
PREFERRED STOCK
-----------------------------------------------------------------------
SERIES A SERIES B SERIES C COMMON STOCK
------------------------ --------------------- ---------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
---------- ------------ --------- ---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE--1/1/97............... 166,667 $ 1,000,000 -- $ -- -- $ -- 1,880,917 $ 37,618
Common stock issued in
acquisition of NPC Energy
Corporation................. -- -- -- -- -- -- 33,463 677
Preferred Series A issued..... 1,500,000 9,000,000 -- -- -- -- -- --
Common stock issued in
acquisition of Bison Energy
Corporation................. -- -- -- -- -- -- 605,556 12,111
Common stock issued in
acquisition of Shore Oil
Company..................... -- -- -- -- -- -- 1,883,333 37,667
Preferred Series B issued in
acquisition of Shore Oil
Company..................... -- -- 266,667 3,627,000 -- -- -- --
Conversion of redeemable
common stock to common
stock....................... -- -- -- -- -- -- -- --
Restricted stock awards....... -- -- -- -- -- -- 49,091 982
Stock options exercised....... -- -- -- -- -- -- 40,833 817
Purchase of oil and gas
working interests........... -- -- -- -- -- -- 26,013 520
Unearned stock compensation... -- -- -- -- -- -- -- --
Net loss...................... -- -- -- -- -- -- -- --
8% Preferred stock Series A
dividends................... -- -- -- -- -- -- -- --
---------- ------------ --------- ---------- ---------- ---------- ---------- ---------
BALANCE--12/31/97............. 1,666,667 10,000,000 266,667 3,627,000 -- -- 4,519,206 90,392
Preferred A Conversion........ (1,666,667) (10,000,000) -- -- -- -- 3,333,334 66,667
Shares issued as finders fee
in Enex Tender Offer........ -- -- -- -- -- -- 33,825 676
Service Drilling Co.
Acquisition................. -- -- -- -- -- -- 666,000 13,320
Restricted stock awards
earned...................... -- -- -- -- -- -- -- --
Enex Consolidated Partners
Acquisition................. -- -- -- -- 1,142,663 5,713,317 -- --
Preferred Stock Registration
Costs....................... -- -- -- -- -- (431,380) -- --
Warrants issued as
compensation................ -- -- -- -- -- -- -- --
Net loss...................... -- -- -- -- -- -- -- --
8% Preferred stock Series A
dividend.................... -- -- -- -- -- -- -- --
---------- ------------ --------- ---------- ---------- ---------- ---------- ---------
ENDING BALANCE-- 12/31/98..... -- $ -- 266,667 $3,627,000 1,142,663 $5,281,937 8,552,365 $ 171,055
========== ============ ========= ========== ========== ========== ========== =========
ADDITIONAL REDEEMABLE
PAID-IN COMMON UNEARNED STOCK ACCUMULATED TREASURY
CAPITAL STOCK COMPENSATION DEFICIT STOCK TOTAL
----------- ----------- -------------- ------------ ----------- -------------
BALANCE--1/1/97............... $ 6,049,442 $ (421,179) $ -- $ (560,703) $ (68,040) $ 6,037,138
Common stock issued in
acquisition of NPC Energy
Corporation................. 93,018 -- -- -- -- 93,695
Preferred Series A issued..... -- -- -- -- -- 9,000,000
Common stock issued in
acquisition of Bison Energy
Corporation................. 3,318,447 -- -- -- -- 3,330,558
Common stock issued in
acquisition of Shore Oil
Company..................... 12,938,498 -- -- -- -- 12,976,165
Preferred Series B issued in
acquisition of Shore Oil
Company..................... -- -- -- -- -- 3,627,000
Conversion of redeemable
common stock to common
stock....................... -- 421,179 -- -- -- 421,179
Restricted stock awards....... 269,018 -- -- -- -- 270,000
Stock options exercised....... 101,266 -- -- -- -- 102,083
Purchase of oil and gas
working interests........... 259,610 -- -- -- -- 260,130
Unearned stock compensation... -- -- (67,500) -- -- (67,500)
Net loss...................... -- -- -- (15,579,340) -- (15,579,340)
8% Preferred stock Series A
dividends................... -- -- -- (604,712) -- (604,712)
----------- ----------- -------------- ------------ ----------- -------------
BALANCE--12/31/97............. 23,029,299 -- (67,500) (16,744,755) (68,040) 19,866,396
Preferred A Conversion........ 9,933,333 -- -- -- -- --
Shares issued as finders fee
in Enex Tender Offer........ 244,556 -- -- -- -- 245,232
Service Drilling Co.
Acquisition................. 3,541,454 -- -- -- -- 3,554,774
Restricted stock awards
earned...................... -- -- 67,500 -- -- 67,500
Enex Consolidated Partners
Acquisition................. -- -- -- -- -- 5,713,317
Preferred Stock Registration
Costs....................... -- -- -- -- -- (431,380)
Warrants issued as
compensation................ 198,946 -- -- -- -- 198,946
Net loss...................... -- -- -- (6,589,007) -- (6,589,007)
8% Preferred stock Series A
dividend.................... -- -- -- (67,945) -- (67,945)
----------- ----------- -------------- ------------ ----------- -------------
ENDING BALANCE-- 12/31/98..... $36,947,588 $ -- $ -- $(23,401,707) $ (68,040) $ 22,557,833
=========== =========== ============== ============ =========== =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
3TEC Energy Corporation (the Company) (formerly Middle Bay Oil Company,
Inc.) was incorporated under the laws of the state of Alabama on November 20,
1992. The Company was reincorporated in Delaware on December 7, 1999 and
changed its name to 3TEC Energy Corporation. Effective March 27, 1998, the
Company acquired 79.2% of Enex Resources Corporation ("Enex") and effective
April 16, 1998, the Company acquired the assets of Service Drilling Co., LLC
("Service Drilling"). Effective October 1, 1998, the Company acquired 100% of
Enex Consolidated Partners, L.P. ("Enex Partnership"), a limited partnership of
which Enex owned greater than a 50% interest. In 1997, the Company acquired
Bison Energy Corporation and Shore Oil Company. The Company is engaged in the
acquisition, development and production of oil and natural gas in the contiguous
United States. The Company considers its business to be a single operating
segment.
SIGNIFICANT ACCOUNTING POLICIES
The Company's accounting policies reflect industry standards and conform to
generally accepted accounting principles. The more significant of such policies
are described below.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company,
Its wholly-owned subsidiary and Enex, an 80% owned subsidiary. The equity of
minority interest in Enex is shown in the consolidated statements as "minority
interest". All significant intercompany balances and transactions have been
eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company classifies all
cash investments with original maturities of three months or less as cash.
OIL AND GAS PROPERTY
The Company follows the successful efforts method of accounting for oil and
gas properties, and accordingly, capitalizes all direct costs incurred in
connection with the acquisition, drilling and development of productive oil and
gas properties. Costs associated with unsuccessful exploration are charged to
expense currently. Geological and geophysical costs and costs of carrying and
retaining unevaluated properties are charged to expense. Depletion, depreciation
and amortization of capitalized costs are computed separately for each property
based on the unit of production method using only proved oil and gas reserves.
In arriving at such rates, commercially recoverable reserves have been estimated
by independent petroleum engineering firms. The Company reviews its undeveloped
properties continually and charges them to expense on a property by property
basis when it is determined that they have been condemned by dry holes, or will
not be retained, sold or drilled upon. Gains and losses are recorded on sales of
entire interests in proved or unproved properties. For the years ended December
31, 1998 and 1997, the Company realized gains on sales of properties of
$1,953,000 and $7,000, respectively.
The Company reviews long-lived assets for impairment when events or changes
in circumstances indicate that the carrying value of such an asset may not be
recoverable. This review consists of a comparison of the carrying value of the
asset to the asset's expected future undiscounted cash flows without interest
costs.
Estimates of expected future cash flows represent management's best estimate
based on reasonable and supportable assumptions and projections. If the expected
future cash flows, assuming escalated prices, are
F-8
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
less than the carrying value of the asset, an impairment exists and is measured
as the excess of the carrying value over the estimated fair value of the asset.
The Company estimates discounted future net cash flows to determine fair value.
Any impairment provisions recognized are permanent and may not be restored in
the future.
For the years 1998 and 1997, the Company's proved properties were assessed
for impairment on an individual field basis and the Company recorded impairment
provisions of $4,092,000 and $21,148,000 respectively, attributable to certain
producing properties.
SITE RESTORATION, DISMANTLEMENT AND ABANDONMENT COSTS
Site restoration, dismantlement and abandonment costs (P&A costs) are common
in the oil and gas industry in which the Company conducts operations. P&A costs
are costs associated with removing the facilities and equipment required to
operate a well and restoring the well site to specified conditions. P&A costs
are incurred when the oil and gas reserves of a well or wells are depleted or
when production drops to the point that it is no longer economically feasible to
produce. P&A costs are governed by federal and state regulations and contractual
obligations.
The Company, in conjunction with its independent engineers and the operators
of the wells, continually reviews its working interests with respect to
potential P&A costs. Estimated P&A costs (net of salvage value) are amortized
through depletion using the units-of-production method.
As of December 31, 1998, the Company's estimated P&A were approximately
$495,000, of which approximately $26,200 was amortized as of December 31, 1998.
The Company's estimated P&A costs at December 31, 1997 were immaterial.
OTHER PROPERTY AND EQUIPMENT
Other property and equipment are stated at cost and depreciation is computed
on the accelerated method over appropriate lives ranging from five to seven
years. Additions and betterments which provide benefits to several periods are
capitalized.
ENVIRONMENTAL LIABILITIES
Environmental expenditures that relate to current or future revenues are
expensed or capitalized as appropriate. Expenditures that relate to an existing
condition caused by past operations, and do not contribute to current or future
revenue generation, are expensed. Liabilities are recorded when environmental
assessments and/or clean-ups are probable, and the costs can be reasonably
estimated. Generally, the timing of these accruals coincides with the Company's
commitment to a formal plan of action.
REVENUE
Oil and gas revenues are recorded using the sales method, whereby the
Company recognizes revenues based on the amount of oil and gas sold to
purchasers on its behalf.
INCOME TAXES
The Company uses the asset and liability method of accounting for income
taxes under which deferred tax assets and liabilities are determined by applying
enacted statutory tax rates applicable to future years to the difference between
the financial statement and tax basis of assets and liabilities. The effect on
deferred
F-9
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
tax assets and liabilities of a change in tax rates is recognized as part of the
provision for income taxes in the period that includes the enactment date.
STOCK BASED COMPENSATION
The Financial Accounting Standards Board ("FASB") issued SFAS No. 123,
"Accounting for Stock Based Compensation", which establishes financial
accounting and reporting standards for stock based compensation plans. The
statement provides the option to continue under the accounting provisions of APB
Opinion No. 25, while requiring proforma footnote disclosures of the effects of
net income and earnings per share, calculated as if the new method had been
implemented. The Company adopted the financial reporting provisions of SFAS No.
123, but continues under the accounting provisions of APB Opinion No. 25.
EARNINGS PER SHARE
Basic earnings per share is based on the weighted average shares outstanding
without any dilutive effects considered. Diluted earnings per share reflects
dilution from all potential common shares, including options, warrants and
convertible preferred stock.
CONCENTRATIONS OF MARKET RISK
The future results of the Company will be affected by the market prices of
oil and natural gas. The availability of a ready market for natural gas and oil
in the future will depend on numerous factors beyond the control of the Company,
including weather, production of other natural gas and crude oil, imports,
marketing of competitive fuels, proximity and capacity of oil and gas pipelines
and other transportation facilities, any oversupply or undersupply of gas and
oil, the regulatory environment, and other regional and political events, none
of which can be predicted with certainty.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which subject the Company to concentrations of credit
risk consist primarily of cash and accounts receivable. The Company places its
cash investments with high credit qualified financial institutions. Risk with
respect to receivables is concentrated primarily in the current production
revenue receivable from multiple oil and gas producers, both major and
independent, and is typical in the industry. No single customer accounted for
greater than 10% of the Company's total oil and gas sales for the year ended
December 31, 1998. The Company sold oil and gas representing approximately 14%
of its total oil and gas sales to one customer, Warren Petroleum Company, L.P.,
for the year ended December 31, 1997.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 standardizes the accounting
for and disclosures of derivative instruments, including certain derivative
instruments embedded in other contracts. The statement is effective for the
Company beginning after January 1, 2000. As the Company historically has not
entered into derivative instruments for non-trading (hedging) purposes or for
trading purposes, the Company does not expect this statement to have a material
impact on its financial condition or results of operations upon implementation.
F-10
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities to prepare the financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications of prior period amounts have been made to conform
to the current presentation.
(2) ACQUISITIONS
On February 28, 1997, the Company completed the acquisition of Bison Energy
Corporation ("BEC"). The transaction consisted of a merger (the "Bison Merger")
of BEC into Bison Energy Corporation-Alabama, a wholly-owned subsidiary of the
Company. On February 28, 1997, Bison Energy Corporation-Alabama merged into BEC
and its separate corporate existence ceased. BEC was merged into the Company in
January, 1998.
The cost of acquiring BEC was approximately $10 million, consisting of the
following (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Estimated fair value of 605,556 shares of Company common stock
issued........................................................... $ 3,330
Cash consideration................................................. 6,654
Legal and accounting expenses...................................... 35
---------
Total.............................................................. $ 10,019
---------
---------
</TABLE>
The fair value of the securities issued in connection with the merger was
calculated using the price of the Company's common stock at the time the Bison
Merger was announced to the public of $5.50 per share.
The Company's purchase price was allocated to the consolidated assets and
liabilities of BEC based on estimates of the fair values with the remaining
purchase price allocated to proved oil and gas properties.
The allocation of the purchase price is summarized as follows: (in
thousands)
<TABLE>
<CAPTION>
<S> <C>
Working capital.................................................... $ 714
Oil and gas properties (proved).................................... 13,268
Yard equipment..................................................... 465
Deferred income taxes.............................................. (4,428)
---------
Total.............................................................. $ 10,019
---------
---------
</TABLE>
The price paid for BEC and the allocation of the purchase price, both
detailed above, excludes the $1,445,890 allocated to non-oil and gas assets that
were purchased in the merger and sold on March 3, 1997 for $1,445,890.
On June 30, 1997, the Company completed the acquisition of Shore Oil Company
("Shore"). The transaction consisted of a merger (the "Shore Merger") of Shore
into Shore Acquisition Company Inc., a wholly-owned subsidiary of the Company.
On June 30, 1997, Shore Acquisition Company merged into Shore
F-11
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(2) ACQUISITIONS (Continued)
and its separate corporate existence ceased. Shore continued as a wholly-owned
subsidiary of the Company until it was merged into the Company in January 1998.
The cost of acquiring Shore was approximately $19 million, consisting of the
following (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Estimated fair value of 1,883,333 shares of Company common stock
issued........................................................... $ 12,976
Estimated fair value of 266,667 shares of Company Series B
preferred stock.................................................. 3,627
Cash consideration................................................. 2,533
Legal and accounting expenses...................................... 38
---------
Total.............................................................. $ 19,174
---------
---------
</TABLE>
The fair value of the securities issued in connection with the merger was
calculated using the average price of the Company's common stock at the time the
Shore Merger was announced to the public and further adjusted for tradability
restrictions. An independent valuation firm determined the tradability discount
for the Company's common stock.
The Company's purchase price was allocated to the consolidated assets and
liabilities of Shore based on estimates of the fair values with the remaining
purchase price allocated to proved and unproved oil and gas properties.
The allocation of the purchase price is summarized as follows: (in
thousands)
<TABLE>
<CAPTION>
<S> <C>
Working capital.................................................... $ 2,288
Oil and gas properties (proved and unproved)....................... 20,688
Fee minerals....................................................... 5,495
Debt assumed....................................................... (2,105)
Deferred income taxes.............................................. (7,192)
---------
Total.............................................................. $ 19,174
---------
---------
</TABLE>
On March 27, 1998, the Company acquired 1,064,432 common shares,
approximately 79.2%, of Enex for $15,966,480. The Company purchased the common
shares of Enex through a cash tender offer that commenced February 19, 1998 (the
"Enex Acquisition"). The Company also incurred approximately $60,934 in legal,
accounting and printing expenses and issued 33,825 shares of Company common
stock for finders fees to unrelated third parties. At the time, Enex was general
partner of Enex Consolidated Partners, L.P., (the "Enex Partnership"), a New
Jersey limited partnership whose principal business is oil and gas exploration
and production. Enex's general partner interest was 4.1%. Enex also owned an
approximate 56.2% limited partner interest in Enex Partnership.
As part of the Enex Acquisition, the Company entered into a consulting
agreement, effective April 15, 1998, with the former president of Enex that
provides for monthly payments of $20,000 until expiration of the agreement on
May 18, 2002. The monthly payments serve as consideration for consulting, a
covenant not to compete and a preferential right to purchase certain oil and gas
acquisitions which the former president controls or proposes to acquire during
the term of the agreement. The Company will reimburse the former president each
month for reasonable and necessary business expenses incurred in connection with
the performance of consulting services. The agreement survives the former
president and his spouse and is nonassignable. At December 31, 1998, the present
value of the agreement, applying a 10% discount, is
F-12
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(2) ACQUISITIONS (Continued)
approximately $677,949. The long-term portion of the agreement is classified as
other liabilities in the financial statements.
The cost of acquiring 79.2% of Enex was allocated using the purchase method
of accounting to the consolidated assets and liabilities of Enex based on
estimates of the fair values with the remaining purchase price allocated to
proved oil and gas properties.
The allocation of the purchase price is summarized as follows: (in
thousands)
<TABLE>
<CAPTION>
<S> <C>
Working capital.................................................... $ 5,640
Oil and gas properties (proved and unproved)....................... 19,090
Minority interest.................................................. (7,669)
---------
Total.............................................................. $ 17,061
---------
---------
</TABLE>
Over the three-week period ended December 23, 1998, the Company acquired an
additional 0.80% (9,747 common shares) of Enex common stock for approximately
$68,000.
On April 16, 1998, the Company acquired substantially all of the oil and gas
assets of Service Drilling Co., LLC and certain affiliates ("Service Drilling"),
in exchange for 666,000 shares of Company common stock and $6,500,000 in cash
for a total acquisition cost of $10,054,774, before post-closing adjustments
(the "Service Acquisition"). The fair value of the securities issued in
connection with the Service Acquisition was calculated using the price of the
Company's common stock at the time the Service Acquisition was announced to the
public and further adjusted for tradability restrictions. An independent
valuation firm determined the tradability discount for the Company's common
stock. The effective date of the acquisition was March 1, 1998 and the cost was
allocated using the purchase method of accounting.
On December 29, 1998, the Company completed the acquisition of the Enex
Partnership (the "Enex Partnership Acquisition"). The transaction consisted of
an exchange offer whereby the Company offered to exchange 2.086 shares of Series
C Preferred stock ("Series C") for each Enex Partnership unit (the "Exchange
Offer"). In connection with the Exchange Offer, the Company submitted a proposal
to investors in the Enex Partnership to amend the partnership agreement to
provide for the transfer of all of the assets and liabilities of the Enex
Partnership to the Company as of October 1, 1998 and dissolve the Enex
Partnership. The Exchange Offer was approved on December 29, 1998 and the
Company issued 2,177,481 Series C shares for 100% of the outstanding limited
partner units. At the close of the Exchange Offer, the Enex Partnership had
1,102,631 units outstanding. Enex was issued 1,293,522 Series C shares for its
56.2% ownership of the Enex Partnership. The remaining 883,959 Series C shares
were issued to the limited partners that elected to take Series C shares in lieu
of cash. Certain dissenting limited partners and fractional shareholders were
paid $538,750 in January 1999. Because of the dissenting limited partners, Enex
owns 59.4% of the Series C shares, of which 20% relating to the minority
interest (258,704 shares) are considered outstanding and held by third parties
in the consolidated financial statements at December 31, 1998.
The intent of the Exchange Offer was to acquire the 43.8% of the outstanding
limited partner units that the Company did not currently own. The tables below
present the consideration paid for 100% of the Enex Partnership and for the
43.8% of the Enex Partnership not owned by Enex.
F-13
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(2) ACQUISITIONS (Continued)
The cost of acquiring 100% of the outstanding limited partner units was
approximately $11.9 million, consisting of the following (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Estimated fair value of 2,177,481 shares of Company Series C
preferred stock.................................................. $ 10,887
Cash consideration................................................. 539
Legal, accounting and other expenses............................... 431
---------
Total.............................................................. $ 11,857
---------
---------
</TABLE>
As Enex is consolidated into the Company's financial statements, the number
of shares outstanding and the value of the shares outstanding attributable to
the 43.8% of the Enex Partnership not owned by Enex and the minority interest
owners of Enex (20%) is 1,142,663 and $5,713,317, respectively. The cost of
acquiring the outstanding limited partner units that were not owned by Enex was
approximately $6.7 million, consisting of the following (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Estimated fair value of 1,142,663 shares of Company Series C
preferred stock.................................................. $ 5,713
Cash consideration................................................. 539
Legal, accounting and other expenses............................... 431
---------
Total.............................................................. $ 6,683
---------
---------
</TABLE>
The Company's purchase price was allocated to the assets and liabilities of
the Enex Partnership based on estimates of the fair values with the remaining
purchase price allocated to proved oil and gas properties. The registration
costs of approximately $431,000 reduced the value of the Series C shares issued.
Because the Enex Partnership was consolidated in the financial statements of the
Company as of the effective date of October 1, 1998, the preliminary purchase
price allocation below shows the effect of the acquisition on the consolidated
financial statements (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Working capital.................................................... $ (539)
Oil and gas properties............................................. (23)
Minority interest.................................................. 5,844
---------
Series C Preferred Stock........................................... $ 5,282
---------
---------
</TABLE>
F-14
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(2) ACQUISITIONS (Continued)
The following pro forma data presents the results of the Company for the
twelve months ended December 31, 1998 and 1997, as if the acquisitions of BEC,
Shore, Service, Enex and the Enex Partnership had occurred on January 1, 1997.
The pro forma results are presented for comparative purposes only and are not
necessarily indicative of the results which would have been obtained had the
acquisitions been consummated as presented. The following data reflect pro forma
adjustments for oil and gas revenues, production costs, depreciation and
depletion related to the properties and businesses acquired, preferred stock
dividends on preferred stock issued, and the related income tax effects (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
PROFORMA
---------------------
1998 1997
--------- ----------
(UNAUDITED)
<S> <C> <C>
Total revenues......................................................... $ 21,232 $ 32,341
Net loss available to stockholders..................................... (7,413) (14,607)
Net loss per share available to stockholders........................... (0.87) (2.84)
</TABLE>
(3) RELATED PARTY TRANSACTIONS
The Company has a note receivable from Bay City Energy Group, Inc., a
shareholder of the Company, as of December 31, 1998 and 1997 in the amount of
$173,115 and $166,165 respectively. The principal balance of the note accrues
interest at 5% annually and is due January 1, 2001. The note is secured by
75,000 shares of Company common stock. Interest of $34,110 was accrued on the
note as of December 31, 1998.
The Company rents office space from C.J. Lett III, a shareholder, officer
and director of the Company. The rent is $3,000 per month for three years
through February, 2000. Mr. Lett has common stock ownership in two oil service
companies that provide services to the Company. The Company paid approximately
$148,000 and $88,000 to these companies for the years ended 1998 and 1997,
respectively.
The Company loaned Frank C. Turner II, Vice-President and Chief Financial
Officer, $14,400 in September 1998 to pay income taxes associated with the
exercise of incentive options. The balance at December 31, 1998 was $14,400.
Gary R. Christopher, a shareholder and director of the Company, is employed
by Kaiser-Francis Oil Co., which owns approximately 39% of the common stock of
the Company.
(4) ACCOUNTS RECEIVABLE-INSURANCE CLAIM
The Company owns a 100% working interest in the Louis Mayard #1 (the "Well")
well located in the Esther Field in Vermillion Parish, Louisiana. Due to a
failed recompletion attempt and the inability of the Company to shut in the Well
using normal operating methods, the Company incurred approximately $1,856,000 to
gain control of the Well using special crews. On November 4, 1998, the insurance
company made a partial payment to the Company under its well control insurance
policy of approximately $1,408,000. At December 31, 1998, the Company had
recorded the estimated remaining amount due from the insurance company in
current assets as Accounts Receivable-Insurance Claim.
F-15
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(5) LONG-TERM DEBT
Long-term debt at December 31, 1998 and 1997, consisted of the following:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Reducing revolving line of credit up to $100,000,000 due April 1, 2001,
secured by oil and gas properties, monthly borrowing base reductions of
$290,000 effective November 1, 1998 and monthly payments of interest at
LIBOR plus 2.00% and prime. At December 31, 1998 the LIBOR rate and the
prime rate were 5.07% and 7.75%, respectively.......................... $ 27,454,567 --
Convertible Loan for $50,000,000 due September 30, 1998, secured by oil
and gas properties, monthly payments of interest only at LIBOR plus
1.75%, convertible into a 72 month term note on September 30, 1998..... -- $ 10,956,298
Note, due 1/1/99, secured by office building, repayable in monthly
installments of $1,511 including interest at 7 3/4%.................... -- 133,952
------------- -------------
Total.................................................................... 27,454,567 11,090,250
Less current maturities.................................................. -- (1,375,537)
------------- -------------
Long tem debt excluding current maturities............................... $ 27,454,567 $ 9,714,713
------------- -------------
------------- -------------
</TABLE>
Effective March 27, 1998 the Company entered into a new reducing revolving line
of credit agreement (the "$100 million Revolver") with Compass Bank, as agent
and lender, and Bank of Oklahoma, as a participant lender, (collectively, the
"Banks"). The $100 million Revolver provided for an initial borrowing base of
$29 million. The initial borrowing base was reduced to $27.5 million ten days
after the effective date and further reduced by $275,000 per month, beginning
May 1, 1998 and ending October 1, 1998. In conjunction with the Service
Acquisition, the borrowing base was increased to $32.6 million and the monthly
borrowing base reductions were increased to $330,000. Effective October 1, 1998,
the semi-annual borrowing base redetermination date, the borrowing base was
calculated to be approximately $28.9 million with monthly borrowing base
reductions of $250,000 beginning November 1, 1998. Effective January 1, 1999,
due to the closing of the Enex Partnership Acquisition, the borrowing base
determined at October 1, 1998 was adjusted to $33.1 million with monthly
borrowing base reductions of $290,000 beginning November 1, 1998. The borrowing
base at December 31, 1998 was $32.5 million and the next semi-annual borrowing
base redetermination date is April 1, 1999.
The principal is due at maturity, April 1, 2001. Monthly principal payments
are made as required in order that the outstanding principal balance plus
outstanding letters of credit does not exceed the borrowing base. Interest is
payable monthly and is calculated at the prime rate. The Company may also elect
to calculate interest under the Libor rate, as defined in the agreement. The
Libor rate increases by (a) 2.00% if the outstanding loan balance and letters of
credit are equal to or greater than 75% of the borrowing base, (b) 1.75% if the
outstanding loan balance and letters of credit are less than 75% or greater than
50% of the borrowing base or (c) 1.50% if the outstanding loan balance and
letters of credit are equal to or less than 50% of the borrowing base. Libor
interest is payable at maturity of the Libor loan which cannot be less than
thirty days.
F-16
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(5) LONG-TERM DEBT (Continued)
At December 31, 1998 the Company had borrowed $27,454,567 and had $1,163,647
of outstanding letters of credit. As of December 31, 1998, the Company is paying
Libor plus 2.00% on a sixty day Libor loan for $25,469,605 and prime on
$1,984,962.
At December 31, 1998, the amount available under the borrowing base on the
$100 million revolver was approximately $3.9 million. Assuming no other changes,
the amount available to be borrowed at April 1 will be approximately $3.0
million. The Company expects that the Banks will complete the April 1 borrowing
base redetermination by May 1, 1999. The Company also expects that the borrowing
base will be less than the amount determined at the October 1, 1998
redetermination, adjusted for the monthly borrowing base reductions. The decline
is expected to be caused primarily by normal production declines and lower oil
and gas pricing scenarios used by the Banks to value the oil and gas reserves
for loan purposes. Pursuant to the terms of the $100 million Revolver, if the
borrowing base is less than the outstanding principal balance plus outstanding
letters of credit the Company has sixty days, after receipt of notice from the
Banks, to cure the excess by prepayment, providing additional collateral or a
combination of both. The Company is unable to predict the April 1 borrowing
base. While there can be no assurance, at the completion of the April 1
redetermination, the Company does not expect to be required to make any
prepayments or provide any additional collateral that would be material to the
financial condition of the Company.
Amounts spent on debt retirement due to reductions in the borrowing base
reduce the cash available to spend on acquisition, development and exploration
activities, and accordingly, oil and natural gas revenues and operating results
may be adversely affected.
The Company paid a facility fee equal to 3/8% of the initial borrowing base
and is required to pay 3/8% on any future increase in the borrowing base within
five days of written notice. The Company is required to pay a quarterly
commitment fee on the unused portion of the borrowing base of 1/2% if the
outstanding loan balance plus letters of credit are greater than 50% of the
borrowing base or 3/8% if the outstanding loan balance plus letters of credit
are less than or equal to 50% of the borrowing base. The Company is required to
pay a letter of credit fee on the date of issuance or renewal of each letter of
credit equal to the greater of $500 or 1 1/2% of the face amount of the letter
of credit.
The Company has granted to the Banks liens on substantially all of the
Company's oil and natural gas properties, whether currently owned or hereafter
acquired, and a negative pledge on all other oil and gas properties.
The $100 million Revolver requires, among other things, a cash flow coverage
ratio of 1.25 to 1.00 and a current ratio, excluding current maturities of the
$100 million Revolver, of 0.9 to 1.00, determined on a quarterly basis.
F-17
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(5) LONG-TERM DEBT (Continued)
Aggregate amounts of expected required repayments of long term debt at
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1999........................................................... $ --
2000........................................................... 3,058,214
2001........................................................... 24,396,353
2002........................................................... --
2003........................................................... --
Thereafter..................................................... --
-----------
$27,454,567
===========
</TABLE>
(6) INCOME TAXES
Income tax (benefit) expense for the years ended December 31 consisted of
the following:
<TABLE>
<CAPTION>
1998 1997
-------------- -------------
<S> <C> <C>
Current......................................................... $ -- $ 6,451
Deferred........................................................ (2,829,762) (7,451,249)
-------------- --------------
Total......................................................... $ (2,829,762) $ (7,444,798)
============== ==============
</TABLE>
The reconciliation of income tax computed at the U.S. federal statutory tax
rates to the provision for income taxes is as follows:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Income tax benefit at statutory rate............................ $ (3,197,251) $ (7,828,207)
Increase in valuation allowance................................. 352,363 --
Increase due to state taxes and other........................... 15,126 383,409
-------------- --------------
Income tax benefit.............................................. $ (2,829,762) $ (7,444,798)
============== ==============
</TABLE>
The Company's net deferred tax liability at December 31, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Deferred tax liability
Oil and Gas Properties........................................ $ 4,087,073 $ 5,906,070
-------------- --------------
Deferred tax asset
NOL carryforward.............................................. (4,056,660) (1,083,324)
AMT tax credit carryforward................................... (36,482) (36,482)
Other......................................................... (394,570) (5,736)
-------------- --------------
(4,487,712) (1,125,542)
-------------- --------------
Valuation allowance............................................. 2,133,806
-------------- --------------
Net deferred tax liability...................................... $ 1,733,167 $ 4,780,528
============== ==============
</TABLE>
F-18
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(6) INCOME TAXES (Continued)
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
asset will not be realized. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. Based upon projections for future taxable
income over the periods which the deferred tax assets are deductible and the
Section 382 limitation discussed below, management believes it is more likely
than not that the Company will realize the benefits of these deductible
differences, net of the existing valuation allowances at December 31, 1998. The
valuation allowance increased $2,133,806 during 1998. No valuation allowance was
recorded in 1997.
In March 1998, the Company acquired Enex which had a net operating loss
carryforward of approximately $5,200,000. These net operating losses expire in
varying amounts through 2012, and their utilization is limited due to an
ownership change pursuant to Section 382 triggered by the Company's acquisition
of Enex. The 1998 increase in valuation allowance includes amounts attributable
to the Enex Acquisition.
(7) RETIREMENT PLAN
All of the employees of the Company participate in a defined contribution
plan that provides for a maximum discretionary Company contribution of 15% of
total wages paid to employees for the year. The Company contributed $51,500 to
the plan for the year ended December 31, 1997. No contributions were made to the
plan for the year ending December 31, 1998.
F-19
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(8) STOCK OPTION AND STOCK APPRECIATION RIGHTS PLAN
At December 31, 1998, the Company had one fixed stock option plan, the 1995
Stock Option and Stock Appreciation Rights Plan (the "1995 Plan"). The Company
applies the intrinsic value method for accounting for stock based compensation
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations; accordingly, no compensation cost has
been recognized, as the exercise price of each option equals the market price of
the Company's Common Stock on the date of grant. Had compensation cost for the
Company's 1995 Plan been determined based on the fair value at the grant date
for stock options granted during 1998 and 1997, the Company's net loss and loss
per share would have been increased to the pro forma amounts listed below:
<TABLE>
<CAPTION>
1998 1997
------------- --------------
<S> <C> <C> <C>
Net loss...................................... As Reported $ (6,656,952) $ (16,184,052)
Pro Forma $ (7,145,580) $ (16,463,666)
Basic loss.................................... As Reported $ (0.83) $ (4.76)
Pro Forma $ (0.89) $ (4.85)
Diluted loss.................................. As Reported $ (0.83) $ (4.76)
Pro Forma $ (0.89) $ (4.85)
</TABLE>
The weighted average fair value of stock options granted during 1998 and
1997 was $2.97 and $2.77 per share, respectively. The fair value of each option
is estimated on the date of grant using the Black-Scholes option-pricing model
with the following assumptions used for the grants in 1998 and 1997; no dividend
yield; expected volatility of 77 percent and 60 percent, respectively; weighted
average risk-free interest rate of 4.93% and 6.07%, respectively; and expected
life of 3 years. At December 31, 1998, the range of exercise prices and weighted
average remaining contractual life of options outstanding was $2.50 to $7.75 and
5.57 years, respectively.
At December 31, 1998 there were 633,000 shares of common stock available for
grant under the 1995 Plan. All of the options granted under the 1995 Plan have
an exercise price equal to the fair market value of the Company's common stock
at the date of the grant and expire ten (10) years from the date of grant if not
exercised. All of the options granted under the 1995 Plan are 100% vested. The
1995 Plan is administered by the Compensation Committee of the Board of
Directors.
Information relating to stock options is summarized below:
<TABLE>
<CAPTION>
AVERAGE
EXERCISE PRICE
SHARES PER SHARE
--------- ---------------
<S> <C> <C>
Options and warrants outstanding at January 1, 1997........................... 125,000 $ 2.50
Granted....................................................................... 520,000 $ 6.07
Exercised..................................................................... (40,833) $ 2.50
---------
Options and warrants outstanding at December 31, 1997......................... 604,167 $ 5.57
Granted....................................................................... 307,000 $ 5.57
---------
Options and warrants outstanding at December 31, 1998......................... 911,167 $ 5.57
=========
Options and warrants exercisable at December 31, 1998......................... 911,167 $ 5.57
=========
</TABLE>
F-20
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(8) STOCK OPTION AND STOCK APPRECIATION RIGHTS PLAN (Continued)
Options to acquire 225,000 shares of the Company common stock at an exercise
price of $5.50 were granted outside of the 1995 Plan on February 13, 1997 to
certain officers of the Company. Warrants to acquire 75,000 shares of the
Company common stock at an exercise price of $5.00 were granted outside of the
1995 Plan on September 15, 1998 to a consultant (See Note 9). Both grants are
included in the table above.
(9) STOCKHOLDERS' EQUITY
PREFERRED STOCK-SERIES A
On September 4, 1996, the Company signed a stock purchase agreement with
Kaiser Francis Oil Company ("Kaiser-Francis"). Kaiser-Francis agreed to purchase
1,666,667 shares of Series A Preferred Stock ("Series A") at $6.00 per share,
for a total investment of $10,000,000. The parties agreed to a five-year
purchase period, effective September 4, 1996, with minimum incremental
investments of $500,000 each. Each issuance of Series A was subject to approval
by Kaiser-Francis of the use of proceeds. The Series A was nonvoting and accrued
dividends at 8% per annum, payable quarterly in cash. The Series A was
convertible at any time after issuance into shares of common stock at the rate
of two shares of common stock for each share of Series A before January 1, 1998.
The conversion rate decreases for every full year (excluding partial years)
thereafter at 8% per annum. As of December 31, 1997, 1,666,667 shares of the
Series A had been issued. On January 31, 1998 Kaiser-Francis converted 100% of
the Series A into 3,333,334 common shares of the Company.
PREFERRED STOCK-SERIES B
In connection with the Shore Merger, effective June 30, 1997, the Company
issued 266,667 shares of Series B Preferred Stock ("Series B"). The Series B is
nonvoting and pays no dividends. The Series B has a liquidation value of $7.50
per share and is junior to the Company's Series A Preferred Stock. Until
December 31, 2002, any holder of the Series B may convert all or any portion of
Series B shares into Company Common Stock ("Common") at the greater ratio of (i)
one share of Common for each share of Series B or (ii) at a ratio based upon the
"Alternative Conversion Factor." The Alternative Conversion Factor is determined
by dividing the net increase in value of approximately 40,000 net mineral acres
owned by the Company in South Louisiana by $8,000,000 and multiplying the
product by 1,066,000 to arrive at the potential number of total Common shares
all holders would receive upon conversion. In no event shall the aggregate total
number of shares of Common into which the Series B are converted be less than
266,667 shares or exceed 1,333,333 shares, unless further increased for any
anti-dilution provisions. Upon expiration of the conversion period, unless the
Company has given notice to redeem the Series B, all of the shares of the Series
B shall be automatically converted.
Since the merger date of June 30, 1997 the value of the fee minerals has not
increased to a level where the alternative conversion rate is more beneficial
than the initial conversion rate of one to one. As of December 31, 1998, no
additional shares of Series B have been issued.
PREFERRED STOCK-SERIES C
In connection with the Enex Partnership Merger, on December 29, 1998, the
Company issued 2,177,481 shares of Series C Preferred Stock ("Series C") in
exchange for 100% of the Enex Partnership units. The holders of Series C are
entitled to receive cumulative cash dividends in an amount per share of $0.50
per year (10% annual rate), payable semi-annually on March 31 and September 30
of each year.
F-21
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
PREFERRED STOCK-SERIES C (CONTINUED)
These dividends are payable in preference to and prior to the payment of any
dividend or distribution to any holder of Company common stock or other junior
security. The Series C dividends begin to accrue on December 30, 1998. Compass
Bank has granted the Company a waiver allowing the Company to pay the dividends
on the Series C as long as no default or event of default exists or would exist
as a result of any Series C dividend payment. The Series C has a liquidation
preference of $5.00 per share plus an amount equal to all accumulated, accrued
and unpaid dividends. The liquidation preference of Series C ranks on parity
with the Series B.
Each share of Series C is convertible into one share of Company common
stock. On or after January 1, 2000, the Company may redeem all or a portion of
the Series C, at its option, at a purchase price of $5.00 per share, plus an
amount equal to all accumulated, accrued and unpaid dividends.
The Series C is generally nonvoting; however, holders of Series C are
entitled to vote on any amendment, alteration or appeal of any provision of the
Company's Articles of Incorporation which would adversely affect any holder's
rights and preferences.
As a result of its limited partnership interest in the Enex Partnership,
Enex owns 1,293,522 shares of the Series C of which the Company owns 80%, or
1,034,818 shares through its 80% ownership of Enex.
COMMON STOCK
On February 13, 1997, the Company awarded to the President, Vice-President
Chief Financial Officer and Vice-President Engineering, 25,909, 11,591 and
11,591 shares of restricted stock of the Company, respectively. The restricted
stock awards were contingent on the performance of services to the Company in
the future with 50% of the restricted shares being earned over the six month
period July 1, 1997 to December 31, 1997 and 50% over the six month period
January 1, 1998 to June 30, 1998. As of December 31, 1998, all restricted shares
were earned.
WARRANTS
On September 15, 1998 the Company entered into a consulting agreement with
Edward K. Andrew ("Andrew") for a term of five years beginning January 1, 1999.
As compensation, the Company granted to Andrew a warrant to purchase 75,000
shares of Company common stock at a price of $5.00. The warrants vested over the
period September 15, 1998 to January 1, 1999. The estimated fair value of the
warrants of $198,946 was determined at the date of grant and charged to stock
compensation expense over the vesting period.
F-22
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(9) STOCKHOLDERS' EQUITY (Continued)
EARNINGS PER SHARE
The following table provides a reconciliation between basic and diluted
earnings (loss) per share:
<TABLE>
<CAPTION>
WEIGHT AVERAGE
COMMON SHARES PER SHARE
NET LOSS OUTSTANDING AMOUNT
-------------- --------------- -----------
<S> <C> <C> <C>
Year Ended December 31, 1998:
Basic earnings per share........................................... $ (6,656,952) 8,050,108 $ (0.83)
Effect of dilutive stock options................................... -- -- --
Diluted earnings per share......................................... $ (6,656,952) 8,050,108 $ (0.83)
Year Ended December 31, 1997:
Basic earnings per share........................................... $ (16,184,052) 3,397,117 $ (4.76)
Effect of dilutive stock options................................... -- -- --
Diluted earnings per share......................................... $ (16,184,052) 3,397,117 $ (4.76)
</TABLE>
At December 31, 1998 and 1997, the Company had a weighted average of 849,890
and 542,249, combined stock options and warrants outstanding, respectively,
which were not included in the computation of diluted earnings per share,
because the effect of the assumed exercise of these stock options would have an
antidilutive effect on the computation of diluted loss per share. At December
31, 1998 and 1997, the Company had shares of convertible preferred stock
outstanding that were convertible into 1,409,330 and 3,600,001 shares of common
stock, respectively, and dividends of $67,945 and $604,712, respectively, which
were not included in the computation of diluted earnings per share, because the
effect of the assumed conversion of these preferred shares would have an
antidilutive effect on the computation of diluted loss per share.
(10) COMMITMENTS AND CONTINGENCIES
The Company is obligated under the terms of certain operating leases for
office space that expire over the next two and one-half years. Total rent
expense was $268,477 and $97,588 for the years ended December 31, 1998 and 1997,
respectively. Future minimum rental payments under the Company's leases total
$119,366, $75,720, and $34,860 for 1999, 2000, and 2001, respectively.
As of December 31, 1998, the Company had $1,163,647 of irrevocable standby
letters of credit outstanding.
The Company is a defendant in various legal proceedings which are considered
routine litigation incidental to the Company's business, the disposition of
which management believes will not have a material effect on the financial
position or results of operations of the Company.
F-23
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(11) SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)
CAPITALIZED COSTS AND COSTS INCURRED
The following tables present the capitalized costs related to oil and gas
producing activities and the related depreciation, depletion, amortization and
impairment and costs incurred in oil and gas property acquisition, exploration
and development activities (in thousands).
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
CAPITALIZED COSTS
Proved properties......................................................................... $ 84,325 $ 56,536
Nonproducing leasehold.................................................................... 6,524 6,118
Accumulated depreciation, depletion, amortization and impairment.......................... (38,810) (30,456)
---------- ----------
Net capitalized costs................................................................... $ 52,039 $ 32,198
========== ==========
COSTS INCURRED
Proved properties......................................................................... $ 28,878 $ 38,099
Unproved properties....................................................................... 337 6,195
Exploration costs......................................................................... 1,802 1,912
Development costs......................................................................... 3,041 1,862
---------- ----------
Total................................................................................... $ 34,058 $ 48,068
========== ==========
Depletion, depreciation, amortization and impairment...................................... $ 11,013 $ 25,651
========== ==========
</TABLE>
ESTIMATED QUANTITIES OF RESERVES
The Company has interests in oil and gas properties that are located
principally in Alabama, Louisiana, Kansas, Oklahoma and Texas. The Company does
not own or lease any oil and gas properties outside the United States. There are
no quantities of oil and gas subject to long-term supply or similar agreements
with any governmental agencies.
The Company retains independent engineering firms to provide year-end
estimates of the Company's future net recoverable oil, gas and natural gas
liquids reserves. In 1998, such estimates were prepared by Lee Keeling and
Associates, Inc. and H.J. Gruy & Associates, Inc. In 1997, such estimates were
prepared by Lee Keeling and Associates, Inc., Cawley, Gillespie and Associates,
Inc., Ryder Scott Company, Huddleston & Company, Inc., and DeGoyler &
MacNaughton. The reserve information was prepared in accordance with guidelines
established by the Securities and Exchange Commission.
Estimated proved net recoverable reserves as shown below include only those
quantities that can be expected to be commercially recoverable at prices and
costs in effect at the balance sheet dates under existing regulatory practices
and with conventional equipment and operating methods. Proved developed reserves
represent only those reserves expected to be recovered through existing wells.
Proved undeveloped reserves include those reserves expected to be recovered from
new wells or on undrilled acreage or from existing wells on which a relatively
major expenditure is required for recompletion.
F-24
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(11) SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED) (Continued)
Net quantities of proved developed and undeveloped reserves of natural gas
and crude oil, including condensate and natural gas liquids, are summarized as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
--------------------------------------------------
1998 1997
------------------------ ------------------------
OIL OIL
PROVED RESERVES (BARRELS) GAS (MCF) (BARRELS) GAS (MCF)
- ------------------------------------------------------------ ---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Beginning of year........................................... 2,933,000 18,419,000 1,389,945 8,964,238
Revisions of previous estimates............................. (277,291) (82,742) (205,733) (1,431,708)
Extensions and discoveries.................................. 103,506 290,347 22,520 705,020
Purchases of reserves in place.............................. 1,254,663 30,997,247 1,980,117 12,110,748
Sale of reserves in place................................... (90,373) (2,294,193) -- --
Production for the year..................................... (581,457) (3,846,679) (253,849) (1,929,298)
---------- ------------ ---------- ------------
End of year................................................. 3,342,048 43,482,980 2,933,000 18,419,000
========== ============ ========== ============
PROVED DEVELOPED RESERVES
- ------------------------------------------------------------
Beginning of year........................................... 2,580,000 14,251,000 1,266,421 8,142,820
End of year................................................. 3,117,839 36,731,365 2,580,000 14,251,000
</TABLE>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM PROVED RESERVES
The following is a summary of the standardized measure of discounted future
net cash flows related to the Company's proved oil and gas reserves. For these
calculations, estimated future cash flows from estimated future production of
proved reserves are computed using oil and gas prices as of the end of each
period presented. Future development and production costs attributable to the
proved reserves were estimated assuming that existing conditions would continue
over the economic lives of the individual leases and costs were not escalated
for the future. Estimated future income taxes were calculated by applying
statutory tax rates (based on current law adjusted for permanent differences and
tax credits) to the estimated future pre-tax net cash flows related to proved
oil and gas reserves, less the tax basis of the properties involved.
The Company cautions against using this data to determine the value of its
oil and gas properties. To obtain the best estimate of the fair value of the oil
and gas properties, forecasts of future economic conditions, varying discount
rates, and consideration of other than proved reserves would have to be
incorporated into the calculation. In addition, there are significant
uncertainties inherent in estimating quantities of proved reserves and in
projecting rates of production that impair the usefulness of the data.
F-25
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(11) SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED) (Continued)
The standardized measure of discounted future net cash flows relating to
proved oil and gas reserves are summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Future cash inflows................................................................. $ 133,549 $ 101,482
Future production costs and development costs....................................... (62,085) (54,358)
Future income tax expenses.......................................................... -- (11,853)
---------- ----------
Future net cash flows............................................................... 71,464 35,271
10% discount to reflect timing of cash flows........................................ (32,570) (10,778)
---------- ----------
Standardized measure of discounted future net cash flows............................ $ 38,894 $ 24,493
========== ==========
</TABLE>
The following are the principal sources of changes in the standardized
measure of discounted future net cash flows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31
---------------------
1998 1997
--------- ----------
<S> <C> <C>
Sales of oil and gas, net of production cost............................................ $ (7,210) $ (6,364)
Net changes in price and production cost................................................ (5,459) (11,108)
Extensions and discoveries.............................................................. 732 851
Purchase of reserves.................................................................... 23,092 20,293
Sale of reserves........................................................................ (1,528) --
Revisions of previous quantity estimates................................................ (1,573) 1,794
Net change in income taxes.............................................................. 2,712 (1,082)
Accretion of discount................................................................... 3,635 2,246
--------- ----------
End of year............................................................................. $ 14,401 $ 6,630
========= ==========
</TABLE>
During recent years, there have been significant fluctuations in the prices
paid for crude oil in the world markets. The situation has had a destabilizing
effect on the crude oil posted prices in the United States, including the posted
prices paid by purchasers of the Company's crude oil. The year end prices of oil
and gas at December 31, 1998 and 1997, used in the above table were $9.50 and
$16.18 per barrel of oil and $2.10 and $2.54 per thousand cubic feet of gas,
respectively.
F-26
<PAGE>
3TEC ENERGY CORPORATION
1998 Management's Discussion and Analysis
The following Management's Discussion and Analysis is taken directly from
the Company's Annual Report on Form 10-KSB for its fiscal year ended December
31, 1998. This Discussion should be read in conjunction with the Management's
Discussion and Analysis included elsewhere in this Proxy Statement with respect
to the nine month period ended September 30, 1999, and the related financial
statements also included elsewhere in this Proxy Statement.
MANAGEMENT'S DISCUSSION AND ANALYSIS
1998 MDA-1
<PAGE>
(a) RESULTS OF OPERATIONS
The factors that most significantly affect the Company's results of
operations are (i) the sales price of crude oil and natural gas, (ii) the level
of production volumes, (iii) the level of lease operating expenses, (iv) the
level of interest rates and (v) the level of general and administrative
expenses. Sales of production and level of borrowing capacity are significantly
impacted by the Company's ability to maintain or increase its production from
existing oil and gas properties or through its exploration and development
activities. Sales prices received by the Company for oil and gas have fluctuated
significantly from period to period. The fluctuations in oil prices during these
periods reflect market uncertainty regarding the inability of OPEC to control
the production of its member countries, production from Iraq, as well as
concerns related to the global supply and demand for crude oil. Gas prices
received by the Company fluctuate generally with changes in the spot market
price for gas. Relatively modest changes in either oil or gas prices
significantly impact the Company's results of operations and cash flow and could
significantly impact the Company's borrowing capacity.
The table below details the increase (decrease) in oil and gas revenues,
excluding plant and other revenues, caused by price and volume changes for the
years ending December 31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------ ----------
<S> <C> <C> <C>
Oil Revenues
Change due to volume........................................ $ 5,375,279 $ 3,549,922 $ 32,436
Change due to price......................................... (3,801,075) (644,906) 437,285
Total change................................................ 1,574,204 2,905,016 469,721
Gas Revenues
Change due to volume........................................ $ 4,578,268 $ 2,161,383 $ 149,921
Change due to price......................................... (1,507,115) 201,483 708,386
Total change................................................ 3,071,153 2,362,866 858,307
</TABLE>
(b) FISCAL 1998
For the current period, the revenues and expenses attributable to the Enex
Acquisition and the Enex Partnership Acquisition are included for the period
April through December and those attributable to the Service Acquisition are
included for the months of May through December. For the comparable period, the
revenues and expenses attributable to the Bison Merger are included for the
period March through December, the Shore Merger for the period July through
December and the Riceville Acquisition for the period August through December.
Total revenues for the current period, of $17,703,000, were $6,270,000
higher than the comparable period. The increase in total revenues was due
primarily to higher oil and gas revenues of $4,798,000 and higher gain on the
sale of properties. During the current period lease bonus and rental income on
the mineral acreage acquired in the Shore Merger decreased $758,000 and other
revenues increased $282,000.
Oil and gas revenues of $15,011,000 increased $4,798,000, consisting of a
$1,574,000 increase in oil revenues, a $3,071,000 increase in gas revenues and a
$153,000 increase in other revenues. The increase in oil and gas revenues was
the result of higher oil and gas production. Production of oil increased 105%
and production of gas increased 99%, over the comparable period. The oil
production increase of 297,000 barrels and the gas production increase of
1,918,000 Mcf, were due primarily to the Riceville Acquisition which closed in
1997, and the Enex and Service Acquisitions which closed in 1998. During the
current period, the Company sold 581,000 barrels of oil and 3,847,000 Mcf of
gas, as compared to 284,000 barrels and 1,929,000 Mcf for the comparable period.
The average price received on the gas sold in the current period of $2.00 per
Mcf was 16% lower than the $2.39 per Mcf received in the comparable period. The
average price received on the oil sold in 1998 of $11.52 per barrel was 36%
lower than the $18.06 per barrel received in the comparable period. For the
comparable period, production of oil was increased 30,000 barrels and oil
revenues were increased $441,000 due to a reclassification.
1998 MDA-2
<PAGE>
The Company received $217,000 in lease bonus and delay rental income on the
fee mineral acreage acquired in the Shore Merger in the current period versus
$975,000 in the comparable period. The decrease in leasing activity is the
primary reason for the decline in income. The Company did not have any acreage
revert to the surface owners in the current period.
The gain on the sale of properties of $1,953,000 in the current period was
primarily the result of sales of non-strategic properties and was $1,946,000
higher than the comparable period. Also included in the current period gain is a
$365,000 gain on the sale of 20% of the Company's 25% interest in the Hawkins
Ranch Prospect.
Other income in the current period of $520,000 increased $284,000 over the
comparable period. Other income consisted principally of a lawsuit settlement
and an accounts payable settlement.
Total expenses for the current period of $27,106,000 were $7,351,000 lower
than the comparable period. The principal reason for the expense decrease was a
decrease in the impairment charge of $16,984,000 to $4,164,000 versus
$21,148,000 in the comparable period. The lower impairment charge was partially
offset by a $3,953,000 increase in lease operating expenses, a $2,549,000
increase in depreciation, depletion and amortization and a $1,906,000 increase
in general and administrative expenses.
In the current period, the Company charged to impairment expense $4,164,000
versus $21,148,000 in the comparable period. The impairment expense was computed
applying the guidelines of SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." The impairment
expense in the current period of $4,164,000 was primarily attributable to oil
and gas impairments of $4,092,000 on four fields--Wellman, Murphy Lake,
Abbeville and Magnolia. The Wellman, Murphy Lake and Abbeville Fields were
acquired in the Shore Merger in 1997 and the Magnolia Field was acquired in
1995. The Wellman, Murphy Lake and Magnolia Fields are oil fields whose value
declined due to the decrease in oil prices. The impairment on the Abbeville
Field was due to an unsuccessful recompletion attempt on the Goldberg #2 well.
The reserves had been classified as proved behind pipe. The remaining oil and
gas impairment expense of approximately $1,300,000 is attributable to several
fields. The principal reasons for the impairment on these fields are the
decrease in oil prices and the decrease or cessation of oil and gas production.
The non-oil and gas impairment of approximately $72,000 is a $39,000 impairment
of transaction costs in the postponed Enex Merger and a $33,000 impairment on
oilfield equipment.
Lease operating expenses of $7,801,000 increased by $3,953,000. The increase
was due primarily to expenses associated with the properties acquired in the
Enex and Service Acquisitions.
Geological and geophysical expenses of $878,000 increased by $655,000. The
primary geological and geophysical expenses in the current period include
approximately $716,000 on Hawkins Ranch Prospect and $135,000 on Sherburne
Prospect.
Depletion, depreciation and amortization expense of $7,116,000 increased by
$2,549,000. Depletion increased primarily due to the depletion associated with
the properties acquired in the Enex and Service Acquisitions.
Dry-hole expense of $503,000 decreased by $615,000 due to less drilling
activity in the current period. The dryhole costs in the current period is due
primarily to abandonment costs on two unsuccessful Exploratory Wells, the
Dishman #1 well in the South Highbaugh Prospect in Texas and the Quarry #1 well
in the Quarry Prospect in New Mexico, with dryhole costs of $197,000 and
$125,000, respectively. Additional dryhole expense of $118,000 was for two wells
in the Reflection Ridge Prospect in Kansas. The remaining dryhole expense of
$63,000 was attributable to several additional wells.
Interest expense of $1,972,000 increased by $1,301,000 due to a higher loan
balance. The loan balance increased as a result of the funds borrowed to finance
the Enex Acquisition in March and to partially finance the Service Acquisition
in April.
1998 MDA-3
<PAGE>
Stock compensation of $266,000 increased by $64,000. The increase was due to
the granting of a warrant to purchase 75,000 shares of Company common stock to a
consultant. The warrant fully vested on January 1, 1999 and was expensed in the
current period.
General and administrative expense of $4,267,000 increased by $1,906,000,
due primarily to higher salary expense of $752,000, higher professional fees of
$310,000 and higher office expenses of $195,000. The increase in salary expense
was due to increases in salaries of existing employees, salaries of new
employees and salaries associated with employees added in the Enex Acquisition.
At December 31, 1998, the Company had twenty-seven full-time executive and
clerical employees and five Enex employees. The increase in professional fees
was due to higher accounting and engineering expenses related to a change in
auditors and increased reserve report needs. The Company also experienced an
increase in rent due to the Company previously owning its office in Mobile,
Alabama versus renting office space since the Company's move to Houston in
November 1997. The remaining increase in general and administrative expenses are
over several categories and were due to the increase in the overall activity of
the Company's business.
Other expenses of $139,000 decreased $179,000 over the comparable period
The Company reported an operating loss before minority interest of
$9,404,000 for the current period, compared to an operating loss of $23,024,000
in the comparable period. Due to the Enex Acquisition, the Company records a
minority interest on its income statement to remove the net income or loss
attributable to the minority interest owners of Enex. For the six-month period
ending September 30, the minority interest accounted for the income or loss for
Enex and the Enex Partnership. For the three-month period ending December 31,
the minority interest accounted only for the Enex operations since the Enex
Partnership was merged into the Company effective October 1. In the current
period the minority interest increased the operating loss by $15,089. The
Company did not have a minority interest in the comparable period.
The Company reported a deferred tax benefit of $2,830,000 for the current
period versus a deferred tax benefit of $7,451,000 in the comparable period. The
primary reason for the deferred tax benefit in the current period was the oil
and gas reserve impairment, depletion expense and intangible drilling costs.
The Company reported a net loss of $6,589,000 versus a net loss of
$15,579,000 for the comparable period. The Company paid preferred dividends of
$68,000 in the current period and $605,000 in the comparable period and reported
a net loss to common stockholders of $6,657,000 in the current period versus a
net loss to common stockholders of $16,184,000 in the comparable period.
(c) FISCAL 1997
For the current period, the revenues and expenses attributable to the Bison
Merger are included for the period March through December, the Shore Merger for
the period July through December and the Riceville Acquisition for the period
August through December.
Total revenues for the current period of $11,433,000, were $6,546,000 higher
than the comparable period. The increase in total revenues was due primarily to
higher oil and gas revenues of $5,738,000. Revenue from lease bonus and delay
rental income received on the fee mineral acreage in Louisiana increased
$975,000. Gain on the sale of properties decreased by $31,000 and other income
decreased by $136,000.
Oil and gas revenues of $10,213,000 increased $5,738,000, consisting of a
$2,905,000 increase in oil revenues, a $2,363,000 increase in gas revenues and a
$470,000 increase in other oil and gas revenues. The increase in oil and gas
revenues was primarily the result of increases in production which resulted from
the Bison and Shore Mergers. Production of oil and gas for the current period,
increased 160% and 96%, respectively, over the comparable period. During the
current period, the Company sold 284,000 barrels of oil and 1,929,000 Mcf of
gas, as compared to 109,000 barrels of oil and 983,000 Mcf of gas for the
comparable period. Oil production for the current period was 175,000 barrels
higher due primarily to production attributable to the Bison and Shore Mergers.
Gas production in the current period was 946,000 Mcf higher due primarily to
production attributable to Bison and Shore Mergers and the Riceville
1998 MDA-4
<PAGE>
Acquisition. The price received on the gas sold in the current period of $2.39
per Mcf was slightly higher than the $2.28 per Mcf received in the comparable
period. Oil prices in the current period of $18.06 per barrel were 11% lower
than the $20.26 per barrel received in the comparable period. For the current
period, production of oil was increased 30,000 barrels and oil revenues were
increased $441,000 due to a reclassification.
The gain on sale of properties in the current period of $7,000 decreased
$31,000. Only a small number of oil and gas properties were sold in the current
and comparable period.
The Company received approximately $975,000 in lease bonus and delay rental
income on the fee mineral acreage acquired in the Shore Merger in the current
period. The Company had no lease bonus or delay rental income in the comparable
period.
Other income of $237,000 decreased $136,000 over the comparable period.
Other income in the current period and comparable period consisted of various
items related to the general business activity of the Company.
Total expenses of $34,457,000 increased $29,851,000 over the comparable
period. The principal reasons for the increase in the overall level of expenses
were increased oil and gas property impairment charge by $20,870,000, increased
lease operating expenses by $2,333,000, increased depletion expenses by
$3,382,000 and increased general and administrative expenses by $1,699,000.
In the fourth quarter of the current period, the Company charged to
impairment expense $21,148,000 versus $278,000 in the comparable period. The
impairment expense was computed applying the guidelines of SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of."
The impairment expense in the current period of $21,148,000 was primarily
attributable to impairments on three fields--the Esther, Spivey and Wellman. The
Esther and Wellman Fields were acquired in the Shore Merger, and the Spivey
Field was acquired in the Bison Merger. The impairment on the Esther Field in
Vermilion Parish, Louisiana was due primarily to a change in the category of
reserves from Proved Undeveloped to Probable Undeveloped and changes in the
economics of the development of the reserves. The category of the reserves was
changed due to an abandoned sidetrack attempt in February, 1998 by the operator
on the Proved Undeveloped Reserves. The impairment on the Spivey Field was due
primarily to a decrease in the level of oil prices and changes in the economics
of the Proved Undeveloped Reserves due to information obtained from the wells
drilled in 1997. The impairment on the Wellman Field in Terry County, Texas was
due primarily to decreases in oil prices. Since July 1, 1997, the posted price
of WTI crude oil fell from approximately $18.00 per barrel to $15.00 per barrel
at December 31, 1997 or 17%. The total oil equivalent reserves of the Wellman
Field are 95% oil. The remaining impairment expense of approximately $4,400,000
is attributable to several fields. The principal reasons for the impairment on
these fields are the decrease in oil prices and the decrease or cessation of oil
and gas production.
Lease operating expenses of $3,849,000 increased by $2,333,000. The increase
was due primarily to the expenses associated with the properties acquired in the
Bison and Shore Mergers.
Depletion expense of $4,567,000 increased by $3,382,000. Depletion increased
primarily due to the depletion associated with the properties acquired in the
Bison and Shore Mergers.
Interest expense of $671,000 increased by $166,000 due to a higher loan
balance. The loan balance increased as a result of the funds borrowed to finance
the Riceville Acquisition.
Dry-hole expense of $1,119,000 increased by $690,000 due primarily to
abandonment costs on three unsuccessful Exploratory Wells drilled in
Louisiana--the Shore Oil Company #1, the Sabine #1 and the Middle Bay Oil
Company #1--with dry-hole costs of $311,000, $177,000 and $168,000,
respectively. Dryhole costs of $463,000 was attributable to several additional
wells.
1998 MDA-5
<PAGE>
General and administrative expense of $2,361,000 increased by $1,699,000,
due primarily to higher salary expense of $724,000, higher professional fees of
$347,000 and higher office expenses of $128,000. The remaining increase in
general and administrative expenses was over several expense categories and was
due primarily to an increase in the overall level of activity at the Company as
a result of the Bison and Shore Mergers. The increase in salary expense is due
to increases in salaries of existing employees and salaries associated with
employees added in the Bison and Shore Mergers. At the time of the Bison Merger,
seven employees occupied the Wichita, Kansas office. Effective August 1, 1997,
only four employees occupied the Wichita, Kansas office--the President of Bison,
an engineer, geologist and secretary. The President of Shore, an engineer and a
secretary were added in the Shore Merger. In addition, the Company hired a land
manager in July 1997 to manage the Company's land and mineral records and an
accounting supervisor in October 1997 to assist with the increased accounting
workload.
Stock compensation expense of $202,000 increased by $202,000 due to the
vesting of 50% of the restricted stock granted to certain Company employees in
February, 1997. The remaining 50% will fully vest on June 30, 1998.
Other expenses of $317,000 increased $285,000 over the comparable period.
The primary reason for the increase was expenses associated with the Bison and
Shore Mergers.
The Company reported an operating loss of $23,024,000 for the current period
as compared to an operating profit of $280,000 in the comparable period.
The Company reported a deferred tax benefit of $7,451,000 for the current
period versus deferred tax expense of $70,000 in the comparable period. The
primary reason for the deferred tax benefit in 1997 was the oil and gas reserve
impairment on the properties acquired in the Bison and Shore Mergers in 1997 and
the NPC Merger in 1996.
The Company reported a net loss of $15,579,000 versus net income of $205,500
for the comparable period. The Company paid preferred dividends of $605,000 in
the current period and reported a net loss to common stockholders of $16,184,000
versus net income available to common stockholders of $205,000 for the
comparable period. No preferred dividends were paid in 1996.
(d) EFFECTS OF OIL AND GAS PRICE FLUCTUATIONS
Fluctuations in the price of crude oil and natural gas significantly affect
the Company's operations and the value of its assets. As a result of the
instability and volatility of crude oil and natural gas prices, financial
institutions have become more selective in the energy lending area and have
reduced the percentage of existing reserves that may qualify for the borrowing
base to support energy loans.
The Company's principal source of cash flow is the production and sale of
its crude oil and natural gas reserves which are depleting assets. Cash flow
from oil and gas production sales depends upon the quantity of production and
the price obtained for that production. An increase in prices permits the
Company to finance its operations to a greater extent with internally-generated
funds, allows the Company to obtain equity financing more easily and lessens the
difficulty of attracting financing alternatives available to the Company from
industry partners and nonindustry investors. However, price increases heighten
the competition for Leases and Prospects, increase the costs of exploration and
development activities and increase the risks associated with the purchase of
Producing Properties.
A decline in oil and gas prices (i) reduces the cash flow internally
generated by the Company, which in turn reduces the funds available for
servicing debt and exploring for and replacing oil and gas reserves, (ii)
increases the difficulty of obtaining equity financing, (iii) reduces the number
of Leases and Prospects available to the Company on reasonable economic terms
and (iv) increases the difficulty of attracting financing alternatives available
to the Company from industry partners and nonindustry investors. However, price
declines reduce the competition for Leases and Prospects and correspondingly
reduce the prices paid for Leases and Prospects. Furthermore, exploration and
production costs generally decline, although the decline may not be at the same
rate of decline of oil and gas prices.
1998 MDA-6
<PAGE>
Since October, 1997, the price of oil has declined dramatically. The posted
price of WTI crude oil has declined from a high of approximately $20.00 per
barrel in October 1997 to lows in December 1998 of approximately $8.00 per
barrel. Oil prices in March 1999 had recovered to approximately $12.50 per
barrel. Gas prices peaked in November 1997, and on average, have declined
slightly during the current period.
(e) SEASONALITY
The results of operations of the Company are somewhat seasonal due to
seasonal fluctuations in the price for natural gas. Generally, natural gas
prices are higher in the first and fourth quarter of the year due to colder
winter weather and resulting higher demand for natural gas during these months.
Due to these seasonal fluctuations, results of operations for individual
quarterly periods may not be indicative of results on an annual basis.
(f) INFLATION AND CHANGING PRICES
Inflation principally affects the costs required to drill, complete and
operate oil and gas wells. In recent years, inflation has had a minimal effect
on the operations of the Company. Costs have generally declined recently due to
the decrease in drilling activity in the United States. Unless increasing oil
and gas prices spur large increases in industry activities, management believes
costs will remain relatively stable over the next year.
(g) CAPITAL RESOURCES AND LIQUIDITY--FISCAL 1998 AND FISCAL 1997
Cash flow from operating activities for the current period of $2,068,000
decreased $1,633,000 over the comparable period. The decrease in cash flow was
due primarily to higher geological and geophysical, interest and general and
administrative expenses, offset by increases in cash flow from oil and gas
properties (oil and gas revenue less lease operating and production taxes) and
working capital changes. Cash flow from oil and gas properties increased
$846,000 over the comparable period. Oil and gas prices decreased 36% and 16%,
respectively, while oil and gas production increased 105% and 99%, respectively.
The change in working capital increased cash flow by $1,698,000 over the
comparable period. The change in working capital was caused principally by
timing differences in the payment of expenses and receipt of revenues.
Cash additions to oil and gas properties were lower than the comparable
period due primarily to the $3.5 million Riceville Acquisition in August 1997.
The cash spent on acquisitions is higher due to the Enex Acquisition that closed
March 27, 1998 and the Service Acquisition that closed April 16, 1998. The
Company acquired approximately 79.2% of Enex common stock for cash in a tender
offer and substantially all of the oil and gas assets of Service Drilling for
cash and common stock. The increase in the amount of cash used for debt payments
was due primarily to the replacing of the $50 million Convertible Loan, with a
principal balance of $10,956,000, with the $100 million Revolver and principal
payments of $5,015,000 on the $100 million Revolver. No monthly principal
payments were required over the period April 1, 1997 to March 31, 1998 on the
Company's $6 million, $15 million and $50 million Convertible Loans. The
increase in the proceeds from debt issued was due to proceeds from the $100
million Revolver which were used to replace the $50 million Convertible Loan, to
finance the Enex Acquisition and to partially finance the Service Acquisition.
No preferred stock was issued for cash in the current period versus the $9
million issued under the Preferred Stock Agreement with Kaiser-Francis in the
comparable period. Kaiser-Francis converted all of the Series A Preferred Stock
on January 31, 1998.
The Company's operating activities provided net cash of $2,068,000 for the
current period. During this period, net cash from operations, cash from property
sales and cash on hand was used principally for acquisitions and exploratory and
developmental drilling. Approximately $925,000 was spent on exploratory drilling
and approximately $2,690,000 was spent on developmental drilling. The principal
exploratory wells in the current period were the S. Highbaugh Prospect
($197,000), the Quarry Prospect ($125,000) and the Sherburne Prospect
($421,000). The principal developmental wells drilled in the current period were
the Kuehling #1 sidetrack ($548,000) in the Esther Field, several wells in the
Lake Trammel Field ($207,000), a recompletion on a well in the Abbeville Field
($248,000), a recompletion on the Baker well in the Riceville Field ($222,000)
and recompletions and drilling in the Spivey ($179,000) and Wellman ($124,000)
1998 MDA-7
<PAGE>
Fields. The remaining $485,000 of capital expenditures on oil and gas was
attributable to leasehold and proved property acquisitions. The Company spent
approximately $15,960,000 on the Enex Acquisition which was financed entirely
with debt proceeds from the $100 million Revolver. The Company spent
approximately $6,500,000, excluding post-closing adjustments, on the cash
portion of the Service Acquisition, $1,000,000 from cash on hand and the
remainder with proceeds from the $100 million Revolver.
Amounts spent on debt retirement consisted principally of the replacement of
the $50 million convertible loan and principal payments on the $100 million
Revolver. The Company paid approximately $1,348,000 in cash distributions to the
minority interest partners in the Enex Partnership for the six-month period
ending September 30. The Company spent approximately $431,000 on registration
costs related to the registration of the Series C issued in the Enex Partnership
Acquisition.
Cash spent on other assets consisted principally of costs related to the
deal costs on the postponed Enex Merger, computer equipment and software.
The Company had current assets of $4,939,000 and current liabilities of
$4,800,000, which resulted in working capital of $139,000 as of December 31,
1998. This was a decrease of $1,206,000 from the working capital of $1,344,000
as of December 31, 1997. Working capital decreased primarily due to the higher
trade payables and amounts payable to dissenters and fractional shareholders in
the Enex Partnership Acquisition. Accounts payable increased because of the
increased number of properties and increased drilling activity.
On August 13, 1998 the Oil and Gas Asset Clearinghouse auctioned several
hundred oil and gas properties owned by the Company. The auctioned properties
included properties acquired in the Enex and Service Acquisitions. Certain
non-strategic properties were subject to minimum bid. The majority of the
properties were sold by auction with no minimum bids. The Company received net
proceeds of $2,635,000 from the sale of properties at the auction.
During the current period, the Company also sold certain other non-strategic
oil and gas properties in private sales for gross proceeds of $2,149,000. The
remaining $28,000 of property sales proceeds was attributable to miscellaneous
sales.
Under the terms of the $100 million Revolver, when mortgaged properties are
sold the borrowing base shall be reduced, and if necessary, proceeds from the
sales of properties shall be applied to the debt outstanding in an amount equal
to the loan value attributable to such properties sold. Of the total proceeds
received from property sales, $2,145,000 was used to repay principal on the $100
million Revolver.
On December 31, 1998 the Company sold 20% of its 25% interest in the Hawkins
Ranch Prospect for $500,000. The proceeds from the sale were collected in
January 1999 and are expected to be used to fund the drilling of the first three
wells at Hawkins Ranch.
$100 MILLION LINE OF CREDIT
In conjunction with the Enex Acquisition on March 27, 1998 the Company
entered into a new debt agreement with Compass Bank and Bank of Oklahoma (the
"Banks"). The new debt agreement is a $100 million reducing, revolving line of
credit (the "$100 million Revolver") with current borrowings under a term note
maturing April 1, 2001. The entire principal balance of the Company's $50
million Convertible Loan at the Bank of Oklahoma was replaced with the $100
million Revolver. The Bank of Oklahoma is a participating lender with Compass
Bank.
The amount the Company can borrow is based upon the borrowing base. The
borrowing base and the monthly borrowing base reduction amounts are redetermined
semi-annually by unanimous consent of the lenders. The principal is due at
maturity, April 1, 2001. Monthly principal payments are made as required in
order that the outstanding principal balance plus outstanding letters of credit
does not exceed the borrowing base. Interest is payable monthly and is
calculated at the prime rate. The Company may elect to calculate interest under
the Libor rate, as defined in the agreement. The Libor rate increases by (a)
2.00% if the outstanding loan balance and letters of credit are equal to or
greater than 75% of the borrowing
1998 MDA-8
<PAGE>
base, (b) 1.75% if the outstanding loan balance and letters of credit are less
than 75% or greater than 50% of the borrowing base or (c) 1.50% if the
outstanding loan balance and letters of credit are equal to or less than 50% of
the borrowing base.
The $100 million Revolver provided for an initial borrowing base of $29
million. The initial borrowing base was reduced to $27.5 million within ten days
after the effective date and further reduced by $275,000 per month, beginning
May 1, 1998 and ending October 1, 1998. In conjunction with the Service
Acquisition, the borrowing base was increased to $32.6 million and the monthly
borrowing base reductions were increased to $330,000. Effective October 1, 1998,
the semi-annual borrowing base redetermination date, the borrowing base was
calculated to be approximately $28.9 million with monthly borrowing base
reductions of $250,000 beginning November 1, 1998. Effective January 1, 1999,
due to the closing of the Enex Partnership Acquisition, the borrowing base
determined at October 1, 1998 was adjusted to $33.1 million with monthly
borrowing base reductions of $290,000 beginning November 1, 1998. The borrowing
base at December 31, 1998 was $32.5 million and the next semi-annual borrowing
base redetermination date is April 1, 1999.
At December 31, 1998 the Company had borrowed $27,454,000 and had $1,164,000
of outstanding letters of credit. In the current period, the Company made
$1,370,000 of required principal payments, $2,145,000 in payments from property
sales proceeds and a $1,500,000 bridge payment ten days after the close of the
Enex Acquisition. The Company is currently paying Libor plus 2.00% on a sixty
day Libor loan for $25,470,000 and prime on $1,985,000.
At December 31, 1998, the amount available under the borrowing base on the
$100 million revolver was approximately $3.9 million. Assuming no other changes,
the amount available to be borrowed at April 1 will be approximately $3.0
million. The Company expects that the Banks will complete the April 1 borrowing
base redetermination by May 1, 1999. The Company also expects that the borrowing
base will be less than the amount determined at the October 1, 1998
redetermination, adjusted for the monthly borrowing base reductions. The decline
is expected to be caused primarily by normal production declines and lower oil
and gas pricing scenarios used by the Banks to value the oil and gas reserves
for loan purposes. Pursuant to the terms of the $100 million Revolver, if the
borrowing base is less than the outstanding principal balance plus outstanding
letters of credit the Company has sixty days, after receipt of notice from the
Banks, to cure the excess by prepayment, providing additional collateral or a
combination of both. The Company is unable to predict the April 1 borrowing
base. While there can be no assurance, at the completion of the April 1
redetermination, the Company does not expect to be required to make any
prepayments or provide any additional collateral that would be material to the
financial condition of the Company.
The Company paid a facility fee equal to 3/8% of the initial borrowing base
and is required to pay 3/8% on any future increase in the borrowing base within
five days of written notice. The Company is required to pay a quarterly
commitment fee on the unused portion of the borrowing base of 1/2 % if the
outstanding loan balance plus letters of credit are greater than 50% of the
borrowing base or 3/8% if the outstanding loan balance plus letters of credit
are less than or equal to 50% of the borrowing base. The Company is required to
pay a letter of credit fee on the date of issuance or renewal of each letter of
credit equal to the greater of $500 or 1 1/2 % of the face amount of the letter
of credit.
The Company has granted to the Banks liens on substantially all of the
Company's oil and natural gas properties, whether currently owned or hereafter
acquired, and a negative pledge on all other oil and gas properties.
The $100 million Revolver requires, among other things, a cash flow coverage
ratio of 1.25 to 1.00 and a current ratio, excluding the current maturity of the
$100 million Revolver, of 0.9 to 1.00, determined on a quarterly basis. As of
December 31, 1998 the Company was in compliance with the cash flow and current
ratio covenants. Because the borrowing base was increased at the October 1
redetermination, no debt payments were required in the current quarter. The only
debt payments made in the current quarter were the mortgage payments on the
Company's former office in Mobile, Alabama.
1998 MDA-9
<PAGE>
Under the terms of the $100 million Revolver, when mortgaged properties are
sold the borrowing base shall be reduced, and if necessary, proceeds from the
sales of properties shall be applied to the debt outstanding in an amount equal
to the loan value attributable to such properties sold.
The $100 million Revolver includes other covenants prohibiting cash
dividends, distributions, loans, advances to third parties in excess of
$100,000, or sales of assets greater than 10% of the aggregate net present value
of the oil and gas properties in the borrowing base. Compass Bank has granted
the Company a waiver allowing the Company to pay the dividends to holders of
Series C as long as no default or event of default exists or would exist as a
result of any Series C dividend payment.
SERIES C PREFERRED STOCK
In connection with the Enex Partnership Merger, on December 29, 1998, the
Company issued 2,177,481 shares of Series C Preferred Stock ("Series C") in
exchange for 100% of the Enex Partnership units. The holders of Series C are
entitled to receive cumulative cash dividends in an amount per share of $0.50
per year (10% annual rate), payable semi-annually on March 31 and September 30
of each year. These dividends are payable in preference to and prior to the
payment of any dividend or distribution to any holder of Company common stock or
other junior security. The Series C dividends begin to accrue on December 30,
1998. The Series C has a liquidation preference of $5.00 per share plus an
amount equal to all accumulated, accrued and unpaid dividends. The liquidation
preference of Series C ranks on parity with the Series B Preferred Stock.
Each share of Series C is convertible into one share of Company common
stock. On or after January 1, 2000, the Company may redeem all or a portion of
the Series C, at its option, at a purchase price of $5.00 per share, plus an
amount equal to all accumulated, accrued and unpaid dividends.
The Series C is generally nonvoting; however, holders of Series C are
entitled to vote on any amendment, alteration or appeal of any provision of the
Company's Articles of Incorporation which would adversely affect any holder's
rights and preferences.
As a result of its limited partnership interest in the Enex Partnership,
Enex owns 1,293,522 shares of the Series C. Through its eighty percent ownership
of Enex, 80% (or 1,034,818) of the shares are attributable to the Company.
SERIES B PREFERRED STOCK
In connection with the Shore Merger, effective June 30, 1997, the Company
issued 266,667 shares of Series B Preferred Stock ("Series B"). The Series B is
nonvoting and pays no dividends. The Series B has a liquidation value of $7.50
per share and is junior to the Company's Series A Preferred Stock. Until
December 31, 2002, any holder of the Series B may convert all or any portion of
Series B shares into Company Common Stock ("Common") at the greater ratio of (i)
one share of Common for each share of Series B or (ii) at a ratio based upon the
"Alternative Conversion Factor." The Alternative Conversion Factor is determined
by dividing the net increase in value of approximately 40,000 net mineral acres
owned by the Company in South Louisiana by $8,000,000 and multiplying the
product by 1,066,000 to arrive at the potential number of total Common shares
all holders would receive upon conversion. In no event shall the aggregate total
number of shares of Common into which the Series B are converted be less than
266,667 shares or exceed 1,333,333 shares, unless further increased for any
anti-dilution provisions. Upon expiration of the conversion period, unless the
Company has given notice to redeem the Series B, all of the shares of the Series
B shall be automatically converted.
Since the merger date of June 30, 1997 the value of the fee minerals has not
increased to a level where the alternative conversion rate is more beneficial
than the initial conversion rate of one to one. As of December 31, 1998, no
additional shares of Series B have been issued.
1998 MDA-10
<PAGE>
SERIES A PREFERRED STOCK
On September 4, 1996, the Company signed a stock purchase agreement with
Kaiser Francis Oil Company ("the Agreement"). The Agreement provided for the
purchase of 1,666,667 shares of Series A Preferred Stock ("Series A") at $6.00
per share, over a five-year period beginning September 4, 1996 with minimum
incremental investments of $500,000 each. Each issuance of Series A was subject
to approval by Kaiser-Francis of the use of proceeds. The Series A was nonvoting
and accrued dividends at 8% per annum, payable quarterly in cash. The Series A
was convertible at any time after issuance into shares of common stock at the
rate of two shares of common stock for each share of Preferred before January 1,
1998. At December 31, 1997, all of the Series A had been issued and on January
31, 1998, all of the Series A was converted into 3,333,334 shares of Company
common stock.
THE ENEX ACQUISITION
On March 27, 1998, the Company acquired 1,064,432 shares of the common stock
of Enex, for $15 cash per share pursuant to the Company's tender offer that
began February 19, 1998. The Enex shares acquired by the Company represent 79.2%
of the total outstanding Enex common stock. The Company applied the purchase
method of accounting to the Enex Acquisition. The purchase price of $15,966,000
was financed with proceeds from the Company's $100 million Revolver. The Company
also incurred approximately $60,934 in legal, accounting and printing expenses
and issued 33,825 shares of Company common stock for finders fees to unrelated
third parties.
Over a three-week period ending December 23, 1998, the Company acquired an
additional 0.80% of Enex common stock for approximately $68,000.
As part of the Enex Acquisition, the Company entered into a consulting
agreement, effective April 15, 1998, with the former president of Enex that
provides for monthly payments of $20,000 until expiration of the agreement on
May 18, 2002. The present value of the agreement, applying a 10% discount rate,
is approximately $788,000 and is included in Other Liabilities (current and long
term). The monthly payments serve as consideration for consulting, a covenant
not to compete and a preferential right to purchase certain oil and gas
acquisitions which the former president controls or proposes to acquire during
the term of the agreement. The Company will reimburse the former president each
month for reasonable and necessary business expenses incurred in connection with
the performance of consulting services. The agreement survives the former
president and his spouse and is nonassignable.
Enex, a Delaware corporation, is an independent oil and gas production and
development company headquartered in Kingwood, Texas with operations primarily
in Texas. Enex engages primarily in managing and acquiring producing oil and gas
properties, and does not engage in significant drilling activities. Enex
operates over 100 wells in South Texas. Before the tender offer, the Enex shares
traded on the NASDAQ Stock Market National Market System under the symbol ENEX.
The Enex shares are currently traded on the OTC Bulletin Board. Concurrent with
the closing of the Enex Acquisition, the Enex Board of Directors resigned and
were replaced by the persons who constitute the Company's Board of Directors.
Enex is presently being operated as a majority-owned subsidiary of the Company.
In addition to managing and acquiring direct interests in producing oil and
gas properties, Enex served as general partner of the Enex Partnership until its
sale to the Company, effective October 1, 1998. See the discussion below
concerning the sale of the Enex Partnership to the Company. Approximately 73% of
Enex's estimated future net revenues from proved reserves at December 31, 1997
is attributable to its interests in the Enex Partnership and approximately 27%
is attributable to the properties owned directly by the Enex, after deducting
the minority interest share of the Enex Partnership. As general partner, Enex
had a 4.1% interest in the net revenues and gains generated by properties owned
by the Enex Partnership. In addition to the general partner interest, Enex owned
a 56.2% limited partner interest in the Enex Partnership. Based on the Company's
80% ownership of Enex, the Company had an effective limited partner ownership of
the Enex Partnership of 44.9%.
1998 MDA-11
<PAGE>
Because the Company's ownership of Enex is greater than 50%, the Company's
consolidated financial statements at December 31, 1998 include 100% of the
accounts of Enex subsequent to the acquisition date. Until the sale of the Enex
Partnership, effective October 1, 1998, Enex consolidated 100% of the Enex
Partnership on its books for financial reporting purposes because its ownership
in the Enex Partnership was greater than 50%. The minority interest on the
Company's balance sheet reflects the equity interest of the minority owners in
Enex (20%).
The operations of Enex for the six-month period ending September 30, which
included the operations of the Enex Partnership until its sale effective October
1, 1998, were included in the financial statements of the Company. The
operations of Enex for the three-month period ending December 31, which excluded
the operations of the Enex Partnership, were also included in the financial
statements of the Company.
On October 31, 1998 the office lease in Kingwood where Enex and the Enex
Partnership were headquartered expired. The Company has moved the majority of
the current files and records for Enex and the Enex Partnership to the Houston
office and has rented a small office in Kingwood where the accounting staff of
Enex and the Enex Partnership will continue to operate until the end of the
first quarter of 1999.
THE ENEX MERGER
On July 17, 1998, the Securities and Exchange Commission declared effective
a registration statement filed under the Securities Act of 1933 for the merger
of Enex into the Company (the "Enex Merger"). A special meeting of the
stockholders of Enex was held on August 20, 1998 to approve the Enex Merger. Due
to market conditions, the Company voted against the Enex Merger. Due to the
postponement of the Enex Merger, the Company impaired deal costs related to the
Enex Merger by approximately $38,000.
THE ENEX PARTNERSHIP MERGER
The Enex Partnership is a New Jersey limited partnership that was formed on
June 30, 1997 from the combination of thirty-four Enex Oil and Gas Limited
Partnerships. The Enex Partnership, headquartered in Kingwood, Texas, is engaged
in the oil and gas business through the ownership of various interests in oil
and gas properties. At October 1, 1998, Enex owned 56.24% of the outstanding
limited partner units and the remaining 43.76% was owned by several thousand
limited partners.
On December 29, 1998 the Company closed an exchange of 2.086 shares of
Series C Preferred stock for each Enex Partnership unit (the "Exchange Offer").
In connection with the Exchange Offer, the Company submitted a proposal to
investors in the Enex Partnership to amend the partnership agreement to provide
for the transfer of all of the assets and liabilities of the Enex Partnership to
the Company as of October 1, 1998 and dissolve the Enex Partnership. The Company
issued 2,177,481 Series C shares for 100% of the outstanding limited partner
units. Enex was issued 1,293,522 Series C shares for its 56.24% ownership of the
Enex Partnership. The remaining 883,959 Series C shares were issued to the
limited partners that elected to take Series C shares in lieu of cash. Certain
dissenting limited partners and fractional shares will be paid cash in January
1999. Because of the dissenting limited partners, Enex owns 59.4% of the Series
C shares.
The operations of the Enex Partnership for the nine-month period ending
December 31 were included in the financial statements of the Company due to the
Company's acquisition of Enex on March 27, 1998. Subsequent to October 1, 1998,
no minority interest was recorded related to the operations of the Enex
Partnership as it was dissolved.
1998 MDA-12
<PAGE>
FUTURE CAPITAL REQUIREMENTS
The Company has made and will continue to make, substantial capital
expenditures for acquisition, development and exploration of oil and natural gas
reserves. In fact, because the Company's principal natural gas and oil reserves
are depleted by production, its success is dependent upon the results of its
acquisition, development and exploration activities.
The Company expects to incur a minimum of approximately $500,000 in capital
expenditures over the next twelve months. The Company expects that available
cash, cash flows from operations and cash proceeds from asset sales of certain
non-core properties will be sufficient to fund the planned capital expenditures
through 1999 in addition to funding interest and principal requirements on the
$100 million Revolver. However, the Company may require additional borrowings
under the $100 million Revolver or additional equity funding to raise additional
capital to fund any acquisitions.
Because future cash flows and the availability of financing are subject to a
number of variables, such as the level of production and prices received for gas
and oil, there can be no assurance that the Company's capital resources will be
sufficient to maintain planned levels of capital expenditures and accordingly,
oil and natural gas revenues and operating results may be adversely affected.
At December 31, 1998, the amount available under the borrowing base on the
$100 million revolver was approximately $3.9 million. Assuming no other changes,
the amount available to be borrowed at April 1 will be approximately $3.0
million. The Company expects that the Banks will complete the April 1 borrowing
base redetermination by May 1, 1999. The Company also expects that the borrowing
base will be less than the amount determined at the October 1, 1998
redetermination, adjusted for the monthly borrowing base reductions. The decline
is expected to be caused primarily by normal production declines and lower oil
and gas pricing scenarios used by the Banks to value the oil and gas reserves
for loan purposes. If the borrowing base is less than the outstanding principal
balance plus outstanding letters of credit the Company has sixty days, after
receipt of notice from the Banks, to cure the excess by prepayment, providing
additional collateral or a combination of both. The Company is unable to predict
the April 1 borrowing base. While there can be no assurance, at the completion
of the April 1 redetermination, the Company does not expect to be required to
make any prepayments or provide any additional collateral that would be material
to the financial condition of the Company. However, depending on the amount of
prepayment, if any is required, the Company may have to raise additional cash to
meet this commitment.
Amounts spent on debt retirement due to reductions in the borrowing base,
reduce the cash available to spend on acquisition, development and exploration
activities and, accordingly, oil and natural gas revenues and operating results
may be adversely affected.
By the end of the first quarter of 1999, the Company expects to have the
operations of Enex and the Enex Partnership fully consolidated into its
operations at the Company's headquarters in Houston. It is expected that the
Company will realize certain cost savings in the consolidation of these
operations.
YEAR 2000 COMPLIANCE
Readers are cautioned that the forward-looking statements contained in the
following Year 2000 discussion should be read in conjunction with the Company's
disclosures under the heading "Forward-Looking Statements." The disclosures also
constitute a "Year 2000 Readiness Disclosure" and "Year 2000 Statement" within
the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998.
STATEMENT OF READINESS
The Company has undertaken various initiatives to ensure that its hardware,
software and equipment will function properly with respect to dates before and
after January 1, 2000. For this purpose, the phrase "hardware, software and
equipment" includes systems that are commonly thought of as Information
Technology systems ("IT"), as well as those Non-Information Technology systems
("Non-IT") and equipment which include embedded technology. IT systems include
computer hardware and software and other
1998 MDA-13
<PAGE>
related systems. Non-IT systems include certain oil and gas production and field
equipment, gathering systems, office equipment, telephone systems, security
systems and other miscellaneous systems. The Non-IT systems present the greatest
readiness challenge since identification of embedded technology is difficult and
because the Company is, to a great extent, reliant on third parties for Non-IT
compliance.
The Company has formed a Year 2000 ("Y2K") Project team, which is chaired by
its Chief Financial Officer, Frank C. Turner, II. The team includes corporate
staff and representatives from the Company's business units. In response to the
possible risks posed to the Company, the team has developed a Y2K Plan (the
"Plan") which includes guidelines for inventory, assessment, remediation,
testing and contingency planning.
The following categories represent the mission-critical operational systems
of the Company. A "mission-critical system" is a system that is vital to the
successful continuation of a core business activity. An application may be
mission critical if it interfaces with a designated mission-critical system.
Each system has been evaluated by the Company as to (a) the risks to the Company
in the event of the most reasonably likely worst case scenario (the "Worst Case
Scenario"); (b) the status of the Company's remediation plan, if any ("Status");
and (c) the Company's contingency plans, if any ("Contingency Plans").
ACCOUNTING SOFTWARE SYSTEMS. The Company relies solely on the software
accounting packages ("Accounting Packages") to provide management with various
reports that allow managers to determine the cash flow and profitability of
individual properties and of the Company as a whole. Management also relies on
the Accounting Packages to provide financial information necessary to prepare
quarterly and annual financial reports that are sent to the Securities and
Exchange Commission, NASDAQ Stock Market, banks and stockholders. In addition,
the Company relies on the Accounting Packages to process and print checks to be
sent to working and royalty interest owners for their share of the monthly oil
and gas sales, to process and print checks for payment to vendors and to process
and print monthly joint-interest statements to be sent to working interest
owners in Company-operated oil and gas properties. Under a Worst Case Scenario,
all accounting functions would have to be completed manually, significantly
hindering the Company's ability to complete the above-described mission-critical
systems.
<TABLE>
<CAPTION>
<S> <C>
Status: The Company has updated its accounting systems. Testing is scheduled to
be completed by April 30, 1999.
Contingency Plans: The Company is currently considering contingency plans for processing
its accounting data. Depending on the results of the testing phase,
contingency plans will be developed.
</TABLE>
CONTROL SYSTEMS AND IMBEDDED TECHNOLOGY. These systems include the
equipment used to produce, monitor, control, sell and record hydrocarbon
production, including all artificial lift equipment, storage, measurement and
control facilities and third-party systems and technology interrelated to the
Company's business. Under a Worst Case Scenario, multiple fields of oil and gas
would lose the ability to account for the amount of hydrocarbon production,
temporarily shutting down the field(s) until the malfunctioning part(s) could be
repaired or replaced. This is not expected to materially adversely effect the
Company.
<TABLE>
<CAPTION>
<S> <C>
Status: The only mission-critical field operated by the Company is the Spivey
Field, whose production operations are not affected by Y2K issues. The
Spivey Field is affected by a third-party operated gas plant that
processes the field's natural gas and may be subject to Y2K issues.
Refer to "Third Party Systems-Gas Plant" for a discussion of the gas
plant at the Spivey Field. The operations of the remaining fields were
not materially affected by Y2K issues.
Contingency Plans: The Company will continue to monitor the operations at its field
locations and develop contingency planning if an exposure becomes
apparent.
</TABLE>
THIRD-PARTY SYSTEMS--OIL AND GAS PURCHASERS. The Company utilizes
third-party purchasers to sell the oil and gas produced from the wells in which
it has a working or royalty interest. The Company also
1998 MDA-14
<PAGE>
depends on third-party purchasers to remit to the Company its share of the
proceeds from the sales of oil and gas. The Company does not directly sell any
oil and gas produced from the wells in which it has a working or royalty
interest and does not take any oil or gas in kind as an alternative to cash
payment. Under a Worst Case Scenario, multiple major purchasers would be
temporarily shut down due to Y2K issues, materially adversely effecting the
Company's revenues.
<TABLE>
<CAPTION>
<S> <C>
Status: Based upon the diversity of purchasers, the Company believes that no
single purchaser is a mission-critical purchaser. The Y2K team does not
anticipate that a problem with any single purchaser for a reasonable
period of time beyond 2000 will force the Company to curtail or shut
down its operations. Although no single purchaser is a mission-critical
purchaser, the loss of a major purchaser or multiple minor purchasers
due to Y2K problems would affect the Company. The Company has obtained
information about the top ten purchasers and their Y2K readiness. All
but two of the top ten purchasers have formal Y2K Plans and are working
to upgrade any mission-critical systems that are affected by Y2K. The
other two purchasers acknowledge that certain systems will be affected
by Y2K and have been undertaking plans to upgrade these systems.
Contingency Plans: The Company continues to monitor the Y2K status of its major
purchasers. Should a purchaser not become Y2K compliant, the Company
will identify alternative purchasers for its production and, if
necessary, temporarily shut-in production.
</TABLE>
THIRD-PARTY SYSTEMS--GAS PLANT. Over 95% of the gas produced in the Spivey
Field, a mission-critical system, is sold to a gas plant under a life of the
lease casinghead tailgate gas contract. The Company owns approximately 11.5% of
the gas plant and related gathering system. Colt Resources Corporation operates
the plant. Under a Worst Case Scenario, the gas plant could be shut down which
could materially adversely effect the Company.
<TABLE>
<CAPTION>
<S> <C>
Status: The Company has received a letter from the operator of the Spivey plant
stating that the Spivey plant's control systems and embedded technology
are not Y2K affected and that its accounting and processing systems are
Y2K compliant.
Contingency Plans: A short-term interruption of gas sales would not materially affect the
Company's operations. If the Spivey plant experiences problems with an
expected duration in excess of one month, the Company has identified
alternative gas markets it could utilize.
</TABLE>
THIRD-PARTY SYSTEMS--BANKING. The Company relies on its banks to deposit
checks payable to the Company and credit the checks to the appropriate accounts.
The Company also relies on its banks to credit third-party accounts for payment.
A Worst Case Scenario would occur if the Company's principal bank is unable to
provide certain services for an extended period of time due to Y2K, causing the
Company to be materially adversely affected.
<TABLE>
<CAPTION>
<S> <C>
Status: The Company's principal bank currently has a formal Y2K Plan in effect
and anticipates that all non-compliant, in-house mission-critical
systems will be substantially remediated by December 31, 1998 and
substantially completed by March 31, 1999 for vendor-supported systems.
The Company's principal bank expects to have all of its non-compliant,
mission-critical systems Y2K compliant by June 30, 1999.
Contingency Plans: The Company intends to have cash on hand sufficient to cover short-term
emergency payments and payroll. The Company also plans to open accounts
with other institutions in the event its principal bank is unable to
rectify its problems in a timely manner. The Company has no long-term
contingency plans in the event of a system-wide failure of banking
institutions.
</TABLE>
1998 MDA-15
<PAGE>
THIRD-PARTY SYSTEMS--SUPPORT FUNCTIONS. The primary material support
functions provided by third parties are electrical service, communication
service and office space. Under a Worst Case Scenario, all primary support
functions would be hindered in the short term.
<TABLE>
<CAPTION>
<S> <C>
Status: All vendors of these services have reported that formal Y2K remediation
plans are in effect and will be substantially complete by September 30,
1999.
Contingency Plans: Short-term (less than two weeks) interruptions of services will not
materially adversely effect the Company. The Company will be able to
conduct business on a reduced scale using alternative business methods.
Longer-term interruptions may materially adversely effect the Company.
The Company has no plans sufficient to fully offset the effect of
long-term interruptions.
</TABLE>
COMPUTER OPERATING SYSTEMS AND APPLICATION SOFTWARE SYSTEMS. The Company
relies solely on its personal computer systems to access the accounting software
package through the Company's computer network. In addition, certain schedules
and databases that are used for critical functions rely on spreadsheet and
work-processing applications that are run on the Company's personal computer
systems.
<TABLE>
<CAPTION>
<S> <C>
Status: All systems appear to be Y2K ready.
Contingency Plans: Operations could be performed manually until non-functioning equipment
or software is repaired or replaced
</TABLE>
COSTS OF Y2K COMPLIANCE
The costs incurred by the Company to implement the Plan were not material to
the Company's financial condition or results of operations. The Company does not
expect any future costs related to the Plan to be material to the Company's
financial condition or results of operations.
THE RISKS OF Y2K ISSUES
The Company presently believes that Y2K issues will not pose significant
operational problems. However, if all significant Y2K issues are not properly
identified or assessed, remediation and testing are not effected timely, the Y2K
issues, either individually or in combination, may materially and adversely
impact the Company's results of operations, liquidity and financial condition or
materially and adversely affect its relationships with its business partners.
Additionally, the misrepresentation of compliance by other entities or the
persistent, universal failure of financial, transportation or other economic
systems will likely have a material and adverse impact on the Company's
operations or financial condition for which it cannot adequately prepare.
F-27
<PAGE>
<TABLE>
<CAPTION>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30 December 31
1999 1998
------------- -------------
(unaudited) (audited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
CASH AND CASH EQUIVALENTS. . . . . . . . . . . . . . . . . $ 25,076,465 $ 1,040,096
ACCOUNTS RECEIVABLE. . . . . . . . . . . . . . . . . . . . 2,716,165 3,309,043
ACCOUNTS RECEIVABLE-INSURANCE CLAIM. . . . . . . . . . . . -- 448,083
OTHER CURRENT ASSETS . . . . . . . . . . . . . . . . . . . 90,567 141,364
------------- -------------
TOTAL CURRENT ASSETS . . . . . . . . . . . . . . . . . . 27,883,197 4,938,586
NON-CURRENT ASSETS
NOTES RECEIVABLE--STOCKHOLDER. . . . . . . . . . . . . . . -- 173,115
PROPERTY (AT COST)
OIL AND GAS (SUCCESSFUL EFFORTS METHOD). . . . . . . . . . 80,659,521 90,849,439
OTHER. . . . . . . . . . . . . . . . . . . . . . . . . . . 988,579 795,323
------------- -------------
81,648,100 91,644,762
ACCUMULATED DEPLETION, DEPRECIATION AND AMORTIZATION . . . . (35,425,362) (39,073,584)
------------- -------------
46,222,738 52,571,178
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . 637,875 257,938
------------- -------------
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . $ 74,743,810 $ 57,940,817
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
CURRENT MATURITY OF LONG-TERM DEBT . . . . . . . . . . . . $ 4,314,318 $ --
ACCOUNTS PAYABLE-TRADE . . . . . . . . . . . . . . . . . . 2,822,415 3,643,241
ACCOUNTS PAYABLE-ENEX LP LIMITED PARTNERS. . . . . . . . . -- 538,750
ACCOUNTS PAYABLE-REVENUE . . . . . . . . . . . . . . . . . 362,065 342,931
OTHER CURRENT LIABILITIES. . . . . . . . . . . . . . . . . 200,806 275,010
------------- -------------
TOTAL CURRENT LIABILITIES. . . . . . . . . . . . . . . . . . 7,699,604 4,799,932
LONG-TERM DEBT . . . . . . . . . . . . . . . . . . . . . . . 24,176,249 27,454,567
CONVERTIBLE SUBORDINATED NOTES . . . . . . . . . . . . . . . 10,850,000 --
DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . 486,353 1,733,167
OTHER LIABILITIES. . . . . . . . . . . . . . . . . . . . . . 304,404 437,949
MINORITY INTEREST. . . . . . . . . . . . . . . . . . . . . . 1,014,155 957,369
STOCKHOLDERS' EQUITY
PREFERRED STOCK, $0.02 PAR, 20,000,000 SHARES AUTHORIZED,
266,667 DESIGNATED SERIES B AND 2,177,481 SHARES
DESIGNATED SERIES C, NONE OTHER DESIGNATED . . . . . . . . -- --
CONVERTIBLE PREFERRED STOCK SERIES B, $7.50 STATED VALUE,
266,667 SHARES ISSUED AND OUTSTANDING AT SEPTEMBER 30,
1999 AND DECEMBER 31, 1998. $2,000,000 AGGREGATE
LIQUIDATION PREFERENCE . . . . . . . . . . . . . . . . . . 3,627,000 3,627,000
CONVERTIBLE PREFERRED STOCK SERIES C, $5.00 STATED VALUE,
1,142,996 AND 1,142,663 SHARES ISSUED AND OUTSTANDING AT
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998, RESPECTIVELY.
$5,714,980 AGGREGATE LIQUIDATION PREFERENCE. . . . . . . . 5,235,083 5,281,937
COMMON STOCK, $.02 PAR VALUE, 40,000,000 SHARES AUTHORIZED,
13,383,005 AND 8,552,365 SHARES ISSUED AND OUTSTANDING AT
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998, RESPECTIVELY . . 267,692 171,055
PAID-IN-CAPITAL. . . . . . . . . . . . . . . . . . . . . . . 48,137,005 36,947,588
ACCUMULATED DEFICIT. . . . . . . . . . . . . . . . . . . . . (26,985,695) (23,401,707)
LESS COST OF TREASURY STOCK; 21,773 SHARES . . . . . . . . . (68,040) (68,040)
------------- -------------
TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . . . . . . 30,213,045 22,557,833
------------- -------------
COMMITMENTS AND CONTINGENCIES
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . . . . . . . . . $ 74,743,810 $ 57,940,817
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-28
<PAGE>
<TABLE>
<CAPTION>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- ----------------------------
1999 1998 1999 1998
------------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUE
OIL AND GAS SALES AND PLANT INCOME . . . . . . . . $ 4,656,156 $3,961,442 $ 11,328,502 $ 11,078,360
GAIN ON SALE OF PROPERTIES . . . . . . . . . . . . 575,287 1,518,139 882,477 1,527,207
DELAY RENTAL AND LEASE BONUS INCOME. . . . . . . . 61,911 20,333 64,911 217,404
OTHER. . . . . . . . . . . . . . . . . . . . . . . 469,508 194,846 691,442 436,783
------------- ----------- ------------- -------------
TOTAL REVENUE. . . . . . . . . . . . . . . . . . . . 5,762,862 5,694,760 12,967,332 13,259,754
------------- ----------- ------------- -------------
COSTS AND EXPENSES
LEASE OPERATING, PRODUCTION TAXES AND PLANT COSTS. 1,434,185 1,934,203 4,450,843 5,539,218
GEOLOGICAL AND GEOPHYSICAL . . . . . . . . . . . . 46,768 139,303 188,484 927,418
DEPRECIATION, DEPLETION AND AMORTIZATION . . . . . 1,466,006 1,945,110 4,046,546 4,970,052
IMPAIRMENTS. . . . . . . . . . . . . . . . . . . . 1,688,443 492,000 1,688,443 492,000
DRYHOLE. . . . . . . . . . . . . . . . . . . . . . 391,477 24,141 455,108 331,405
INTEREST . . . . . . . . . . . . . . . . . . . . . 717,917 615,792 1,739,362 1,428,633
STOCK COMPENSATION . . . . . . . . . . . . . . . . 729,938 -- 729,938 67,500
SEVERANCE PAYMENT. . . . . . . . . . . . . . . . . 284,060 -- 284,060 --
COMPENSATION PLAN PAYMENT. . . . . . . . . . . . . 292,527 -- 292,527 --
GENERAL AND ADMINISTRATIVE . . . . . . . . . . . . 1,112,181 975,435 3,048,430 3,231,349
OTHER. . . . . . . . . . . . . . . . . . . . . . . 272,233 -- 481,622 4,639
------------- ----------- ------------- -------------
TOTAL COSTS AND EXPENSES . . . . . . . . . . . . . . 8,435,735 6,125,984 17,405,363 16,992,214
LOSS BEFORE INCOME TAX BENEFIT AND MINORITY INTEREST (2,672,873) (431,224) (4,438,031) (3,732,460)
MINORITY INTEREST. . . . . . . . . . . . . . . . . . 23,545 154,209 (40,228) 5,523
------------- ----------- ------------- -------------
LOSS BEFORE INCOME TAX BENEFIT . . . . . . . . . . . (2,696,418) (585,433) (4,397,803) (3,737,983)
INCOME TAX BENEFIT . . . . . . . . . . . . . . . . . (686,314) (199,047) (1,242,324) (1,270,914)
------------- ----------- ------------- -------------
NET LOSS . . . . . . . . . . . . . . . . . . . . . . (2,010,104) (386,386) (3,155,479) (2,467,069)
DIVIDENDS TO PREFERRED STOCKHOLDERS. . . . . . . . . 142,843 -- 428,509 67,945
------------- ----------- ------------- -------------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS . . . . $ (2,152,947) $ (386,386) $ (3,583,988) $ (2,535,014)
============= =========== ============= =============
NET LOSS PER SHARE
Basic. . . . . . . . . . . . . . . . . . . . . . . $ (0.21) $ (0.05) $ (0.39) $ (0.32)
============= =========== ============= =============
Diluted. . . . . . . . . . . . . . . . . . . . . . $ (0.21) $ (0.05) $ (0.39) $ (0.32)
============= =========== ============= =============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic. . . . . . . . . . . . . . . . . . . . . . . 10,351,990 8,530,592 9,137,784 7,889,947
============= =========== ============= =============
Diluted. . . . . . . . . . . . . . . . . . . . . . 10,351,990 8,530,592 9,137,784 7,889,947
============= =========== ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-29
<PAGE>
<TABLE>
<CAPTION>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30
----------------------------
1999 1998
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES
NET LOSS. . . . . . . . . . . . . . . . . . . . . . . . . . $ (3,155,479) $ (2,467,069)
ADJUSTMENTS TO RECONCILE NET LOSS
TO NET CASH PROVIDED BY OPERATING ACTIVITIES
DEPLETION, DEPRECIATION AND AMORTIZATION. . . . . . . . . 4,046,546 4,970,052
IMPAIRMENTS . . . . . . . . . . . . . . . . . . . . . . . 1,688,443 492,000
DRYHOLE COSTS . . . . . . . . . . . . . . . . . . . . . . 455,108 331,405
STOCK COMPENSATION EXPENSE. . . . . . . . . . . . . . . . 729,938 67,500
GAIN ON SALE OF PROPERTIES. . . . . . . . . . . . . . . . (882,477) (1,527,207)
DEFERRED INCOME TAX BENEFIT . . . . . . . . . . . . . . . (1,242,324) (1,270,914)
MINORITY INTEREST . . . . . . . . . . . . . . . . . . . . (40,228) 5,523
OTHER CHARGES . . . . . . . . . . . . . . . . . . . . . . 345,533 (34,680)
------------- -------------
CASH FLOW FROM OPERATIONS BEFORE CHANGES IN CURRENT ASSETS
AND LIABILITIES . . . . . . . . . . . . . . . . . . . . . 1,945,060 566,610
CHANGES IN CURRENT ASSETS AND LIABILITIES, NET OF
ACQUISITION EFFECTS:
ACCOUNTS RECEIVABLE AND OTHER CURRENT ASSETS. . . . . . . 827,906 (588,159)
ACCOUNTS PAYABLE, REVENUE PAYABLE, AND OTHER CURRENT
LIABILITIES . . . . . . . . . . . . . . . . . . . . . . (1,330,626) 2,080,921
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES . . . . . . . . . 1,442,340 2,059,372
INVESTING ACTIVITIES
PROCEEDS FROM SALES OF PROPERTIES . . . . . . . . . . . . . 3,614,453 4,707,497
ADDITIONS TO OIL AND GAS PROPERTIES . . . . . . . . . . . . (1,827,614) (3,305,635)
ACQUISITION OF ENEX RESOURCES CORPORATION, NET OF
CASH ACQUIRED OF $4,698,211 . . . . . . . . . . . . . . . . -- (11,329,203)
ACQUISITION OF ASSETS OF SERVICE DRILLING CO. . . . . . . . -- (6,337,689)
OTHER ASSETS. . . . . . . . . . . . . . . . . . . . . . . . (251,680) (492,129)
PAYMENTS FROM (ADVANCES TO) STOCKHOLDER . . . . . . . . . . 173,115 (5,211)
------------- -------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES . . . . 1,708,274 (16,762,370)
FINANCING ACTIVITIES
PROCEEDS FROM DEBT ISSUED . . . . . . . . . . . . . . . . 1,036,000 32,469,604
PROCEEDS FROM SUBORDINATED NOTES ISSUED . . . . . . . . . 10,850,000 --
PROCEEDS FROM COMMON STOCK ISSUED . . . . . . . . . . . . 9,975,000 --
PRINCIPAL PAYMENTS ON DEBT. . . . . . . . . . . . . . . . -- (15,976,432)
PREFERRED STOCK DIVIDENDS PAID. . . . . . . . . . . . . . (242,293) (67,945)
REGISTRATION COSTS ON SERIES C PREFERRED STOCK. . . . . . (48,518) (778,501)
OTHER . . . . . . . . . . . . . . . . . . . . . . . . . . (684,434) (242,375)
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES . . . . . . . . . 20,885,755 15,404,351
NET INCREASE IN CASH AND CASH EQUIVALENTS . . . . . . . . . 24,036,369 701,353
CASH AND CASH EQUIVALENTS- BEGINNING. . . . . . . . . . . . 1,040,096 1,587,184
------------- -------------
CASH AND CASH EQUIVALENTS- ENDING . . . . . . . . . . . . . $ 25,076,465 $ 2,288,537
============= =============
SUPPLEMENTAL CASH FLOW INFORMATION:
INTEREST PAID IN CASH . . . . . . . . . . . . . . . . . . $ 1,446,736 $ 1,322,038
============= =============
PREFERRED DIVIDENDS INCURRED BUT NOT PAID . . . . . . . . $ 186,216 $ --
============= =============
ACQUISITION OF OIL AND GAS PROPERTIES FROM 3TEC . . . . . $ 875,000 $ --
============= =============
DRYHOLE COST ACCRUED BUT NOT PAID . . . . . . . . . . . . $ 345,841 $ --
============= =============
CONVERSION OF SERIES A PREFERRED STOCK. . . . . . . . . . $ -- $ 10,000,000
============= =============
COMMON STOCK ISSUED AS FINDERS' FEE
IN ENEX RESOURCES CORP. TENDER OFFER. . . . . . . . . . $ -- $ 245,231
============= =============
COMMON STOCK ISSUED IN ACQUISITION OF ASSETS FROM SERVICE
DRILLING CO., LLC . . . . . . . . . . . . . . . . . . . $ -- $ 5,078,250
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-30
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
3TEC Energy Corporation (the Company) (formerly Middle Bay Oil Company,
Inc.), was incorporated under the laws of the State of Alabama on November 30,
1992. The Company was reincorporated in Delaware on December 7, 1999 and
changed its name to 3TEC Energy Corporation. Effective March 27, 1998, the
Company acquired 79.2% of Enex Resources Corporation ("Enex") and over a
three-week period ending December 23, 1998, the Company acquired an additional
0.80% of Enex for a total of 80% of Enex. Effective April 16, 1998, the Company
acquired the assets of Service Drilling Co., LLC ("Service Drilling").
Effective October 1, 1998, the Company acquired 100% of Enex Consolidated
Partners, L.P. ("Enex Partnership"), a limited partnership of which Enex owned
greater than a 50% interest. The Company and its subsidiaries are engaged in
the acquisition, development and production of oil and gas in the contiguous
United States.
BASIS OF PRESENTATION
In management's opinion, the accompanying consolidated financial statements
contain all adjustments (consisting solely of normal recurring adjustments)
necessary to present fairly the consolidated financial position of the Company
as of September 30, 1999 and December 31, 1998 and the consolidated results of
operations and consolidated cash flows for the periods ended September 30, 1999
and 1998.
The consolidated financial statements were prepared pursuant to the rules
and regulations of the Securities and Exchange Commission. An independent
accountant has not audited the accompanying consolidated financial statements.
Certain information and disclosures normally included in annual audited
financial statements prepared in accordance with generally accepted accounting
principles have been omitted, although the Company believes that the disclosures
made are adequate to make the information presented not misleading. These
consolidated financial statements should be read in conjunction with the
Company's financial statements and notes thereto included in the Company's
Annual Report on Form 10-KSB for the year ended December 31, 1998.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiary and Enex, an 80% owned subsidiary. The equity of
the minority interest in Enex is shown in the consolidated statements as
"minority interest". Significant intercompany accounts and transactions are
eliminated in consolidation.
EARNINGS PER SHARE
Basic earnings per share is based on the weighted average shares
outstanding without any dilutive effects considered. Diluted earnings per share
reflects dilution from all potential common shares, including options, warrants
and convertible preferred stock. A weighted average of 2,041,751 and 3,285,751
common stock equivalents in 1999 and 330,297 and 288,535 common stock
equivalents in 1998, are not considered in the calculation of diluted earnings
per share for the nine and three month periods ending September 30,
respectively, due to the net loss recorded during these periods.
F-31
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain reclassifications of prior period amounts have been made to conform
to the current presentation.
(2) ACQUISITIONS
On March 27, 1998, the Company acquired 1,064,432 common shares,
approximately 79.2%, of Enex for $15,966,480. The Company purchased the common
shares of Enex through a cash tender offer that commenced February 19, 1998 (the
"Enex Acquisition"). The Company also incurred approximately $60,934 in legal,
accounting and printing expenses and issued 33,825 shares of Company common
stock for finders fees to unrelated third parties. At the time, Enex was
general partner of Enex Consolidated Partners, L.P., (the "Enex Partnership"), a
New Jersey limited partnership whose principal business was oil and gas
exploration and production. Enex's general partner interest was 4.1%. Enex
also owned an approximate 56.2% limited partner interest in Enex Partnership.
The cost of acquiring 79.2% of Enex was allocated using the purchase method
of accounting to the consolidated assets and liabilities of Enex based on
estimates of the fair values with the remaining purchase price allocated to
proved oil and gas properties.
The allocation of the purchase price is summarized as follows: (in
thousands)
<TABLE>
<CAPTION>
<S> <C>
Working capital. . . . . . . . . . . . . . . $ 5,640
Oil and gas properties (proved and unproved) 19,090
Minority interest. . . . . . . . . . . . . . (7,669)
--------
Total. . . . . . . . . . . . . . . . . . . . $17,061
========
</TABLE>
Over a three-week period ending December 23, 1998, the Company acquired an
additional 0.80% (9,747 common shares) of Enex common stock for approximately
$68,000.
On April 16, 1998, the Company acquired substantially all of the oil and
gas assets of Service Drilling Co., LLC and certain affiliates ("Service
Drilling"), in exchange for 666,000 shares of Company common stock and
$6,500,000 in cash for a total acquisition cost of $10,054,774, before
post-closing adjustments (the "Service Acquisition"). The fair value of the
securities issued in connection with the Service Acquisition was calculated
using the price of the Company's common stock at the time the Service
Acquisition was announced to the public and further adjusted for tradability
restrictions. An independent valuation firm determined the tradability discount
for the Company's common stock. The effective date of the acquisition was March
1, 1998 and the cost was allocated using the purchase method of accounting.
On December 30, 1998, the Company completed the acquisition of the Enex
Partnership (the "Enex Partnership Acquisition"). The transaction consisted of
an exchange offer whereby the Company offered to exchange 2.086 shares of Series
C Preferred stock ("Series C") for each Enex Partnership unit (the "Exchange
Offer"). In connection with the Exchange Offer, the Company submitted a
proposal to investors in the Enex Partnership to amend the partnership agreement
to provide for the transfer of all of the assets and liabilities of the Enex
Partnership to the Company as of October 1, 1998 and dissolve the
F-32
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(2) ACQUISITIONS (CONTINUED)
Enex Partnership. The Exchange Offer was approved on December 30, 1998 and the
Company issued 2,177,481 Series C shares for 100% of the outstanding limited
partner units. At the close of the Exchange Offer, the Enex Partnership had
1,102,631 units outstanding. Enex was issued 1,293,521 Series C shares for its
56.2% ownership of the Enex Partnership. The remaining 883,959 Series C shares
were issued to the limited partners that elected to take Series C shares in lieu
of cash. In January 1999, certain dissenting limited partners were paid
$516,000 and other unitholders were paid $23,000 in lieu of fractional shares.
Because of the dissenting limited partners, Enex owns 59.4% of the Series C
shares, of which 20% (258,704 shares) are considered outstanding and held by
third parties. The Series C accrues dividends at an annual rate of $0.50 per
share which are paid on March 31 and September 30 and has a $5.00 per share
liquidation value.
The cost of acquiring 100% of the outstanding limited partner units was
approximately $11.9 million, consisting of the following (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Estimated fair value of 2,177,481 shares of Company Series C
preferred stock. . . . . . . . . . . . . . . . . . . . . . $10,887
Cash consideration . . . . . . . . . . . . . . . . . . . . . 539
Legal, accounting and other expenses . . . . . . . . . . . . 431
-------
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,857
=======
</TABLE>
As Enex is consolidated into the Company's financial statements, the number
of shares outstanding and the value of the shares outstanding attributable to
the 43.8% of the Enex Partnership not owned by Enex and the minority interest
owners of Enex (20%) is 1,142,663 and $5,713,317, respectively. The cost of
acquiring the outstanding limited partner units that were not owned by Enex was
approximately $6.7 million, consisting of the following (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Estimated fair value of 1,142,663 shares of Company Series C
preferred stock. . . . . . . . . . . . . . . . . . . . . . $5,713
Cash consideration . . . . . . . . . . . . . . . . . . . . . 539
Legal, accounting and other expenses . . . . . . . . . . . . 431
------
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,683
======
</TABLE>
The Company's purchase price was allocated to the assets and liabilities of
the Enex Partnership based on estimates of the fair values with the remaining
purchase price allocated to proved oil and gas properties. The registration
costs of approximately $431,000 reduced the value of the Series C shares issued.
Because the Enex Partnership was consolidated in the financial statements of the
Company as of the effective date
F-33
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(2) ACQUISITIONS (CONTINUED)
of October 1, 1998, the purchase price allocation below shows the effect of the
acquisition on the consolidated financial statements (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Working capital. . . . . $ (539)
Oil and gas properties . (23)
Minority interest. . . . 5,844
-------
Series C Preferred Stock $5,282
=======
</TABLE>
The following pro forma data presents the results of the Company for the
nine months ended September 30, 1998, as if the acquisitions of Service, Enex
and the Enex Partnership had occurred on January 1, 1998. The pro forma results
are presented for comparative purposes only and are not necessarily indicative
of the results which would have been obtained had the acquisitions been
consummated as presented. The following data reflect pro forma adjustments for
oil and gas revenues, production costs, depreciation and depletion related to
the properties and businesses acquired, preferred stock dividends on preferred
stock issued, and the related income tax effects (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
PROFORMA
NINE MONTHS
ENDED
SEPTEMBER 30, 1998
--------------------
(UNAUDITED)
<S> <C>
Total revenues . . . . . . . . . . . . . . . $ 20,765
Net loss available to stockholders . . . . . (3,346)
Net loss per share available to stockholders (0.41)
</TABLE>
(3) COMMON STOCK, WARRANT AND SENIOR SUBORDINATED NOTE SALE TO 3TEC ENERGY
COMPANY, L.L.C. ("3TEC")
On August 27, 1999, the Company closed a Securities Purchase Agreement(the
"Agreement') for a total of $21,400,000 with 3TEC Energy Corporation, a
privately-held company ("Old 3TEC"). Contemporaneously with the closing of the
transactions contemplated by the Securities Purchase Agreement, Old 3TEC was
merged with and into 3TEC with 3TEC as the surviving entity. As a result of the
merger, all of the properties, rights, privileges, powers and franchises of Old
3TEC, including without limitation, the rights, obligations and duties of Old
3TEC under the Securities Purchase Agreement became vested in 3TEC as the
surviving entity. The Securities Purchase Agreement and contemplated
transactions were approved by the stockholders at the Company's annual meeting
on August 10, 1999.
The controlling person of 3TEC is EnCap Investments L.L.C., a Delaware
limited liability company ("EnCap Investments"). The sole member of EnCap
Investments is El Paso Field Services Company, a Delaware corporation ("El Paso
Field Services"). The controlling person of El Paso Field Services is El Paso
Energy Corporation, a Delaware corporation. The Company received $9,825,000 in
cash and oil and gas properties valued at $875,000 for 4,755,556 shares of
common stock and 3,600,000 warrants (the
F-34
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(3) COMMON STOCK, WARRANT AND SENIOR SUBORDINATED NOTE SALE TO 3TEC ENERGY
COMPANY, L.L.C. ("3TEC") (CONTINUED)
"Warrants")(See Note 7) and $10,700,000 for a 5-year senior subordinated
convertible note with a face value of $10,700,000 (the "Note").
At closing, 3TEC became the Company's largest shareholder with ownership of
approximately 36% of the outstanding common stock. If 3TEC chooses to fully
exercise the Warrants and fully convert the Note to common shares, 3TEC would
control approximately 58% of the then issued and outstanding shares of common
stock of the Company.
As part of the Agreement, at closing, five of the seven directors resigned
and all of the executive officers, except Stephen W. Herod and Robert W.
Hammons, resigned from their executive positions. A new five-member board was
formed. John J. Bassett, former president, chief executive officer and
chairman of the Company and Gary C. Christopher, continued as directors and
3TEC appointed three new board members, Floyd C. Wilson, David B. Miller and
D. Martin Phillips. Floyd C. Wilson is Managing Director and a member of
3TEC. David B. Miller and D. Martin Phillips are Managing Directors of EnCap
Investments. The Company appointed Mr. Wilson Chairman of the Board, President,
Chief Executive Officer, Secretary and Treasurer, Mr. Bassett Executive
Vice-President and Frank C. Turner II acting Chief Financial Officer.
Subsequently, Mr. Bassett resigned and Mr. Herod was named to the Board
effective September 30, 1999.
(4) ACCOUNTS RECEIVABLE-INSURANCE CLAIM
The Company owns a 100% working interest in the Louis Mayard #1 well (the
"Well") located in the Esther Field in Vermillion Parish, Louisiana. Due to a
failed recompletion attempt and the inability of the Company to shut in the Well
using normal operating methods, the Company incurred approximately $1,856,000
during 1998 to gain control of the Well using special crews. On November 4,
1998, the insurance company made a partial payment to the Company under its well
control insurance policy of approximately $1,408,000. In April, 1999 the
Company was paid $383,000 in final settlement of all claims related to the Well.
The Company had recorded the estimated remaining amount due from the insurance
company in current assets as Accounts Receivable-Insurance Claim.
(5) LONG-TERM DEBT
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1999 1998
-------------- ------------
<S> <C> <C>
Reducing revolving line of credit of up to $100,000,000 due
April 1, 2001, secured by oil and gas properties, monthly
borrowing base reductions of $250,000 effective May 1,
1999 and monthly payments of interest at Libor plus 2.00%
and prime. At September 30, 1999 the Libor and prime rates
were 5.30% and 8.25%, respectively. . . . . . . . . . . . . 28,490,567 27,454,567
Less current maturities . . . . . . . . . . . . . . . . . . . (4,314,318) --
-------------- ------------
Long-term debt excluding current maturities . . . . . . . . . $ 24,176,249 $ 27,454,567
============== ============
</TABLE>
F-35
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(5) LONG-TERM DEBT (CONTINUED)
In connection with the Enex Acquisition the Company entered into a new
reducing revolving line of credit agreement (the "$100 million Revolver"). The
$100 million Revolver is subject to semi-annual borrowing base redeterminations
which are affected by acquisitions and dispositions of assets. The borrowing
base at September 30, 1999 was $27,600,000 and monthly borrowing base reduction
requirements are $250,000.
The principal is due at maturity, April 1, 2001. Monthly principal
payments are made as required in order that the outstanding principal balance
plus outstanding letters of credit does not exceed the borrowing base. Interest
is payable monthly and is calculated at the prime rate. The Company may also
elect to calculate interest under the Libor rate, as defined in the agreement.
The Libor rate increases by (a) 2.00% if the outstanding loan balance and
letters of credit are equal to or greater than 75% of the borrowing base, (b)
1.75% if the outstanding loan balance and letters of credit are less than 75% or
greater than 50% of the borrowing base or (c) 1.50% if the outstanding loan
balance and letters of credit are equal to or less than 50% of the borrowing
base. Libor interest is payable at maturity of the Libor loan which cannot be
less than thirty days.
At September 30, 1999, the Company had borrowed $28,490,567 and had
$373,750 of outstanding letters of credit. As of September 30, 1999, the
Company is paying Libor plus 2.00% on a ninety day Libor loan for $26,505,605
and prime on $1,984,962.
Effective May 1, 1999, the borrowing base was redetermined to be
$31,000,000 with monthly borrowing base reductions of $250,000. Effective
September 1, 1999, the Company sold mortgaged properties for $2,741,000 with a
borrowing base of $2,200,000. Considering the monthly reductions and the
September property sale, the outstanding principal balance and letters of credit
exceed the borrowing base by $1,314,000 as of September 30. The property sale
closed on September 30 and the Company made a $1,900,000 principal payment on
October 1. The terms of the October 1, 1999 redetermination for the Company's
$100 million Revolver have been deferred pending execution of a definitive
agreement with Bank One (See Note 10). Pursuant to the terms of the $100
million Revolver, if the borrowing base is less than the outstanding principal
balance plus outstanding letters of credit the Company has sixty days, after
receipt of notice from the Banks, to cure the excess by prepayment, providing
additional collateral or a combination of both.
Amounts spent on debt retirement due to reductions in the borrowing base
reduce the cash available to spend on acquisition, development and exploration
activities, and accordingly, oil and natural gas revenues and operating results
may be adversely affected.
The Company paid a facility fee equal to 3/8% of the initial borrowing base
and is required to pay 3/8% on any future increase in the borrowing base within
five days of written notice. The Company is required to pay a quarterly
commitment fee on the unused portion of the borrowing base of 1/2% if the
outstanding loan balance plus letters of credit are greater than 50% of the
borrowing base or 3/8% if the outstanding loan balance plus letters of credit
are less than or equal to 50% of the borrowing base. The Company is required to
pay a letter of credit fee on the date of issuance or renewal of each letter of
credit equal to the greater of $500 or 1 1/2% of the face amount of the letter
of credit.
F-36
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(5) LONG-TERM DEBT (CONTINUED)
The Company has granted to the Banks liens on substantially all of the
Company's oil and natural gas properties, whether currently owned or hereafter
acquired, and a negative pledge on all other oil and gas properties.
The $100 million Revolver requires, among other things, a cash flow
coverage ratio of 1.25 to 1.00 and a current ratio, excluding current maturities
of the $100 million Revolver, of 0.9 to 1.00, determined on a quarterly basis.
(6) SENIOR SUBORDINATED NOTES
On August 27, 1999, senior subordinated promissory notes (the "Senior
Notes") were sold to 3TEC and affiliates of Alvin V. Shoemaker ("Shoemaker"), a
former director and significant shareholder, for $10,700,000 and $150,000,
respectively. The Senior Notes bear interest at an annual rate of 9%. Interest
is payable on December 31, 1999 and on every March 31, June 30, September 30 and
December 31, thereafter until maturity. The Company may defer payment of fifty
percent (50%) of the first eight quarterly interest payments. The Senior Notes
may be prepaid, without premium or penalty, in whole or in part, at any time
after August 27, 2001. 3TEC and Shoemaker may convert all or any portion of
outstanding principal and accrued interest at any time into shares of Company
common stock at a conversion price of $3.00 per common share, a total of
3,616,667 common shares. The conversion price may be adjusted from time to time
based on the occurrence of certain events. In the event of a change in control
(as defined in the Agreement), the entire outstanding principal balance and all
accrued but unpaid interest shall be immediately due and payable.
The Senior Notes rank senior in right of payment to all Company notes and
indebtedness other than the $100 Million Revolver.
(7) COMMON STOCK, OPTIONS AND WARRANTS
On August 27, 1999, the Company sold 3TEC 4,755,556 shares of common stock
and five-year warrants to purchase 3,600,000 shares of common stock for
$9,825,000 in cash and oil and gas properties valued at $875,000. On the same
date, the Company sold 66,666 shares of common stock and five-year warrants to
purchase 50,466 shares of common stock to Shoemaker for $150,000.
The warrants issued to 3TEC and Shoemaker are exercisable for $1.00 per
share and expire five years from the issue date. Sixty percent of the warrants
are immediately exercisable, in whole or in part at any time until the
expiration date. An additional 10% of the warrants may be exercised at each
anniversary of the grant date until expiration. On the occurrence of either a
change of control, payment in full of the Senior Notes or conversion of the
entire principal balance of the Senior Notes, all of the warrants become
immediately exercisable. If less than the entire principal balance of the
Senior Notes are converted, a pro-rata portion of the warrants will be
convertible based on the portion of the Senior Notes that are converted.
On August 24, 1999, the Company amended the 1995 Stock Option and Stock
Appreciation Rights Plan due to the change in control that resulted from the
sale of securities to 3TEC. The Plan was amended to extend the exercise date
for all options issued prior to July 1, 1999 to one year from the following
dates: (1) the termination date of employees if the termination date is without
cause and occurred during the
F-37
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(7) COMMON STOCK, OPTIONS AND WARRANTS (CONTINUED)
six-month period commencing with the closing of the Purchase Agreement; (2) the
date of termination for employees terminated for "Good Reason" as defined in
such employee's employment agreement; and (3) the date of resignation of a
holder who is also a director who resigns at closing of the Purchase Agreement.
According to APB Opinion 25, the extension of the exercise period results
in a new measurement date and compensation expense, equal to the intrinsic value
of all of the Plan's outstanding options, is recognized. A one-time charge of
$730,000 due to the Plan amendment was recorded as Compensation Expense during
the three-month period ending September 30, 1999.
On February 9, 1999 and January 13, 1998, the Board of Directors granted to
certain employees and directors, options with exercise prices of $1.50 and $5.75
per share, respectively, to acquire 200,000 and 232,000 shares of Company common
stock, respectively. All of the options were granted under the 1995 Stock
Option and Stock Appreciation Rights Plan at fair market value on date of grant
and will expire five years from date of grant if not exercised. On September
15, 1998, warrants to acquire 75,000 shares of Company common stock at an
exercise price of $5.00 were granted to a consultant as compensation. The
warrants vested over the period September 15, 1998 to January 1, 1999. The
estimated fair value of the warrants of $198,946 was determined at the date of
grant and charged to stock compensation expense over the vesting period. The
agreement was amended on August 9, 1999 to include issuing the consultant 10,000
shares of Series C Preferred Stock as additional compensation for services
performed to date. General and administrative expense was charged $50,000
during the three-month period ending September 30, 1999 for the issuance of the
10,000 Series C shares.
(8) COMMITMENTS AND CONTINGENCIES
Effective September 30, 1999, John J. Bassett, resigned as executive
vice-president and board member and ceased employment with the Company. Under
the terms of Mr. Bassett's employment agreement, the Company is obligated to
make a lump-sum payment of $280,000 to Mr. Bassett within ten days of his
resignation. The severance payment, and associated taxes of $4,060, was
recognized as severance payment expense during the quarter ending September 30.
Mr. Bassett was paid on October 10. Stephen W. Herod, Vice-President Corporate
Development, was appointed to the Board to replace Mr. Bassett.
In March 1995, the Board of Directors adopted an employee incentive
compensation plan (the "Plan") for the benefit of Company employees. The Plan
benefits are equal to one percent (1%) of the annual net profit from oil and gas
properties acquired or discovered on or after January 1, 1994 and one percent
(1%) of the annual sales proceeds from any oil and gas properties sold on or
after January 1, 1994. The Compensation Committee of the Board of Directors has
sole authority regarding the amount and timing of payment of any Plan benefits
to eligible employees.
On August 27, 1999, the Compensation Committee authorized the payment of
$274,625 to the eligible participants in the Plan. The authorized amount, equal
to 100% of the Plan benefits through August 27, 1999, was paid to the Plan
participants and the Plan was terminated pursuant to the terms of the 3TEC
Agreement. The entire amount of the payment, including associated taxes of
$17,902, was recognized as compensation expense during the quarter ending
September 30, 1999. Prior to the Compensation Committee's authorization, the
Plan benefits were not accrued as an expense in the financial statements because
F-38
<PAGE>
3TEC ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
(UNAUDITED)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
the likelihood that the Compensation Committee would determine that the benefits
would be payable to eligible employees was less than probable.
The Company is a defendant in various legal proceedings which are
considered routine litigation incidental to the Company's business, the
disposition of which management believes will not have a material effect on the
financial position or results of operations of the Company.
(9) HEDGING ACTIVITIES
In April, the Company entered into costless collar hedges for approximately
3,650 Mcf per day with a weighted average floor and ceiling of $2.06 and $2.20,
for the months of May through October of 1999. During the three month and nine
month periods ending September 30, 1999, the Company incurred hedging losses of
approximately $118,000 and $131,000, respectively.
(10) SUBSEQUENT EVENTS
On October 1, 1999 the Company executed, and subsequently amended on
October 22, a commitment letter with Bank One Texas, N.A. and Banc One Capital
Markets, Inc. ("Bank One") for a $250 million credit facility (the "Facility")
to finance the potential Floyd Oil Acquisition, subject to an initial borrowing
base of $95 million. Unless a definitive agreement is executed on or before
November 30, 1999 the $95 million commitment with Bank One will terminate. The
terms of the October 1, 1999 redetermination for the Company's $100 million
Revolver have been deferred pending execution of a definitive agreement with
Bank One.
On October 7, 1999, the Company announced that it had entered into an
agreement for the acquisition of properties and interests owned by a group of
private sellers and managed by Floyd Oil Company. There is no relationship
between Floyd C. Wilson, President of the Company, and Floyd Oil Company. The
transaction has an adjusted purchase price of approximately $96 million with an
effective date of January 1, 1999. The majority of the properties are located
in Texas and Louisiana. The properties being acquired have estimated proved
reserves at August 1, 1999 of 186,000 Mmcfe with 73% of the reserves classified
as proved developed producing. The reserves being acquired are 76% natural gas.
The Company will operate the majority of the properties. Closing is expected to
be on or before November 30, 1999 and is subject to execution of definitive
agreements and completion of due diligence. The transaction is expected to be
financed through the Bank One Facility and from working capital.
On October 19, 1999, the Company closed a private placement of securities
to The Prudential Insurance Company of America ("Prudential"). The economic
terms and conditions of the private placement are similar to those of the
Agreement with 3TEC entered into on July 1, 1999. The private placement
consisted of the sale of 1,055,042 shares of common stock and five-year warrants
to purchase 798,677 shares at $1.00 per share of common stock for $2,373,844 and
a five-year senior subordinated convertible note for $2,373,844. The
subordinated note will bear interest at a rate of 9% per annum and is
convertible into 791,281 shares of common stock.
On November 2, 1999, the operator authorized the plugging and abandonment
of the Cornelius #1 well on the Hawkins Ranch Prospect which was spudded on
September 3, 1999. The Company incurred approximately $363,000 in costs, which
were charged to dryhole expense in the current period.
F-39
<PAGE>
3TEC ENERGY CORPORATION
Nine Months ended September 30, 1999 Management's Discussion and Analysis
The following Management's Discussion and Analysis is taken directly from
the Company's Amended Quarterly Report on Form 10-QSB/A for the quarter ended
September 30, 1999. This Discussion should be read in conjunction with the
Financial statements for such period included elsewhere herein and in
conjunction with the Management's Discussion and Analysis included elsewhere in
the Proxy Statement with respect to the year ended December 31, 1998, and the
related financial statements also included elsewhere in this Proxy Statement.
MANAGEMENT'S DISCUSSION AND ANALYSIS
3Q1999 MDA-1
<PAGE>
RESULTS OF OPERATIONS
The following table reflects certain summary operating data for the periods
presented:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
SEPTEMBER 30 SEPTEMBER 30
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Production Data:
Oil and Liquids (MBbls)................................. 116 163 367 427
Natural Gas (MMcf)...................................... 982 1,031 2,778 2,713
Equivalent Production (Mcfe)............................ 1,680 2,009 4,980 5,277
Average Sales Price (1)
Oil and Liquids (per Bbl)............................... $19.10 11.35 14.66 11.91
Natural Gas (per Mcf)................................... 2.35 1.90 2.01 2.04
Average equivalent price (per Mcfe)......................... 2.69 1.90 2.20 2.02
Expenses ($ per Mcfe)
Oil and gas operating (2)............................... 0.78 0.92 0.82 0.99
General and administrative.............................. 0.66 0.49 0.61 0.61
Depreciation and depletion (3).......................... 0.85 0.95 0.79 0.93
Cash Margin ($ per Mcfe) (4)................................ 1.25 0.49 0.77 0.42
</TABLE>
- ------------------------
(1) Excludes revenue from Spivey Field gas plant.
(2) Includes lease operating costs, production and ad valorem taxes and excludes
Spivey Field plant costs.
(3) Represents depreciation and depletion, excluding impairments, of oil and gas
properties only.
(4) Represents average equivalent price per Mcfe less oil and gas operating
expenses per Mcfe and general and administrative expenses per Mcfe.
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
For the three months ended September 30, 1998, the revenues and expenses
include the Enex Acquisition and the Service Acquisition but do not include the
Enex Partnership Acquisition.
REVENUES--
Total revenues for the current period of $5,763,000 were $68,000 higher than
the comparable period. The increase in total revenues was due principally to
increases in oil and gas revenues of $695,000 and other income of $275,000,
offset partially by a $943,000 decrease in gains on sales of properties.
Oil and gas revenues increased $695,000. The increase in oil and gas
revenues consisted of a $371,000 increase in oil revenues, a $348,000 increase
in gas revenues and a $24,000 decrease in other revenues. The increase in gas
revenues included a loss on hedging of $118,000. The increase in oil and gas
revenues was the result of higher oil and gas prices. Production of oil and gas
decreased 29% and 5%, respectively while oil and gas prices increased 68% and
24%, respectively. Normal production decline and property sales contributed to
the declines in oil and gas production.
In April, the Company entered into costless collar hedges for approximately
3,650 Mcf per day with a weighted average floor and ceiling of $2.06 and $2.20,
for the months of May through October. During the current period, the Company
incurred a hedging loss of $118,000. In the current period, the realized gas
price would have been $2.47, if the hedging loss was excluded versus a realized
price of $2.35.
The Company recorded gains on the sale of properties in the current and
comparable periods of $575,000 and $1,518,000, respectively. The sale of
approximately 157 wells in 19 fields for approximately $2,741,000 to a private
company accounted for the primary portion of the gain in the current period. The
3Q1999 MDA-2
<PAGE>
effective date of the private sale was September 1. In the prior period, the
Company also sold several hundred properties at auction and in private sales for
approximately $4,140,000. In the current and comparable periods a significant
portion of the proceeds was credited against the original acquisition cost.
Other income in the current period of $469,000 includes $256,000 from a
lawsuit settlement. Other income in the comparable period includes a lawsuit
settlement of $123,000.
COSTS AND EXPENSES--
Total expenses increased $2,310,000 over the comparable period. The primary
reasons for the total expense increase were non-recurring charges of $1,307,000
associated with the sale of securities to 3TEC and the resulting change in
management control increased impairments of $1,196,000 and increased dryhole
costs of $367,000. The non-recurring charges were stock compensation expense of
$730,000, severance payment of $284,000 and employee incentive compensation plan
payment of $293,000. The stock compensation charge resulted from an amendment to
the Company's stock option plan, prior to the sale of securities to 3TEC, which
increased the length of time employees and directors could exercise their
options if they were terminated or resigned, in the case of directors, for a
certain period of time after the sale of securities to 3TEC. The severance
payment was the amount payable to John J. Bassett upon his resignation on
September 30, 1999, according to the terms of his employment agreement. The
employee incentive compensation plan payment was the result of an agreement
between 3TEC and the Company to pay the benefits due under the plan as a
condition precedent to the closing of the securities sale to 3TEC.
Lease operating expense decreased $500,000. Property sales that have closed
throughout the twelve month period ending September 30, 1999 contributed to the
lower lease operating expenses.
Geological and geophysical expenses ("G&G expenses") decreased $92,000. In
the current and comparable periods, the Company incurred approximately $47,000
and $139,000, respectively, of G&G expenses. The principal G&G expenses in the
current and comparable periods were attributable to the Cedartown Prospect and
the Sherburne Prospect, respectively.
Depletion, depreciation and amortization expenses decreased $479,000.
Reserve write-downs, property sales and lower production contributed to the
lower depletion, depreciation and amortization expenses.
Impairment expense in the current period of $1,688,000 consists of a
$472,000 impairment on the fee mineral acreage situated in Louisiana, a $27,000
impairment of various non-producing leases and a $1,189,000 impairment on
various oil and gas properties. The fee mineral impairment was the result of
6,227 unleased acres in Terrebonne Parish that are expected to revert to the
surface owners by December 1, 1999. Impairments on oil and gas properties were
incurred primarily as a result of reserve reclassifications and estimates by new
reserve engineers engaged by the Company to evaluate the Company's reserves as
of October 1, 1999. Impairment expense in the comparable period was due to the
writedown of reserves resulting from an unsuccessful recompletion attempt.
During the current period, dryhole expense increased by $367,000. In the
current and comparable periods, the Company incurred approximately $391,000 and
$24,000, respectively, of dryhole expenses. Dryhole expense attributable to the
Cornelius #1 of $363,000 was the primary dryhole expense in the current period.
The Cornelius #1 was declared a dryhole subsequent to September 30 and the
estimated costs to complete the drilling and plug and abandon the well were
accrued at September 30.
Interest expense increased $102,000. Accrued interest on the subordinated
notes since August 27, 1999 resulted in slightly higher interest expense.
Interest rates and the loan balance did not vary significantly between the
current and comparable periods.
General and administrative expenses ("G&A") increased $137,000. Increases in
salary, legal and consulting expenses in the current period offset decreases in
salary, office and rent expenses in the comparable period. The increase in
salary expense was due to employees hired subsequent to the sale of securities
to 3TEC. Legal and consulting expenses increased for various reasons. The
decrease in salary,
3Q1999 MDA-3
<PAGE>
office and rent expenses in the comparable period was due to the staff
reductions at Enex and the closing of the Enex offices in Kingwood, Texas.
Other expenses increased $272,000. Bad debt expense of $70,000 and various
other charges accounted for the increase.
OPERATING LOSS AND NET LOSS--
The Company reported an operating loss before minority interest of
$2,673,000 for current period versus an operating loss of $431,000 for the
comparable period. Due to the Enex Acquisition, the Company records a minority
interest on its income statement to remove the net income or loss attributable
to the minority interest holders of Enex (20%). In the current and comparable
periods, the minority interest increased the operating loss by $23,000 and
$154,000, respectively. The minority interest in the current period accounted
only for the Enex operations while the minority interest in the comparable
period accounted for the operations of Enex and the Enex Partnership. The Enex
Partnership was acquired by the Company effective October 1, 1998.
The Company reported an income tax benefit of $686,000 in the current period
versus a $199,000 benefit in the comparable period.
The Company reported a net loss of $2,010,000 for the current period versus
a net loss of $386,000 for the comparable period. After considering the
preferred stock dividend requirement of $143,000 in the current period versus
none in the comparable period, the Company reported a net loss attributable to
common stockholders in the current and comparable periods of $2,153,000 and
$386,000, respectively. The preferred dividends in the current period represent
three months of accrued dividends on the Series C preferred stock.
If the non-recurring charges of $1,307,000 associated with the sale of
securities to 3TEC and the resulting change in management control in the current
period were excluded, the Company would have reported net loss attributable to
common stockholders of $1,060,000 versus the actual net loss attributable to
common stockholders of $2,153,000.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
For the nine months ended September 30, 1998, the revenues and expenses
include the Enex Acquisition for the period April through September and do not
include the Enex Partnership Acquisition. The Service Acquisition is included in
the revenues and expenses for the months of May through September.
REVENUES--
Total revenues for the current period of $12,967,000 were $292,000 lower
than the comparable period. The decrease in total revenues was due principally
to a decrease in gain on sale of properties of $645,000 offset partially by
increases in other income and oil and gas revenues.
Oil and gas revenues increased $250,000. The increase in oil and gas
revenues consisted of a $292,000 increase in oil revenues, a $35,000 increase in
gas revenues and a $77,000 decrease in other revenues. The increase in gas
revenues included a loss on hedging of $131,000. The increase in oil and gas
revenues was primarily the result of higher oil prices. Oil production decreased
14% while oil prices increased 23%. The 2% increase in gas production was almost
entirely offset by the 2% lower gas prices caused by the hedging loss. Normal
production decline and property sales contributed to the reduced oil production
over the comparable period. The Enex, Service and Enex Partnership Acquisitions,
which closed subsequent to March 26, 1998, increased oil and gas production over
the comparable period.
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In April, the Company entered into costless collar hedges for approximately
3,650 Mcf per day with a weighted average floor and ceiling of $2.06 and $2.20,
for the months of May through October. During the current period, the Company
incurred a hedging loss of $131,000. In the current period, the realized gas
price would have been $2.06, if the hedging loss was excluded versus a realized
price of $2.01.
The Company recorded gains on the sale of properties in the current and
comparable periods of $882,000 and $1,527,000, respectively. The sale of
approximately 157 wells in 19 fields for approximately $2,741,000 to a private
company accounted for the primary portion of the gain in the current period. The
effective date of the private sale was September 1. In the comparable period,
the Company also sold several hundred properties at auction and in private sales
for approximately $4,495,000. In the current and comparable periods a
significant portion of the proceeds was credited against the original
acquisition cost.
Other income in the current period of $691,000 includes $256,000 from a
lawsuit settlement and $135,000 in interest income. Other income in the
comparable period includes a lawsuit settlement of $123,000.
COSTS AND EXPENSES--
Total expenses increased $413,000 over the comparable period. The primary
reason for the total expense increase was an increase in impairments, offset by
lower lease operating expenses, production taxes and plant costs ("lease
operating expenses"), geological and geophysical expenses and depletion. Certain
non-recurring charges associated with the sale of securities to 3TEC and the
resulting change in management control increased total expenses by $1,307,000.
The non-recurring charges were stock compensation expense of $730,000, severance
payment of $284,000 and employee incentive compensation plan payment of
$293,000. The stock compensation charge resulted from an amendment to the
Company's stock option plan, prior to the sale of securities to 3TEC, which
increased the length of time employees and directors could exercise their
options if they were terminated or resigned, in the case of directors, for a
certain period of time after the sale of securities to 3TEC. The severance
payment was the amount payable to John J. Bassett upon his resignation on
September 30, 1999, according to the terms of his employment agreement. The
employee incentive compensation plan payment was the result of an agreement
between 3TEC and the Company to pay the benefits under the plan as a condition
precedent to the closing of the securities sale to 3TEC.
Lease operating expense decreased $1,088,000. Property sales that have
closed throughout the twelve month period ending September 30, 1999 contributed
to the lower lease operating expenses.
Geological and geophysical expenses ("G&G expenses") decreased $739,000. In
the current and comparable periods, the Company incurred approximately $188,000
and $927,000, respectively, of G&G expenses. The principal G&G expenses in the
current and comparable periods were attributable to the Cedartown Prospect and
Hawkins Ranch Prospect, respectively.
Depletion, depreciation and amortization expenses decreased $923,000.
Reserve write-downs, property sales and lower production contributed to the
lower depletion, depreciation and amortization expenses.
Impairment expense in the current period of $1,688,000 consists of a
$472,000 impairment on the fee mineral acreage situated in Louisiana, a $27,000
impairment of various non-producing leases and a $1,189,000 impairment on
various oil and gas properties. The fee mineral impairment was the result of
6,227 unleased acres in Terrebonne Parish that are expected to revert to the
surface owners by December 1, 1999. Impairments on oil and gas properties were
incurred primarily as a result of reserve reclassifications and estimations by
new reserve engineers engaged by the Company to evaluate the Company's reserves
as of October1, 1999. Impairment expense in the comparable period was due to the
writedown of reserves resulting from an unsuccessful recompletion attempt.
During the current period, dryhole expense increased by $124,000. The
dryhole expense in the current period of $455,000 was due primarily to expenses
on the Hawkins 60 #1 of $39,000 and Cornelius #1 of $363,000. Both wells are
part of the Hawkins Ranch Prospect. The dryhole expense in the prior period of
3Q1999 MDA-5
<PAGE>
$331,000 consisted principally of a $199,000 dryhole on the S. Highbaugh
Prospect and additional dryhole expense of $102,000 on two dryholes in the
Reflection Ridge Prospect.
Interest expense increased $311,000 due to a lower average loan balance in
the first quarter of the comparable period and higher interest expense in the
current period due to the interest on the subordinated notes issued on
August 27, 1999. The loan balance was lower in the first quarter of the
comparable period compared to the second quarter of the comparable period
because the Enex Acquisition closed on March 27, 1998 and the Service
Acquisition closed on April 16, 1998. In addition, advances on the $100 Million
Revolver occurred in February and April of the current period.
General and administrative expenses ("G&A") decreased $183,000. Decreases in
several expense categories contributed to the decrease. The primary expense
decrease was due to decreases in salary, contract labor, office and rent
expenses. The staff reductions at Enex and the closing of the Enex offices in
Kingwood, Texas contributed largely to these expense reductions. Increases in
salary, legal, accounting and consulting expenses in the current period
partially offset the expense reductions. An increase in salary expense was due
to employees hired subsequent to the sale of securities to 3TEC. Legal,
accounting and consulting expenses increased for various reasons.
Other expenses increased $477,000. Bad debt expense of $170,000 and other
miscellaneous adjustments resulted in the expense increase.
OPERATING LOSS AND NET LOSS--
The Company reported an operating loss before minority interest of
$4,438,000 for current period versus an operating loss of $3,732,000 for the
comparable period. Due to the Enex Acquisition, the Company records a minority
interest on its income statement to remove the net income or loss attributable
to the minority interest holders of Enex (20%). In the current and comparable
periods, the minority interest decreased the operating loss by $40,000 and
increased the operating loss by $6,000, respectively. The minority interest in
the current period accounted only for the Enex operations while the minority
interest in the comparable period accounted for the operations of Enex and the
Enex Partnership. The Enex Partnership was acquired by the Company effective
October 1, 1998.
The Company reported an income tax benefit of $1,242,000 in the current
period versus a $1,271,000 benefit in the comparable period.
The Company reported a net loss of $3,155,000 for the current period versus
a net loss of $2,467,000 for the comparable period. After considering the
preferred stock dividend requirement of $428,000 in the current period versus
$68,000 in the comparable period, the Company reported a net loss attributable
to common stockholders in the current and comparable periods of $3,584,000 and
$2,535,000, respectively. The preferred dividends in the current period
represent nine months of accrued dividends on the Series C preferred stock. The
preferred dividend in the comparable period represents accrued dividends on the
Series A preferred stock.
If the non-recurring charges of $1,307,000 associated with the sale of
securities to 3TEC and the resulting change in management control in the current
period were excluded, the Company would have reported net loss attributable to
common stockholders of $2,469,000 versus the actual net loss attributable to
common stockholders of $3,584,000.
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
Cash flow from operating activities for the current period of $1,442,000
decreased $617,000 from the comparable period. The decrease in cash flow was due
primarily to working capital changes offset partially by lower lease operating
and geological and geophysical expenses. Cash flow from oil and gas properties
3Q1999 MDA-6
<PAGE>
(oil and gas revenues and plant income less lease operating expenses, production
taxes and plant costs) increased $1,338,000 over the comparable period. Lower
lease operating expense was the primary reason for the increased cash flow from
oil and gas properties. Increases in oil prices and gas production resulted in
higher oil and gas revenues. Oil prices increased 23%, while oil production
decreased 14%. Gas prices decreased 1%, while gas production increased 2%. The
change in working capital was caused principally by timing differences in the
payment of expenses and receipt of revenues.
Cash additions to oil and gas properties were lower than the comparable
period due primarily to less exploratory and developmental drilling in the
current period. The amount spent on acquisitions was lower due to no
acquisitions in the current period versus the Enex and Service Acquisitions that
closed in the comparable period. The Company acquired approximately 79% of Enex
common stock for cash in a tender offer that closed March 27, 1998 and acquired
the oil and gas assets of Service Drilling Co., LLC and certain affiliates for
cash and stock in a transaction that closed April 16, 1998.
During the current period, the Company was advanced $516,000 on the
$100 million Revolver to pay the dissenting limited partners in the Enex
Partnership Acquisition and $520,000 to pay for developmental drilling projects
on several of its major properties. In the comparable period, the Company
refinanced its existing debt and financed the Enex and Service Acquisitions with
proceeds from the $100 million Revolver. The Company made no principal payments
on the $100 million Revolver during the current period. In the comparable
period, the Company made principal payments, excluding refinancings, of
$5,015,000.
During the current period, the Company sold $10,850,000 of common stock,
receiving $9,975,000 in cash and $875,000 in oil and gas properties, and
$10,850,000 of subordinated notes to 3TEC and Shoemaker. No common stock or note
sales were made in the comparable period. Cash costs of $684,000 were incurred
in the sale of the securities to 3TEC and classified as Other Financing
Activities.
In the current period, the Company paid approximately $242,000 in dividends
on the Series C preferred stock issued in the Enex Partnership Acquisition. The
amount paid represents a portion of the $428,000 of dividends accrued for the
nine months ended September 30, 1999. Of the $428,000, $97,000 is attributable
to the 20% minority interest ownership in Enex. The remaining dividends were not
immediately paid in cash because of unknown addresses and non-receipt of
preferred stock issuance forms.
Net cash from operations, property sales, $100 million Revolver advances and
cash on hand were used during the period ending September 30, 1999 principally
for proved property and leasehold acquisitions, exploratory and developmental
drilling and geological and geophysical expenses. Approximately $134,000 and
$198,000 was spent on leasehold and legal costs on the Cedartown and Hawkins
Ranch Prospects, respectively. Approximately $1,329,000 was spent on exploratory
and developmental drilling and recompletions. Approximately $167,000 was spent
on abandonment costs on a field in Florida. The principal exploratory well
drilled in the current period was the Hawkins 60 #1 on the Hawkins Ranch
Prospect which was unsuccessful. The principal developmental expenditure in the
current period was a recompletion in the Murphy Lake Field for approximately
$351,000. The remaining exploratory and developmental work was throughout
several fields.
The Company had current assets of $27,883,000 and current liabilities of
$7,700,000, which resulted in working capital of $20,183,000 as of
September 30, 1999. Current period working capital increased $20,044,000 from
working capital of $139,000 as of December 31, 1998. Cash received from the sale
of securities to 3TEC and Shoemaker of $20,825,000 caused the increase in
working capital. The current maturity of long-term debt increased from
December 31, 1998 because the amount of debt outstanding increased and the
borrowing base decreased since December 31, 1998. The Company's current ratio of
8.24, calculated under the terms of the $100 million Revolver agreement, which
excludes current maturities of debt due under the $100 million Revolver, was in
excess of the 0.90 to 1.00 required.
3Q1999 MDA-7
<PAGE>
COMMON STOCK, WARRANT AND SENIOR SUBORDINATED NOTE SALE TO 3TEC ENERGY COMPANY,
L.L.C. ("3TEC")
On August 27, 1999, the Company closed a Securities Purchase Agreement(the
"Agreement') for a total of $21,400,000 with 3TEC Energy Corporation, a
privately-held company ("Old 3TEC"). Contemporaneously with the closing of the
transactions contemplated by the Securities Purchase Agreement, Old 3TEC was
merged with and into 3TEC with 3TEC as the surviving entity. As a result of the
merger, all of the properties, rights, privileges, powers and franchises of Old
3TEC, including without limitation, the rights, obligations and duties of Old
3TEC under the Securities Purchase Agreement became vested in 3TEC as the
surviving entity. The Securities Purchase Agreement and contemplated
transactions were approved by the stockholders at the Company's annual meeting
on August 10, 1999. The controlling person of 3TEC is EnCap Investments L.L.C.,
a Delaware limited liability company ("EnCap Investments"). The sole member of
EnCap Investments is El Paso Field Services Company, a Delaware corporation ("El
Paso Field Services"). The controlling person of El Paso Field Services is El
Paso Energy Corporation, a Delaware corporation. The Company received $9,825,000
in cash and oil and gas properties valued at $875,000 for 4,755,556 shares of
common stock and 3,600,000 warrants (the "Warrants") and $10,700,000 for a
5-year senior subordinated convertible note with a face value of $10,700,000
(the "Note"). The Warrants may be exercised for up to 3,600,000 shares of common
stock at an exercise price of $1 per share. Sixty percent of the Warrants may be
exercised immediately. The remaining 40% will be exercisable over a 4-year
period commencing 12 months from the closing date of the Agreement. The Note
will bear interest at a rate of 9% per annum and is convertible into 3,566,667
shares of common stock.
Simultaneous with the close of the Agreement with 3TEC, the Company sold
66,666 shares of Company common stock for $150,000 and $150,000 of 5-year senior
subordinated convertible notes to affiliates of Alvin V. Shoemaker, a former
director and significant shareholder of the Company ("Shoemaker").
At closing, 3TEC became the Company's largest shareholder with ownership of
approximately 36% of the outstanding common stock. If 3TEC chooses to fully
exercise the Warrants and fully convert the Note to common shares, 3TEC would
control approximately 58% of the then issued and outstanding shares of common
stock of the Company.
As part of the Agreement, at closing, five of the seven directors resigned
and a new five-member board was formed. John J. Bassett, former president, chief
executive officer and chairman of the Company and Gary C. Christopher, continued
as directors and 3TEC appointed three new board members, Floyd C. Wilson, David
B. Miller and D. Martin Phillips. Floyd C. Wilson is Managing Director and a
member of 3TEC. David B. Miller and D. Martin Phillips are Directors of EnCap
Investments. Subsequently, Mr. Bassett resigned and Mr. Herod was named to the
Board effective September 30, 1999.
As part of the Agreement, at closing, all of the officers of the Company,
except Stephen W. Herod and Robert W. Hammons, resigned from their executive
positions. The Company appointed Mr. Wilson Chairman of the Board, President,
Chief Executive Officer, Secretary and Treasurer, Mr. Bassett Executive
Vice-President and Frank C. Turner II acting Chief Financial Officer.
COMMITMENT FOR A $250 MILLION CREDIT FACILITY
On October 1, 1999 the Company executed, and subsequently amended on October
22, a commitment letter with Bank One Texas, N.A. and Banc One Capital
Markets, Inc. ("Bank One") for a $250 million credit facility (the "Facility")
to finance the potential Floyd Oil Acquisition, subject to an initial borrowing
base of $95 million. Unless a definitive agreement is executed on or before
November 30, 1999 the $95 million commitment with Bank One will terminate. The
terms of the October 1, 1999 redetermination for the Company's $100 million
Revolver have been deferred pending execution of a definitive agreement with
Bank One.
3Q1999 MDA-8
<PAGE>
$100 MILLION LINE OF CREDIT
In conjunction with the Enex Acquisition on March 27, 1998 the Company
entered into a $100 million reducing, revolving line of credit (the
"$100 million Revolver") with current borrowings under a term note maturing
April 1, 2001. The entire principal balance of the Company's $50 million
Convertible Loan was replaced with the $100 million Revolver.
The amount the Company can borrow is based upon the borrowing base. The
borrowing base and the monthly borrowing base reduction amounts are redetermined
semi-annually by unanimous consent of the lenders. The principal is due at
maturity, April 1, 2001. Monthly principal payments are made as required in
order that the outstanding principal balance plus outstanding letters of credit
does not exceed the borrowing base. Interest is payable monthly and is
calculated at the prime rate. The Company may elect to calculate interest under
the Libor rate, as defined in the agreement. The Libor rate increases by
(a) 2.00% if the outstanding loan balance and letters of credit are equal to or
greater than 75% of the borrowing base, (b) 1.75% if the outstanding loan
balance and letters of credit are less than 75% or greater than 50% of the
borrowing base or (c) 1.50% if the outstanding loan balance and letters of
credit are equal to or less than 50% of the borrowing base.
The borrowing base at September 30, 1999 was $27,600,000. Effective May 1,
the borrowing base was redetermined to be $31,000,000 with monthly borrowing
base reductions of $250,000. The borrowing base was reduced by $2,200,000 due to
the sale of mortgaged properties for $2,741,000 effective September 1, 1999. At
September 30, 1999 the Company had borrowed $28,491,000 and had $374,000 of
outstanding letters of credit. During the current period, the Company did not
make any principal payments and was advanced $1,036,000 under the $100 million
Revolver. The Company is currently paying Libor plus 2.00% on a ninety day Libor
loan for $26,506,000 and prime on $1,985,000.
At September 30, 1999, the outstanding principal balance and letters of
credit exceed the borrowing base by $1,314,000. The property sale closed on
September 30 and the Company made a $1,900,000 principal payment on October 1.
Pursuant to the terms of the $100 million Revolver, if the borrowing base is
less than the outstanding principal balance plus outstanding letters of credit
the Company has sixty days, after receipt of notice from the Banks, to cure the
excess by prepayment, providing additional collateral or a combination of both.
The terms of the October 1, 1999 redetermination have been deferred pending
execution of a definitive agreement on the $250 million credit facility with
Bank One.
The Company paid a facility fee equal to 3/8% of the initial borrowing base
and is required to pay 3/8% on any future increase in the borrowing base within
five days of written notice. The Company is required to pay a quarterly
commitment fee on the unused portion of the borrowing base of 1/2% if the
outstanding loan balance plus letters of credit are greater than 50% of the
borrowing base or 3/8% if the outstanding loan balance plus letters of credit
are less than or equal to 50% of the borrowing base. The Company is required to
pay a letter of credit fee on the date of issuance or renewal of each letter of
credit equal to the greater of $500 or 1 1/2% of the face amount of the letter
of credit.
The Company has granted to the Banks liens on substantially all of the
Company's oil and natural gas properties, whether currently owned or hereafter
acquired, and a negative pledge on all other oil and gas properties.
The $100 million Revolver requires, among other things, a cash flow coverage
ratio of 1.25 to 1.00 and a current ratio, excluding the current maturity of the
$100 million Revolver, of 0.9 to 1.00, determined on a quarterly basis. As of
September 30, 1999 the Company was in compliance with the cash flow and current
ratio covenants. Because the borrowing base was higher than the debt and
outstanding letters of credit during the current period, excluding the effects
of the property sale that closed on September 30, no debt payments were
required.
3Q1999 MDA-9
<PAGE>
Under the terms of the $100 million Revolver, when mortgaged properties are
sold the borrowing base shall be reduced, and if necessary, proceeds from the
sales of properties shall be applied to the debt outstanding in an amount equal
to the loan value attributable to such properties sold.
The $100 million Revolver includes other covenants prohibiting cash
dividends, distributions, loans, advances to third parties in excess of
$100,000, or sales of assets greater than 10% of the aggregate net present value
of the oil and gas properties in the borrowing base. The bank has granted the
Company a waiver allowing the Company to pay the dividends to holders of
Series C as long as no default or event of default exists or would exist as a
result of any Series C dividend payment.
SENIOR SUBORDINATED NOTES
On August 27, 1999, as part of the Agreement with 3TEC, senior subordinated
promissory notes (the "Senior Notes") were sold to 3TEC and Shoemaker for
$10,700,000 and $150,000, respectively. The Senior Notes bear interest at an
annual rate of 9%. Interest is payable on December 31, 1999 and on every
March 31, June 30, September 30 and December 31, thereafter until maturity. The
Company may defer payment of fifty percent (50%) of the first eight quarterly
interest payments. The Senior Notes may be redeemed, in whole or in part, at any
time after August 27, 2001. 3TEC and Shoemaker may convert all or any portion of
outstanding principal and accrued interest at any time into shares of Company
common stock at a conversion price of $3.00 per common share, for a total of
3,616,667 common shares. The conversion price may be adjusted from time to time
based on the occurrence of certain events. In the event of a change in control,
the entire outstanding principal balance and all accrued but unpaid interest
shall be immediately due and payable.
The Senior Notes rank senior in right of payment to all Company notes and
indebtedness other than the $100 Million Revolver.
PRIVATE PLACEMENT OF SECURITIES TO THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
On October 19, 1999, the Company closed a private placement of securities to
The Prudential Insurance Company of America ("Prudential"). The economic terms
and conditions of the private placement are similar to those of the Agreement
with 3TEC entered into on July 1, 1999. The private placement consisted of the
sale of 1,055,042 shares of common stock and five-year warrants to purchase
798,677 shares of common stock at $1.00 per share for $2,373,844 and a five-year
senior subordinated convertible note for $2,373,844. The subordinated note will
bear interest at a rate of 9% per annum and is convertible into 791,281 shares
of common stock. Prudential owns approximately 7% of the Company's currently
outstanding common stock.
PROPERTY SALES
During the nine-month period ending September 30, 1999, the Company received
approximately $3,600,000 in cash from the sales of non-strategic oil and gas
properties. The Company recorded a gain of $869,000 on the sales of the oil and
gas properties.
Subsequent to the May 1 borrowing base redetermination, the borrowing base
on the $100 Million Revolver was reduced by $2,200,000 for the loan value of the
sold properties.
FUTURE CAPITAL REQUIREMENTS AND AVAILABLE FINANCING
The Company has made and will continue to make, substantial capital
expenditures for acquisition, development and exploration of oil and natural gas
reserves. The timing of most of the Company's capital expenditures is
discretionary with no material long-term commitments. Consequently, the Company
has a significant degree of flexibility to adjust the level of such expenditures
as conditions warrant.
3Q1999 MDA-10
<PAGE>
The Company expects to spend approximately $3,400,000 on development and
exploration projects over the next twelve months, which excludes any exploration
and development projects associated with any future significant acquisitions.
The Company intends to use available cash, cash flows from operations and cash
proceeds from asset sales of certain non-core properties to fund capital
expenditures other than significant acquisitions and expects such funds to be
adequate for such purposes.
On October 7, 1999, the Company announced that it had entered into an
agreement for the acquisition of properties and interests owned by a group of
private sellers and managed by Floyd Oil Company. There is no relationship
between Floyd C. Wilson, President of the Company, and Floyd Oil Company. The
transaction has an adjusted purchase price of approximately $96 million with an
effective date of January 1, 1999. The majority of the properties are located in
Texas and Louisiana. The properties being acquired have estimated proved
reserves at August 1, 1999 of 186,000 Mmcfe with 73% of the reserves classified
as proved developed producing. The reserves being acquired are 76% natural gas.
The Company will operate the majority of the properties. Closing is expected to
be on or before November 30, 1999 and is subject to execution of definitive
agreements and completion of due diligence. The transaction is expected to be
financed through the Bank One Facility and from working capital.
Other than the Floyd Oil Acquisition, the Company does not have a specific
acquisition budget as a result of the unpredictability of the timing and size of
potential acquisition activities. The Company intends to use borrowings under
its bank credit facility, or other debt or equity financings, to the extent
available, to finance significant acquisitions. The availability and
attractiveness of these sources of financing will depend upon a number of
factors, some of which will relate to the financial condition and performance of
the Company, and some of which will be beyond the Company's control, such as
prevailing interest rates, oil and gas prices and other market conditions.
On October 17, 1999 the Company spudded a well in the Cedartown Prospect.
The Company's share of the dryhole cost is $187,000.
On November 2, 1999, the operator agreed to plug and abandon the second
exploratory well drilled on the Hawkins Ranch Prospect, the Cornelius #1, which
was spudded on September 3. The first well drilled on the Hawkins Ranch Prospect
in the first quarter of 1999 was also unsuccessful. The operator is currently
evaluating the future drilling plans on the Hawkins Ranch Prospect in light of
the results of the Cornelius #1. Prior to the results of the Cornelius #1, the
operator had scheduled the drilling of three additional exploratory wells
through February 1, 2000 with total estimated dryhole costs, net to the Company,
of approximately $885,000. The Company expects to pay approximately $300,000 in
the fourth quarter of 1999 to fund the remaining Cornelius #1 dryhole costs. As
of November 12, 1999 the Company had not committed to drill any additional wells
on the Hawkins Ranch Prospect.
At September 30, 1999, the outstanding principal balance and letters of
credit on the $100 million revolver exceeded the borrowing base by $1,314,000.
The Company paid $1,900,000 on the outstanding principal balance on October 1,
1999. The terms of the October 1, 1999 redetermination have been deferred
pending execution of a definitive agreement on the $250 million credit facility
with Bank One. If a definitive agreement on the Bank One credit facility is
executed, the outstanding principal balance on the $100 million Revolver will be
paid in full.
Amounts spent on debt retirement due to reductions in the borrowing base
reduce the cash available to spend on acquisition, development and exploration
activities and, accordingly, oil and natural gas revenues and operating results
may be adversely affected.
The Company believes that cash flow from operations, cash on hand and
available borrowings will be sufficient to fund its operations and future growth
as contemplated under its current business plan. However, if the Company's plans
or assumptions change or if its assumptions prove to be inaccurate, the Company
may be required to seek additional capital. Management cannot be assured that
the Company will be able to obtain such capital or, if such capital is
available, that the Company will be able to obtain it on acceptable terms.
3Q1999 MDA-11
<PAGE>
CURRENT ACTIVITIES
As of November 12, 1999, there was one exploratory well drilling on the
Cedartown Prospect in Lincoln Parish, Louisiana.
YEAR 2000 COMPLIANCE
Readers are cautioned that the forward-looking statements contained in the
following Year 2000 discussion should be read in conjunction with the Company's
disclosures under the heading "Forward-Looking Statements." The disclosures also
constitute a "Year 2000 Readiness Disclosure" and "Year 2000 Statement" within
the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998.
STATEMENT OF READINESS
The Company has undertaken various initiatives to ensure that its hardware,
software and equipment will function properly with respect to dates before and
after January 1, 2000. For this purpose, the phrase "hardware, software and
equipment" includes systems that are commonly thought of as Information
Technology systems ("IT"), as well as those Non-Information Technology systems
("Non-IT") and equipment which include embedded technology. IT systems include
computer hardware and software and other related systems. Non-IT systems include
certain oil and gas production and field equipment, gathering systems, office
equipment, telephone systems, security systems and other miscellaneous systems.
The Non-IT systems present the greatest readiness challenge since identification
of embedded technology is difficult and because the Company is, to a great
extent, reliant on third parties for Non-IT compliance.
The Company has formed a Year 2000 ("Y2K") Project team, which is chaired by
its Chief Financial Officer, Frank C. Turner, II. The team includes corporate
staff and representatives from the Company's business units. In response to the
possible risks posed to the Company, the team has developed a Y2K Plan (the
"Plan") which includes guidelines for inventory, assessment, remediation,
testing and contingency planning.
The following categories represent the mission-critical operational systems
of the Company. A "mission-critical system" is a system that is vital to the
successful continuation of a core business activity. An application may be
mission critical if it interfaces with a designated mission-critical system.
Each system has been evaluated by the Company as to (a) the risks to the Company
in the event of the most reasonably likely worst case scenario (the "Worst Case
Scenario"); (b) the status of the Company's remediation plan, if any ("Status");
and (c) the Company's contingency plans, if any ("Contingency Plans").
ACCOUNTING SOFTWARE SYSTEMS. The Company relies solely on certain software
accounting packages ("Accounting Packages") to provide management with various
reports that allow managers to determine the cash flow and profitability of
individual properties and of the Company as a whole. Management also relies on
the Accounting Packages to provide financial information necessary to prepare
quarterly and annual financial reports that are sent to the Securities and
Exchange Commission, NASDAQ Stock Market, banks and stockholders. In addition,
the Company relies on the Accounting Packages to process and print checks to be
sent to working and royalty interest owners for their share of the monthly oil
and gas sales, to process and print checks for payment to vendors and to process
and print monthly joint-interest statements to be sent to working interest
owners in Company-operated oil and gas properties. Under a Worst Case Scenario,
all accounting functions would have to be completed manually, significantly
hindering the Company's ability to complete the above-described mission-critical
tasks.
Status: The Company has updated its accounting systems. Testing was completed
on June 30, 1999 and all primary functions utilizing dates functioned
properly.
Contingency Plans: Based on the results of the independent testing of the
Accounting Software System, the Y2K Team believes the risk of the
Accounting Software System being adversely affected by Y2K is remote. If
the Accounting Software System is adversely affected by Y2K, the Company
3Q1999 MDA-12
<PAGE>
has developed various contingency plans which include the utilization of
support personnel and the performance of manual tasks.
CONTROL SYSTEMS AND IMBEDDED TECHNOLOGY. These systems include the
equipment used to produce, monitor, control, sell and record hydrocarbon
production, including all artificial lift equipment, storage, measurement and
control facilities and third-party systems and technology interrelated to the
Company's business. Under a Worst Case Scenario, multiple fields of oil and gas
would lose the ability to account for or produce the amount of hydrocarbon
production, temporarily shutting down the field(s) until the malfunctioning
part(s) could be repaired or replaced. This is not expected to materially
adversely affect the Company.
Status: The only mission-critical field operated by the Company is the Spivey
Field, whose production operations are not affected by Y2K issues. The
Spivey Field is affected by a third-party operated gas plant that
processes the field's natural gas and may be subject to Y2K issues.
Refer to "Third Party Systems-Gas Plant" for a discussion of the gas
plant at the Spivey Field. The operations of the remaining fields were
not materially affected by Y2K issues.
Contingency Plans: The Company will continue to monitor the operations at its
field locations and develop contingency planning if an exposure becomes
apparent.
THIRD-PARTY SYSTEMS--OIL AND GAS PURCHASERS. The Company utilizes
third-party purchasers to sell the oil and gas produced from the wells in which
it has a working or royalty interest. The Company also depends on third-party
purchasers to remit to the Company its share of the proceeds from the sales of
oil and gas. The Company does not directly sell any oil and gas produced from
the wells in which it has a working or royalty interest and does not take any
oil or gas in kind as an alternative to cash payment. Under a Worst Case
Scenario, multiple major purchasers would be temporarily shut down due to Y2K
issues, materially adversely affecting the Company's revenues.
Status: Based upon the diversity of purchasers, the Company believes that no
single purchaser is a mission-critical purchaser. The Y2K team does not
anticipate that a problem with any single purchaser for a reasonable
period of time beyond 2000 will force the Company to curtail or shut
down its operations. Although no single purchaser is a mission-critical
purchaser, the loss of a major purchaser or multiple minor purchasers
due to Y2K problems would affect the Company. The Company has obtained
information about the top ten purchasers and their Y2K readiness. All
but two of the top ten purchasers have formal Y2K Plans and are working
to upgrade any mission-critical systems that are affected by Y2K. The
other two purchasers acknowledge that certain systems will be affected
by Y2K and have been undertaking plans to upgrade these systems.
Contingency Plans: The Company continues to monitor the Y2K status of its major
purchasers. Should a purchaser not become Y2K compliant, the Company
will identify alternative purchasers for its production and, if
necessary, temporarily shut-in production.
THIRD-PARTY SYSTEMS--GAS PLANT. Over 95% of the gas produced in the Spivey
Field, a mission-critical system, is sold to a gas plant under a life of the
lease casinghead tailgate gas contract. The Company owns approximately 11.5% of
the gas plant and related gathering system. Colt Resources Corporation operates
the plant. Under a Worst Case Scenario, the gas plant would be shut down less
than one month which would not materially adversely affect the Company.
Status: The Company has received a letter from the operator of the Spivey plant
stating that the Spivey plant's control systems and embedded technology
are not Y2K affected and that its accounting and processing systems are
Y2K compliant.
Contingency Plans: A short-term interruption of gas sales would not materially
affect the Company's operations. If the Spivey plant experiences
problems with an expected duration in excess of one month, the Company
has identified alternative gas markets it could utilize.
3Q1999 MDA-13
<PAGE>
THIRD-PARTY SYSTEMS--BANKING. The Company relies on its banks to deposit
checks payable to the Company and credit the checks to the appropriate accounts.
The Company also relies on its banks to credit third-party accounts for payment.
A Worst Case Scenario would occur if the Company's principal bank is unable to
provide certain services for an extended period of time due to Y2K, causing the
Company to be materially adversely affected.
Status: The Company's principal bank has represented that it has a formal Y2K
Plan in effect and has substantially remediated and tested all of its
non-compliant, in-house and vendor-supported mission-critical systems
as of June 30, 1999.
Contingency Plans: The Company intends to have cash on hand sufficient to cover
short-term emergency payments and payroll. The Company also plans to
open accounts with other institutions in the event its principal bank is
unable to rectify its problems in a timely manner. The Company has no
long-term contingency plans in the event of a system-wide failure of
banking institutions.
THIRD-PARTY SYSTEMS--SUPPORT FUNCTIONS. The primary material support
functions provided by third parties are electrical service, communication
service and office space. Under a Worst Case Scenario, all primary support
functions would be hindered in the short term.
Status: All vendors of these services have reported that formal Y2K remediation
plans are in effect and are substantially complete as of September 30,
1999.
Contingency Plans: Short-term (less than two weeks) interruptions of services
will not materially adversely affect the Company. The Company will be
able to conduct business on a reduced scale using alternative business
methods. Longer-term interruptions may materially adversely affect the
Company. The Company has no plans sufficient to fully offset the effect
of long-term interruptions.
COMPUTER OPERATING SYSTEMS AND APPLICATION SOFTWARE SYSTEMS. The Company
relies solely on its personal computer systems to access the accounting software
package through the Company's computer network. In addition, certain schedules
and databases that are used for critical functions rely on spreadsheet and
word-processing applications that are run on the Company's personal computer
systems.
Status: All systems appear to be Y2K ready.
Contingency Plans: Operations could be performed manually until non-functioning
equipment or software is repaired or replaced
COSTS OF Y2K COMPLIANCE
The costs incurred by the Company to implement the Plan were not material to
the Company's financial condition or results of operations. The Company does not
expect any future costs related to the Plan to be material to the Company's
financial condition or results of operations.
THE RISKS OF Y2K ISSUES
The Company presently believes that Y2K issues will not pose significant
operational problems. However, if all significant Y2K issues are not properly
identified or assessed, remediation and testing are not effected timely, the Y2K
issues, either individually or in combination, may materially and adversely
impact the Company's results of operations, liquidity and financial condition or
materially and adversely affect its relationships with its business partners.
Additionally, the misrepresentation of compliance by other entities or the
persistent, universal failure of financial, transportation or other economic
systems will likely have a material and adverse impact on the Company's
operations or financial condition for which it cannot adequately prepare.
3Q1999 MDA-14
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
3TEC Energy Corporation:
We have audited the accompanying statements of revenues and direct
operating expenses for the years ended December 31, 1998 and 1997, for the
Acquired Properties (as described in Note 1). These financial statements are the
responsibility of 3TEC Energy Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The accompanying statements were prepared as described in Note 2 for the
purpose of complying with certain rules and regulations of the Securities and
Exchange Commission ("SEC") for inclusion in certain SEC regulatory reports and
filings and are not intended to be a complete financial presentation.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the revenues and direct operating expenses of the
Acquired Properties for the years ended December 31, 1998 and 1997, in
conformity with generally accepted accounting principles.
Houston, Texas Arthur Andersen LLP
December 13, 1999
F-40
<PAGE>
<TABLE>
<CAPTION>
ACQUIRED PROPERTIES
Statements of Revenues and Direct Operating Expenses
(In thousands)
Unaudited
---------
Years Ended Nine Months Ended
December 31, September 30,
---------------- ----------------
1997 1998 1998 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Oil revenues . . . . . . . $17,713 $10,520 $ 8,349 $ 8,558
Gas revenues . . . . . . . 29,458 22,790 17,855 17,563
Plant product revenues . . 1,391 757 610 652
------- ------- ------- -------
48,562 34,067 26,814 26,773
------- ------- ------- -------
Direct operating expenses:
Lease operating expenses . 12,466 12,748 9,624 8,861
Production taxes . . . . . 2,673 1,869 1,507 1,390
------- ------- ------- -------
Direct operating expenses. 15,139 14,617 11,131 10,251
------- ------- ------- -------
Revenues in excess of direct
operating expenses . . . . $33,423 $19,450 $15,683 $16,522
======= ======= ======= =======
</TABLE>
See accompanying notes.
F-41
<PAGE>
ACQUIRED PROPERTIES
Notes to Statements of Revenues and Direct Operating Expenses
1. The Properties
On November 23, 1999, 3TEC Energy Corporation ("3TEC Energy"), formerly
known as Middle Bay Oil Company, Inc., acquired certain oil and gas properties
and interests (the "Acquired Properties") from Floyd Oil Company ("Floyd") and
certain partnerships and other entities managed or sponsored by Floyd
(collectively, the "Sellers") for a purchase price of approximately $87 million
in cash and 1.5 million shares of 3TEC Energy's common stock. The effective
date of the transaction was January 1, 1999. The majority of the Acquired
Properties are located in Texas and Louisiana.
2. Basis of Presentation
During the periods presented, the Acquired Properties were not accounted
for or operated as a separate division by Floyd. Information with respect to
depreciation, depletion and amortization is not available for the Acquired
Properties. General and administrative expenses incurred by Floyd were not
allocated to the Acquired Properties. The Sellers were not taxpaying entities
and, therefore, income tax information with respect to the Acquired Properties
is not available. Accordingly, full separate financial statements prepared in
accordance with generally accepted accounting principles do not exist and are
not practicable to obtain in these circumstances.
Revenues and direct operating expenses included in the accompanying
statements represent the Sellers' net working and royalty interests in the
Acquired Properties and are presented on the accrual basis of accounting.
Depreciation, depletion, and amortization, allocated general and administrative
expenses and income tax expense have been excluded.
The statements presented are not indicative of the future results of
operations of the Acquired Properties due to anticipated changes in various
operating expenses and the omission of other costs as discussed above.
3. Commitments and Contingencies
The management of 3TEC Energy is not aware of any legal, environmental or
other commitments or contingencies that would be materially important in
relation to the revenues and direct operating expenses of the Acquired
Properties.
4. Related Party Transactions
An affiliate of Floyd operated certain oil and gas wells included in the
Acquired Properties. Fees related to such wells in the amount of $442,600 and
$460,000 were charged to the Acquired Properties during the years ended December
31, 1997 and 1998, respectively, and $345,600 and $353,700 for the nine month
periods ended September 30, 1998 and 1999, respectively. These fees are
reflected in direct operating expenses in the accompanying statements.
F-42
<PAGE>
5. Capital Expenditures (Unaudited)
Direct operating expenses do not include exploration and development
expenditures related to the Acquired Properties which totaled $4.3 million and
$4.1 million for the years ended December 31, 1997 and 1998, respectively and
$2.9 million and $2.6 million for the nine month periods ended September 30,
1998 and 1999, respectively.
6. Supplemental Oil and Gas Reserve Information (Unaudited)
Total proved and proved developed oil and gas reserves of the Acquired
Properties at December 31, 1998 have been estimated based on reserve estimates
prepared by Ryder Scott Company Petroleum Engineers as of September 30, 1999,
adjusted for production from September 30, 1999 to December 31, 1998. Comparable
estimates were not readily available for subsequent or prior periods. Therefore,
reserves for December 31, 1997 and 1998 have been calculated by adjusting the
September 30, 1999 amounts for the respective period's activities and,
consequently, no revisions of previous estimates have been reflected. All
reserve estimates are based on economic and operating conditions existing at
September 30, 1999. The future net cash flows from production of these proved
reserve quantities were computed by applying current prices of oil and gas,
averaging $22.44 per barrel of oil and $2.75 per thousand cubic foot of gas
(with consideration of price changes only to the extent provided by contractual
arrangements) as of September 30, 1999 to estimated future production of proved
oil and gas reserves less the estimated future expenditures (based on current
costs) as of September 30, 1999, to be incurred in developing and producing the
proved reserves. As discussed above, income tax information for the Acquired
Properties is not available and therefore is not presented.
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------- Nine Months Ended
1997 1998 September 30, 1999
--------------- ---------------- ----------------
Oil Gas Oil Gas Oil Gas
(Mbbl) (MMcf) (Mbbl) (MMcf) (Mbbl) (MMcf)
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Proved reserves:
Beginning of year. . . . 9,244 162,669 8,321 151,175 7,470 140,194
Production . . . . . . . (923) (11,494) (851) (10,981) (565) (8,078)
------ -------- ------ -------- ------ --------
End of period. . . . . . 8,321 151,175 7,470 140,194 6,905 132,116
====== ======== ====== ======== ====== ========
Proved developed reserves:
Beginning of year. . . . 8,794 125,396 7,871 113,902 7,020 102,921
====== ======== ====== ======== ====== ========
End of period. . . . . . 7,871 113,902 7,020 102,921 6,455 94,843
====== ======== ====== ======== ====== ========
</TABLE>
F-43
<PAGE>
6. Supplemental Oil and Gas Reserve Information (Unaudited) (Continued)
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved
Reserves as of September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Future cash inflows . . . . . . . . . . . $ 471,417
Future production costs . . . . . . . . . (124,753)
Future development costs. . . . . . . . . (22,060)
----------
Future net inflows before income taxes. . 324,604
10% discount factor . . . . . . . . . . . (153,809)
----------
Standardized measure of discounted future
net cash flows before income taxes. . . $ 170,795
==========
</TABLE>
Changes to Standardized Measure of Discounted Future Net Cash Flows
Relating to Proved Reserves for the Nine Month Period Ended September 30, 1999
(in thousands):
<TABLE>
<CAPTION>
<S> <C>
Standardized measure, beginning of year. $175,609
Sales, net of production costs . . . . (16,522)
Net change in future development costs 2,612
Accretion of discount. . . . . . . . . 9,096
---------
Standardized measure, end of period. . . $170,795
=========
</TABLE>
F-44
<PAGE>
3TEC ENERGY CORPORATION
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
The unaudited pro forma condensed consolidated balance sheet of the Company
as of September 30, 1999 gives effect to the Purchase of the Acquired Properties
(the Purchase) as if it occurred on September 30, 1999. The unaudited pro forma
condensed consolidated statements of operations of the Company for the nine
months ended September 30, 1999 and the year ended December 31, 1998 give effect
to the Purchase as if it had occurred at the beginning of the periods presented.
The unaudited pro forma condensed consolidated financial statements have also
been prepared to give effect to the issuance of 1,055,042 shares of common stock
and warrants to purchase 798,677 shares of Common Stock for an aggregate
purchase price of $2,373,844 and the issuance of a senior convertible
subordinated note for $2,373,844 under a securities purchase agreement between
The Prudential Insurance Company of America (Prudential) and 3TEC Energy
Corporation (3TEC) on October 19, 1999, as if it had occurred on September 30,
1999 and at the beginning of the periods presented. These unaudited pro forma
condensed consolidated statements of operations also give effect to the August
27, 1999 issuance of 4,755,556 shares of common stock and warrants to purchase
3,600,000 shares of Common Stock for an aggregate purchase price of $10,700,000
and the issuance of a senior convertible subordinated notes for $10,700,000
under the securities purchase agreement with 3TEC Energy Company L.L.C. (3TEC)
as if it had occurred at the beginning of the periods presented. The Prudential
and 3TEC transactions are included in the pro forma condensed consolidated
financial statements as the transactions provided a significant portion of the
financing for the Purchase of the Acquired Properties.
The following unaudited pro forma financial data have been included as
required by the rules of the SEC and are provided for comparative purposes only.
The unaudited pro forma financial data presented are based upon the historical
consolidated financial statements of 3TEC and the historical statements of
revenues and direct operating expenses of the Acquired Properties and should be
read in conjunction with such financial statements and the related notes thereto
which are incorporated herein by reference.
The pro forma financial data are based upon assumptions and include
adjustments as explained in the notes to the unaudited pro forma condensed
consolidated financial statements, and the actual recording of the transactions
could differ. The unaudited pro forma financial data are not necessarily
indicative of the financial results that would have occurred had the Purchase
been effective on and as of the dates indicated and should not be viewed as
indicative of operations in future periods.
F-45
<PAGE>
<TABLE>
<CAPTION>
3TEC ENERGY CORPORATION
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
September 30, 1999
PRO FORMA
3TEC COMBINED PRO FORMA
CONSOLIDATED ADJUSTMENTS COMBINED
---------------------------------- -------------
<S> <C> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents. . . . . . . . . . . . . $ 25,076,465 $ 4,747,688 (A)
(27,032,778)(C) $ 2,791,375
Accounts receivable. . . . . . . . . . . . . . . . 2,716,165 0 2,716,165
Other current assets . . . . . . . . . . . . . . . 90,567 0 90,567
---------------------------------- -------------
Total Current Assets. . . . . . . . . . . . . 27,883,197 (22,285,090) 5,598,107
Property and equipment (at cost)
Oil and gas properties (successful efforts method) 80,659,521 94,918,548 (B) 175,578,069
Other. . . . . . . . . . . . . . . . . . . . . . . 988,579 85,000 (B) 1,073,579
---------------------------------- -------------
81,648,100 95,003,548 176,651,648
Accumulated depletion, depreciation, and amortization . (35,425,362) 0 (35,425,362)
---------------------------------- -------------
46,222,738 95,003,548 141,226,286
Other assets. . . . . . . . . . . . . . . . . . . . . . 637,875 531,250 (B)
(87,045) (C) 1,082,080
---------------------------------- -------------
Total Assets. . . . . . . . . . . . . . . . . . . . . . $ 74,743,810 $ 73,162,663 $147,906,473
================================== =============
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities
Current maturity of long-term debt . . . . . . . . $ 4,314,318 $(4,314,318) (C) $ 0
Accounts payable - trade . . . . . . . . . . . . . 2,822,415 0 2,822,415
Accounts payable - revenue . . . . . . . . . . . . 362,065 0 362,065
Other current liabilities. . . . . . . . . . . . . 200,806 0 200,806
---------------------------------- -------------
Total current liabilities . . . . . . . . . . . . . . . 7,699,604 (4,314,318) 3,385,286
Long-term debt. . . . . . . . . . . . . . . . . . . . . 24,176,249 65,823,751 (C) 90,000,000
Convertible subordinated notes. . . . . . . . . . . . . 10,850,000 2,373,844 (A) 13,223,844
Deferred income taxes . . . . . . . . . . . . . . . . . 486,353 (30,466) (C) 455,887
Other liabilities . . . . . . . . . . . . . . . . . . . 304,404 0 304,404
Minority Interest . . . . . . . . . . . . . . . . . . . 1,014,155 0 1,014,155
Stockholders' equity
Convertible preferred stock (Series B) . . . . . . 3,627,000 0 3,627,000
Convertible preferred stock (Series C) . . . . . . 5,235,083 0 5,235,083
Common stock, $.02 par value, issued 13,383,005. . 267,692 21,101 (A)
shares (historical) and 15,948,325 (pro forma). . . . . 30,206 (C) 318,999
Paid-in-capital. . . . . . . . . . . . . . . . . . 48,137,005 6,962,381 (C)
2,352,743 (A) 57,452,129
Accumulated deficit. . . . . . . . . . . . . . . . (26,985,695) (56,579) (C) (27,042,274)
Less cost of treasury stock, 21,773 shares . . . . (68,040) 0 (68,040)
---------------------------------- ------------
Total stockholders' equity. . . . . . . . . . . . . . . 30,213,045 9,309,852 39,522,897
---------------------------------- -------------
Total Liabilities and Stockholders' Equity. . . . . . . $ 74,743,810 $ 73,162,663 $147,906,473
================================== =============
</TABLE>
Note: Accompanying Notes are an integral part of these statements.
F-46
<PAGE>
<TABLE>
<CAPTION>
3 TEC ENERGY CORPORATION
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
Year Ended December 31, 1998
3TEC ACQUIRED COMBINED PRO FORMA
CONSOLIDATED PROPERTIES ADJUSTMENTS COMBINED
------------------------------------------------ ------------
<S> <C> <C> <C> <C>
Revenues
Oil and gas sales and plant income. . . . . . . . . $15,011,354 $ 34,067,434 (D) $ 0 $49,078,788
Gain on sale of properties. . . . . . . . . . . . . 1,953,362 0 0 1,953,362
Delay rental and lease bonus income . . . . . . . . 217,404 0 0 217,404
Other. . . . . . . . . . . . . . . . . . . . . . . . 520,458 0 0 520,458
------------------------------------------------ ------------
Total Revenues . . . . . . . . . . . . . . . . . . . . . 17,702,578 34,067,434 0 51,770,012
Costs and Expenses
Lease operating, production taxes
and plant costs . . . . . . . . . . . . . . . . . . 7,801,249 14,617,417 (D) (681,000)(E) 21,737,666
Geological and geophysical. . . . . . . . . . . . . 877,643 0 0 877,643
Depreciation, depletion and amortization. . . . . . 7,116,116 0 7,908,630 (F) 15,024,746
Impairments . . . . . . . . . . . . . . . . . . . . 4,164,184 0 0 4,164,184
Dry-hole. . . . . . . . . . . . . . . . . . . . . . 503,444 0 0 503,444
Interest. . . . . . . . . . . . . . . . . . . . . . 1,971,595 0 6,580,420 (G) 8,552,015
Stock compensation. . . . . . . . . . . . . . . . . 266,445 0 0 266,445
General and administrative. . . . . . . . . . . . . 4,266,727 0 2,135,613 (H) 6,402,340
Other . . . . . . . . . . . . . . . . . . . . . . . 138,855 0 0 138,855
------------------------------------------------ ------------
Total Costs and Expenses . . . . . . . . . . . . . . . . 27,106,258 14,617,417 15,943,663 57,667,338
Income (loss) before income taxes and minority interest. (9,403,680) 19,450,017 (15,943,663) (5,897,326)
Minority interest. . . . . . . . . . . . . . . . . . . . 15,089 0 0 15,089
Provision for income taxes (benefit) . . . . . . . . . . (2,829,762) 0 1,192,160 (I) (1,637,602)
Net income (loss). . . . . . . . . . . . . . . . . . . . (6,589,007) 19,450,017 (17,135,823) (4,274,813)
------------------------------------------------ ------------
Dividends to Preferred Stockholders. . . . . . . . . . . 67,945 0 0 67,945
------------------------------------------------ ------------
Net income (loss) applicable to common stockholders . . $(6,656,952) $ 19,450,017 $(17,135,823) $(4,342,758)
Net income (loss) per share-Basic. . . . . . . . . . . . $ (0.83) $ (0.28)
================================================ ============
Net income (loss) per share-Diluted. . . . . . . . . . . $ (0.83) $ (0.28)
Weighted average common shares outstanding
Basic . . . . . . . . . . . . . . . . . . . . . . . 8,050,108 7,388,092 (J) 15,438,200
Diluted . . . . . . . . . . . . . . . . . . . . . . 8,050,108 7,388,092 (K) 15,438,200
</TABLE>
F-47
<PAGE>
<TABLE>
<CAPTION>
3 TEC ENERGY CORPORATION
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
Nine Months Ended September 30, 1999
PRO FORMA
3TEC ACQUIRED COMBINED PRO FORMA
CONSOLIDATED PROPERTIES ADJUSTMENTS COMBINED
----------------------------- ----------------- ------------
<S> <C> <C> <C> <C>
Revenues
Oil and gas sales and plant income. . . . . . . . . $11,328,502 $26,772,564 (D) $ 0.00 $38,101,066
Gain on sale of properties. . . . . . . . . . . . . 882,477 0 0 882,477
Delay rental and lease bonus income . . . . . . . . 64,911 0 0 64,911
Other . . . . . . . . . . . . . . . . . . . . . . . 691,442 0 0 691,442
----------------------------- ----------------- ------------
Total Revenues . . . . . . . . . . . . . . . . . . . . . 12,967,332 26,772,564 0 39,739,896
Costs and Expenses
Lease operating, production taxes
and plant costs . . . . . . . . . . . . . . . . . 4,450,843 10,251,016 (D) (530,000) (E) 14,171,859
Geological and geophysical. . . . . . . . . . . . . 188,484 0 0 188,484
Depreciation, depletion and amortization. . . . . . 4,046,546 0 5,607,811 (F) 9,654,357
Impairments . . . . . . . . . . . . . . . . . . . . 1,688,443 0 0 1,688,443
Dry-hole. . . . . . . . . . . . . . . . . . . . . . 455,108 0 0 455,108
Interest. . . . . . . . . . . . . . . . . . . . . . 1,739,362 0 3,484,787 (G) 5,224,149
Stock compensation. . . . . . . . . . . . . . . . . 729,938 0 0 729,938
Severance payment . . . . . . . . . . . . . . . . . 284,060 0 0 284,060
Compensation plan payment . . . . . . . . . . . . . 292,527 0 0 292,527
General and administrative. . . . . . . . . . . . . 3,048,430 0 1,483,252 (H) 4,531,682
Other . . . . . . . . . . . . . . . . . . . . . . . 481,622 0 0 481,622
----------------------------- ----------------- ------------
Total Costs and Expenses . . . . . . . . . . . . . . . . 17,405,363 10,251,016 10,045,850 37,702,229
Income (loss) before income taxes and minority interest. (4,438,031) 16,521,548 (10,045,850) 2,037,667
Minority interest. . . . . . . . . . . . . . . . . . . . (40,228) 0 0 (40,228)
Provision for income taxes (benefit) . . . . . . . . . . (1,242,324) 0 2,201,737 (I) 959,413
----------------------------- ----------------- ------------
Net income (loss). . . . . . . . . . . . . . . . . . . . (3,155,479) 16,521,548 (12,247,587) 1,118,482
Dividends to Preferred Stockholders. . . . . . . . . . . 428,509 0 0 428,509
----------------------------- ----------------- ------------
Net income (loss) applicable to common stockholders. . . $(3,583,988) $16,521,548 $(12,247,587) $ 689,973
============================= ================= ============
Net income (loss) per share-Basic. . . . . . . . . . . . $ (0.39) $ 0.04
Net income (loss) per share-Diluted. . . . . . . . . . . $ (0.39) $ 0.04
Weighted average common shares outstanding
Basic . . . . . . . . . . . . . . . . . . . . . . . 9,137,784 6,782,566 (J) 15,920,350
Diluted . . . . . . . . . . . . . . . . . . . . . . 9,137,784 8,824,317 (K) 17,962,101
</TABLE>
F-48
<PAGE>
3TEC ENERGY CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
F-49
<PAGE>
(A) To record the issuance of 1,055,042 shares of common stock and 798,677
warrants for an aggregate purchase price of $2,373,844 and the issuance
of a senior convertible subordinated note for $2,373,844 under a
securities purchase agreement to The Prudential Insurance Company of
America (Prudential) to provide partial financing for the acquisition.
(B) To record the purchase of the Acquired Properties and other assets
pursuant to the transaction. The allocation of the purchase price
using the purchase method of accounting is presented below. The
allocation of the purchase price is preliminary and, therefore subject
to change. Any future adjustments to the allocation of the purchase
price are not anticipated to be material to the unaudited pro forma
financial statements.
<TABLE>
<CAPTION>
The purchase price entries are as follows:
<S> <C>
Purchase price. . . . . . . . . . . . . . . . . . . . . . . . . . . . $96,916,453
Estimated purchase price adjustments, including distributions of cash
flows from the Acquired Properties from the effective date to the
closing date of November 30, 1999 . . . . . . . . . . . . . . . . . (3,080,905)
Deferred financing costs. . . . . . . . . . . . . . . . . . . . . . . 531,250
Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,168,000
------------
Total purchase price. . . . . . . . . . . . . . . . . . . . . . . . . $95,534,798
============
Purchase price allocation:
Acquisition costs allocated to oil and gas properties . . . . . . . $94,918,548
Deferred debt costs . . . . . . . . . . . . . . . . . . . . . . . . 531,250
Furniture and fixtures. . . . . . . . . . . . . . . . . . . . . . . 85,000
------------
Total purchase allocation . . . . . . . . . . . . . . . . . . . . . $95,534,798
============
</TABLE>
(C) To record the effect of borrowings of $90,000,000 under 3TEC's $250
million Restated Credit Agreement, issuance of 1,510,278 shares of
common stock, valued at $6,992,587, or $4.63 per share, and use of
existing cash to finance the Purchase and repay the outstanding
borrowing of $28,490,567 under 3TEC's former revolving line of credit.
In addition, to record the bank facility fee associated with 3TEC's $250
million Restated Credit Agreement, and eliminate $87,045 ($56,579, net
of $30,466 of tax) of net deferred debt costs associated with 3TEC's
former revolving line of credit.
(D) To record the revenues and direct operating expenses related to the
Acquired Properties.
(E) To eliminated overhead charges that will no longer be incurred on a
portion of the acquired properties, as such will be operated by 3TEC and
its subsidiaries.
(F) To adjust depletion, depreciation and amortization to give effect to the
purchase price allocated to the Acquired Properties using the unit of
production method under the successful efforts method of accounting.
(G) To record the net increase in interest expense (at 9.24% and 7.27% for
the year ended December 31, 1998 and the period ended September 30,
1999, respectively) and amortization of deferred financing costs
relating to the borrowings under 3TEC's $250 million Restated Credit
Agreement, and to record interest expense on convertible subordinated
notes issued to EnCap Investments L.L.C. (EnCap) and Prudential of
$1,190,146 and $800,384 for the year ended December 31, 1998 and the
period ended September 30, 1999 respectively.
(H) To record additional general and administrative expenses relating to
additional costs anticipated to be incurred due to contractual
obligations incurred in completing the Purchase.
(I) To record income tax expense on the pro forma adjustments based on
3TEC's statutory tax rate of 34%.
(J) To reflect the impact on basic weighted average common shares
outstanding of 1,510,278 shares of 3TEC common stock issued for the
Acquired Properties, 1,055,042 shares of 3TEC common stock issued to
Prudential under the securities purchase agreement, and 4,822,772 shares
of 3TEC common stock issued to EnCap.
F-50
<PAGE>
3TEC ENERGY CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
(K) To reflect the impact on diluted weighted average common shares
outstanding of 1,510,278 shares of 3TEC common stock issued for the
Acquired Properties, 1,055,042 shares of 3TEC common stock issued to
Prudential under the securities purchase agreement, and 4,822,772 shares
of 3TEC common stock issued to EnCap, for the nine months ended
September 30, 1999. The weighted average common stock equivalents were
not included in 3TEC's diluted weighted average common shares
outstanding for the year ended December 31, 1998, because their effect
would have been antidilutive.
F-51
<PAGE>
3TEC ENERGY CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
UNAUDITED PRO FORMA SUPPLEMENTAL OIL AND GAS DISCLOSURE
The following tables set forth certain unaudited pro forma information
concerning 3TEC's proved oil and gas reserves at September 30, 1999, giving
effect to the acquisition of the Acquired Properties as if they had occurred on
January 1, 1998. There are numerous uncertainties inherent in estimating the
quantities of proved reserves and projecting future rates of production and
timing of development expenditures. The following reserve data represent
estimates only and should not be construed as being exact. The proved oil and
gas reserve information is as of September 30, 1999 and reflects prices and
costs in effect as of such date.
RESERVES:
<TABLE>
<CAPTION>
OIL AND CONDENSATE (MBBLS) NATURAL GAS (MMCF)
------------------------------ ----------------------------------
ACQUIRED ACQUIRED
3TEC PROPERTIES PRO FORMA 3TEC PROPERTIES PRO FORMA
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1998 . . . 3,342 7,470 10,812 43,483 140,194 183,677
Extensions and discoveries . . 13 13 1,286 1,286
Purchase of minerals in-place. 97 97 38 38
Revision of previous estimates 319 319 (4,981) (4,981)
Production . . . . . . . . . . (369) (565) (934) (2,778) (8,078) (10,856)
Sales of minerals in-place . . (355) (355) (1,693) (1,693)
------ ----------- --------- ---------- ---------- ----------
Balance at September 30, 1999. 3,047 6,905 9,952 35,355 132,116 167,471
====== =========== ========= ========== ========== ==========
Proved developed reserves. . . 3,040 6,455 9,495 31,034 94,843 125,877
====== =========== ========= ========== ========== ==========
</TABLE>
STANDARD MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL &
GAS RESERVES:
<TABLE>
<CAPTION>
ACQUIRED
3TEC PROPERTIES PRO FORMA
(IN THOUSANDS)
---------------------------------------
<S> <C> <C> <C>
Future cash inflows. . . . . . . . . . . . . . . . . . . $163,124 $ 471,417 $ 634,541
Future production costs. . . . . . . . . . . . . . . . . (60,653) (124,753) (185,406)
Future development costs . . . . . . . . . . . . . . . . (2,024) (22,060) (24, 084)
--------- --------------- -----------
Future net inflows before income taxes . . . . . . . . . 100,447 324,604 425,051
Income taxes . . . . . . . . . . . . . . . . . . . . . . (6,982) - (6,982)
Future net cash flows. . . . . . . . . . . . . . . . . . 93,465 324,604 418,069
--------- --------------- -----------
10% discount factor. . . . . . . . . . . . . . . . . . . (40,866) (153,809) (194,675)
--------- --------------- -----------
Standardized measure of discounted future net cash flows $ 52,599 $ 170,795 $ 223,394
========= =============== ===========
</TABLE>
F-52
<PAGE>
3TEC ENERGY CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED)
CHANGES TO STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO
PROVED OIL AND GAS RESERVES:
<TABLE>
<CAPTION>
ACQUIRED
3TEC PROPERTIES PRO FORMA
(IN THOUSANDS)
<S> <C> <C> <C>
Standardized measure, January 1, 1999. . . . . . . . . . $38,894 $ 175,609 $ 214,503
Sales, net of production costs . . . . . . . . . . . . . . . (6,878) (16,522) (23,400)
Purchases of reserves in place . . . . . . . . . . . . . . . 749 749
Net changes in prices and production costs . . . . . . . . . 21,595 21,595
Net changes in income taxes. . . . . . . . . . . . . . . . . (3,929) (3,929)
Extensions, discoveries and improved recovery, net of future
production and development costs . . . . . . . . . . . . . 2,268 2,268
Changes in estimated future development costs 2,612 2,612
Revisions of quantity estimates. . . . . . . . . . . . . . . (3,030) - (3,030)
Accretion of discount. . . . . . . . . . . . . . . . . . . . 3,889 9,096 12,985
Sales of reserves in place . . . . . . . . . . . . . . . . . (1,643) - (1,643)
Changes in production rates and other. . . . . . . . . . . . 684 - 684
-------- --------------- -----------
Standardized measure, September 30, 1999 . . . . . . . . $52,599 $ 170,795 $ 233,394
======== =============== ===========
</TABLE>
F-53
<PAGE>
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
<S> <C>
Glossary of Oil and Gas Terms . . A-1
Opinion of Harris Webb & Garrison B-1
Agreement and Plan of Merger. . . C-1
</TABLE>
<PAGE>
EXHIBIT A
GLOSSARY OF TERMS
The following are definitions of certain technical terms used in the Proxy
Statement in connection with the oil and gas exploration and development
business of the Company:
"Bbl" - One stock tank barrel or 42 U.S. Gallons liquid volume, usually
used herein in reference to crude oil or other liquid hydrocarbons.
"Bcf" - One billion cubic feet; expressed, where gas sales contracts are in
effect, in terms of contractual temperature and pressure basis and, where
contracts are nonexistent, at 60 degrees Fahrenheit and 14.65 pounds per square
inch absolute.
"Bcfe" - One billion cubic feet equivalent, determined using a ratio of six
Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
"exploratory well" - A well drilled in search of a new undiscovered pool of
oil or gas, or to extend the known limits of a field under development.
"gross acres or wells" - The total acres or wells, as the case may be, in
which an entity has an interest, either directly or through an affiliate.
"lease" - Full or partial interests in an oil and gas lease, oil and gas
mineral rights, fee rights or other rights, authorizing the owner thereof to
drill for, reduce to possession and produce oil and gas upon payment of rentals,
bonuses and/or royalties. Oil and gas leases are generally acquired from private
landowners and federal and state governments.
"Mcf" - One thousand cubic feet; expressed, where gas sales contracts are
in effect, in terms of contractual temperature and pressure bases and, where
contracts are nonexistent, at 60 degrees Fahrenheit and 14.65 pounds per square
inch absolute.
"Mcfe" - One thousand cubic feet equivalent, determined using a ratio of
six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas
liquids.
A-1
<PAGE>
"Mmcf" - One million cubic feet; expressed, where gas sales contracts are
in effect, in terms of contractual temperature and pressure bases and, where
contracts are nonexistent, at 60 degrees Fahrenheit and 14.65 pounds per square
inch absolute.
"Mmcfe" - One million cubic feet equivalent, determined using a ratio of
six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas
liquids.
"NRI" - Net revenue interest in oil and gas property entitling the owner to
a share of the net revenues from oil and gas production.
"net acres or wells" - A party's interest in acres or wells calculated by
multiplying the number of Gross Acres or Gross Wells in which such party has an
interest by the fractional interest of such party in each such acre or well.
"Prospect" - An area in which a party owns or intends to acquire one or
more oil and gas interests which is geographically defined on the basis of
geological data and which is reasonably anticipated to contain at least one
reservoir of oil, gas or other hydrocarbons.
"proved developed reserves" - Proved reserves which can be expected to be
recovered through existing wells with existing equipment and operating methods.
"proved reserves" - The estimated quantities of crude oil, natural gas and
other hydrocarbons which, based upon geological and engineering data, are
expected to be produced from known oil and gas reservoirs under existing
economic and operating conditions, and the estimated present value thereof based
upon the prices and costs on the date that the estimate is made and any price
changes provided for by existing conditions.
"proved undeveloped reserves" - Reserves that are expected to be recovered
from new wells on undrilled acreage or from existing wells where a relatively
major expenditure is required for recompletion.
"PV-10" - The discounted future net cash flows for proved oil and gas
reserves computed using contract prices and costs, at the dates indicated,
before income taxes and a discounted at a rate of 10%.
"royalty interest" - An interest in an oil and gas property entitling the
owner to a share of oil and gas production free of the costs of production.
A-2
<PAGE>
"Working Interest" - The operating interest under a Lease which gives the
owner the right to drill, produce and conduct operating activities on the
property and a share of production, subject to all Royalty Interests, and other
burdens and to all costs of exploration, development and operations and all
risks in connection therewith.
A-3
<PAGE>
EXHIBIT B
OPINION OF HARRIS WEBB & GARRISON
G. CLYDE BUCK
MANAGING DIRECTOR
December 21, 1999
PERSONAL AND CONFIDENTIAL
- ---------------------------
Special Committee of the Board of Directors
3TEC Energy Corporation
1221 Lamar, Suite 1020
Houston, Texas 77010
Gentlemen:
You have advised Harris Webb & Garrison, Inc. ("HWG") that 3TEC Energy
Corporation ("3TEC"), formerly known as Middle Bay Oil Company, Inc. ("Middle
Bay"), and Magellan Exploration, LLC ("Magellan") propose to enter into an
agreement and plan of merger dated December 21, 1999 (the "Merger Agreement")
that provides for, among other things, the merger (the "Merger") of a wholly
owned subsidiary of 3TEC with and into Magellan, as a result of which Magellan
will become a wholly owned subsidiary of 3TEC. Upon consummation of the Merger,
the membership interests in Magellan will be converted into the following
consideration:
(a) 3,300,000 shares of 3TEC common stock, which will be issued in a
private transaction, which will include certain registration rights;
(b) 1,875,000 shares of 3TEC convertible preferred stock with a stated
value of $8.00 per share ($15,000,000 in the aggregate) to be
designated Series D, with terms to include a 5% dividend rate with an
option for three years for 3TEC to choose to pay the dividend with
additional Series D shares with a stated value of $8.00 per share; and
with each Series D share convertible into one share of 3TEC common and
no rights of the holders to "put" the Series D shares to 3TEC, but the
Series D shares will be redeemable by 3TEC at any time, upon thirty
days written notice, for the stated value of $8.00 per share;
(c) a contingent "back-in" 5% working interest in certain exploration
prospects; and
(d) warrants to purchase 1,000,000 shares of 3TEC common stock at $10.00
per share for four years.
You have requested that HWG act as financial advisor and issue an opinion
("Opinion") as to the fairness to the public common shareholders of 3TEC of the
financial terms of the Merger.
B-1
<PAGE>
HWG, as part of its investment banking business, is frequently engaged in
the valuation of businesses and their securities in connection with mergers and
acquisitions, negotiated underwritings, secondary distributions of listed and
unlisted securities, private placements, and valuations for estate, corporate
and other purposes.
In arriving at our Opinion, we have, among other things:
1. Reviewed a letter of intent outlining the proposed acquisition of
Magellan by 3TEC dated November 22, 1999;
2. Reviewed the definitive Merger Agreement;
3. Reviewed Magellan's unaudited balance sheet and income statement for
the ten month interim period ended October 31, 1999;
4. Reviewed Middle Bay's 10-KSB report for the year ended December 31,
1998;
5. Reviewed Middle Bay's 10-QSB reports for the quarters ended March 31,
1999; June 30, 1999 and September 30, 1999;
6. Reviewed summary pages of Middle Bay's reserve report prepared by
Cawley, Gillespie & Associates, Inc. as of August 1, 1999;
7. Reviewed summary pages of Floyd Oil Company's reserve report prepared
by Cawley, Gillespie & Associates, Inc. as of August 1, 1999;
8. Reviewed summary pages of 3TEC's reserve report prepared by Ryder
Scott Company as of October 1, 1999;
9. Reviewed summary pages of Magellan's reserve report prepared by Ryder
Scott Company as of October 1, 1999;
10. Reviewed certain confidential analyses of Magellan's reserves and
exploration prospects conducted by 3TEC's management and certain
consultants;
11. Reviewed confidential financial forecasts for 3TEC prepared by
management of 3TEC;
12. Reviewed Middle Bay proxy statements for August 10, 1999 and November
18, 1999 shareholder meetings;
13. Reviewed Middle Bay's Bank One credit agreement executed November 23,
1999;
14. Reviewed various confidential schedules and discounted cash flow
analysis prepared by Magellan covering Magellan's assets being
acquired through the Merger;
B-2
<PAGE>
15. Discussed with management of 3TEC and Magellan the outlook for future
operating results, the assets and liabilities of both companies,
materials in the foregoing documents, and other matters we considered
to be relevant to our inquiry;
16. Considered such other information, financial studies, analyses and
investigations as we deemed relevant under the circumstances.
In our review and in arriving at our Opinion, we have, with your
permission, (i) not independently verified any of the foregoing information and
have relied upon its being complete and accurate in all material respects, (ii)
with respect to any estimates, evaluations and projections furnished to us,
assumed that such information was reasonably prepared and based upon the best
currently available information and good faith judgment of the person furnishing
the same and (iii) not made an independent evaluation or appraisal of specific
assets of 3TEC or Magellan.
In addition, we have not made a physical inspection of the oil and gas
properties of 3TEC or Magellan, nor have we made any independent evaluations,
appraisals or investigations of the other assets of 3TEC or Magellan.
We are not experts in geological and engineering evaluation of oil and gas
reserves. In rendering our Opinion, we have relied upon the reserve reports
noted as items 6, 7, 8 and 9 above.
Our Opinion is based upon market, economic and other conditions as they
exist and can be evaluated as of the date of this letter. HWG consents to the
inclusion of the text of this Opinion in any notice, proxy statement or
appropriate disclosure to the public common shareholders of 3TEC and in any
filing that 3TEC or Magellan is required by law to make, or include in documents
filed, with the Securities and Exchange Commission.
Based upon and subject to the foregoing, it is our Opinion that, as of the
date hereof, the Merger is fair to the public common shareholders of 3TEC from a
financial point of view.
HARRIS WEBB & GARRISON, INC.
By: /S/ G. Clyde Buck
-------------------------------
G. Clyde Buck
Managing Director
B-3
<PAGE>
EXHIBIT C
AGREEMENT AND PLAN OF MERGER
AMONG
3TEC ENERGY CORPORATION,
3TM ACQUISITION L.L.C.,
MAGELLAN EXPLORATION, LLC
AND
ECIC CORPORATION
ENCAP ENERGY CAPITAL FUND III, L.P.,
ENCAP ENERGY ACQUISITION III-B, INC.,
BOCP ENERGY PARTNERS, L.P., AND
PEL-TEX PARTNERS, L.L.C.
DECEMBER 21, 1999
C-1
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C> <C>
ARTICLE I TERMS DEFINED. . . . . . . . . . . . . . . . . . . . . . . . . . 1
SECTION 1.1. Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . 1
SECTION 1.2. Accounting Terms and Determinations. . . . . . . . . . . . . . 10
SECTION 1.3. Gender and Number. . . . . . . . . . . . . . . . . . . . . . . 11
SECTION 1.4. References to Agreement. . . . . . . . . . . . . . . . . . . . 11
ARTICLE II THE MERGER. . . . . . . . . . . . . . . . . . . . . . . . . . . 11
SECTION 2.1. The Merger . . . . . . . . . . . . . . . . . . . . . . . . . . 11
SECTION 2.2. Closing Date . . . . . . . . . . . . . . . . . . . . . . . . . 11
SECTION 2.3. Consummation of the Merger . . . . . . . . . . . . . . . . . . 11
SECTION 2.4. Effects of the Merger. . . . . . . . . . . . . . . . . . . . . 11
SECTION 2.5. Certificate of Formation; LLC Agreement. . . . . . . . . . . . 12
SECTION 2.6. Managers and Officers. . . . . . . . . . . . . . . . . . . . . 12
SECTION 2.7. Conversion of Securities . . . . . . . . . . . . . . . . . . . 12
SECTION 2.8. Merger Consideration . . . . . . . . . . . . . . . . . . . . . 12
ARTICLE III RESERVATION AND ISSUANCE OF CONVERSION SHARES. . . . . . . . . . 12
ARTICLE IV CERTAIN TERMS APPLICABLE TO WARRANTS . . . . . . . . . . . . . . 13
SECTION 4.1. Exercise of Warrants . . . . . . . . . . . . . . . . . . . . . 13
SECTION 4.2. Adjustment of Number of Warrant Shares Purchasable . . . . . . 14
SECTION 4.3 Notices to Warrant Holders . . . . . . . . . . . . . . . . . . 15
SECTION 4.4. Reservation and Issuance of Warrant Shares . . . . . . . . . . 16
ARTICLE V TRANSFER OF SECURITIES . . . . . . . . . . . . . . . . . . . . . 16
SECTION 5.1. Restrictions on Transfer . . . . . . . . . . . . . . . . . . . 16
SECTION 5.2. Registration, Transfer and Exchange of Warrants. . . . . . . . 16
SECTION 5.3. Mutilated or Missing Warrant Certificates. . . . . . . . . . . 17
ARTICLE VI CONDITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
SECTION 6.1. Conditions Precedent to Obligations of 3TEC and Sub at Closing 17
SECTION 6.2. Conditions Precedent to Magellan's and Prepayout Members'
a Obligations at Closing . . . . . . . . . . . . . . . . . . . . 19
ARTICLE VII REPRESENTATIONS AND WARRANTIES OF MAGELLANAND
THE PREPAYOUT MEMBERS. . . . . . . . . . . . . . . . . . . . . . 21
SECTION 7.1. Existence and Power. . . . . . . . . . . . . . . . . . . . . . 21
SECTION 7.2. Authorization; Contravention . . . . . . . . . . . . . . . . . 22
SECTION 7.3. Binding Effect . . . . . . . . . . . . . . . . . . . . . . . . 22
SECTION 7.4. Ownership. . . . . . . . . . . . . . . . . . . . . . . . . . . 22
SECTION 7.5. Financial Statements . . . . . . . . . . . . . . . . . . . . . 22
SECTION 7.6. Material Agreements. . . . . . . . . . . . . . . . . . . . . . 23
SECTION 7.7. Investments. . . . . . . . . . . . . . . . . . . . . . . . . . 23
C-2
<PAGE>
SECTION 7.8. Outstanding Debt . . . . . . . . . . . . . . . . . . . . . . . 23
SECTION 7.9. Transactions with Affiliates . . . . . . . . . . . . . . . . . 23
SECTION 7.10. Employment Matters . . . . . . . . . . . . . . . . . . . . . . 23
SECTION 7.11. Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . 24
SECTION 7.12. ERISA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
SECTION 7.13. Taxes and Filing of Tax Returns. . . . . . . . . . . . . . . . 25
SECTION 7.14. Title to Assets. . . . . . . . . . . . . . . . . . . . . . . . 25
SECTION 7.15. Licenses, Permits, Etc.. . . . . . . . . . . . . . . . . . . . 25
SECTION 7.16. Proprietary Rights . . . . . . . . . . . . . . . . . . . . . . 25
SECTION 7.17. Compliance with Law. . . . . . . . . . . . . . . . . . . . . . 26
SECTION 7.18. Environmental Matters. . . . . . . . . . . . . . . . . . . . . 26
SECTION 7.19. Investment Representation. . . . . . . . . . . . . . . . . . . 27
SECTION 7.20. Fiscal Year. . . . . . . . . . . . . . . . . . . . . . . . . . 27
SECTION 7.21. Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . 27
SECTION 7.22. Government Regulation. . . . . . . . . . . . . . . . . . . . . 27
SECTION 7.23. Brokers and Finders. . . . . . . . . . . . . . . . . . . . . . 27
SECTION 7.24. Oil and Gas Operations . . . . . . . . . . . . . . . . . . . . 28
SECTION 7.25. Financial and Commodity Hedging. . . . . . . . . . . . . . . . 29
SECTION 7.26. Books and Records. . . . . . . . . . . . . . . . . . . . . . . 29
SECTION 7.27. Reserve Report . . . . . . . . . . . . . . . . . . . . . . . . 29
SECTION 7.28. Nature of Magellan Assets. . . . . . . . . . . . . . . . . . . 30
SECTION 7.29. Full Disclosure. . . . . . . . . . . . . . . . . . . . . . . . 30
SECTION 7.30. Year 2000 Compliance . . . . . . . . . . . . . . . . . . . . . 30
SECTION 7.31. Disclaimer of Warranties . . . . . . . . . . . . . . . . . . . 30
ARTICLE VIII REPRESENTATIONS AND WARRANTIES OF 3TEC AND SUB . . . . . . . . . 30
SECTION 8.1. Corporate Existence and Power. . . . . . . . . . . . . . . . . 31
SECTION 8.2. Corporate and Governmental Authorization; Contravention. . . . 31
SECTION 8.3. Binding Effect . . . . . . . . . . . . . . . . . . . . . . . . 31
SECTION 8.4. Brokers and Finders. . . . . . . . . . . . . . . . . . . . . . 31
SECTION 8.5. SEC Documents. . . . . . . . . . . . . . . . . . . . . . . . . 31
SECTION 8.6. Absence of Undisclosed Liabilities . . . . . . . . . . . . . . 32
SECTION 8.7. Absence of Certain Changes . . . . . . . . . . . . . . . . . . 32
SECTION 8.8. Securities . . . . . . . . . . . . . . . . . . . . . . . . . . 32
ARTICLE IX COVENANTS OF MAGELLAN. . . . . . . . . . . . . . . . . . . . . . 32
SECTION 9.1. Maintenance of Insurance . . . . . . . . . . . . . . . . . . . 32
SECTION 9.2. Payment of Taxes and Claims. . . . . . . . . . . . . . . . . . 33
SECTION 9.3. Compliance with Laws and Documents . . . . . . . . . . . . . . 33
SECTION 9.4. Operation of Properties and Equipment. . . . . . . . . . . . . 33
SECTION 9.5. Maintenance of Books and Records . . . . . . . . . . . . . . . 33
SECTION 9.6. Environmental Matters. . . . . . . . . . . . . . . . . . . . . 33
SECTION 9.7 Access to Information. . . . . . . . . . . . . . . . . . . . . 33
SECTION 9.8 Conduct of the Business of Magellan. . . . . . . . . . . . . . 34
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ARTICLE X COVENANTS OF 3TEC. . . . . . . . . . . . . . . . . . . . . . . . 36
SECTION 10.1 Meeting; Proxy Statement . . . . . . . . . . . . . . . . . . . 36
ARTICLE XI TERMINATION. . . . . . . . . . . . . . . . . . . . . . . . . . . 37
SECTION 11.1 Termination. . . . . . . . . . . . . . . . . . . . . . . . . . 37
SECTION 11.2. Effect of Termination. . . . . . . . . . . . . . . . . . . . . 37
ARTICLE XII MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . . . . . 38
SECTION 12.1. Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
SECTION 12.2. Amendment and Waivers. . . . . . . . . . . . . . . . . . . . . 38
SECTION 12.3. Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
SECTION 12.4. Indemnification. . . . . . . . . . . . . . . . . . . . . . . . 38
SECTION 12.5. Survival . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
SECTION 12.6. Invalid Provisions . . . . . . . . . . . . . . . . . . . . . . 42
SECTION 12.7. Successors and Assigns . . . . . . . . . . . . . . . . . . . . 42
SECTION 12.8. Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . 43
SECTION 12.9. Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . 43
SECTION 12.10. No Third Party Beneficiaries . . . . . . . . . . . . . . . . . 43
SECTION 12.11. Final Agreement. . . . . . . . . . . . . . . . . . . . . . . . 43
SECTION 12.12. Waiver of Right to Trial by Jury . . . . . . . . . . . . . . . 43
SECTION 12.13. DTPA Waiver . . . . . . . . . . . . . . . . . . . . . . . . . 43
SECTION 12.14. Public Announcements . . . . . . . . . . . . . . . . . . . . .. 43
</TABLE>
Exhibits
- --------
Exhibit A List of Prepayout Members
Exhibit B Assumption Agreement
Exhibit C Back-In Agreement
Exhibit D Registration Rights Agreement
Exhibit E Certificate of Designation
Exhibit F Warrant Certificate
Exhibit G Allocation of Merger Consideration
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<PAGE>
AGREEMENT AND PLAN OF MERGER
THIS AGREEMENT AND PLAN OF MERGER is entered into effective this 21st day
of December, 1999, by and among 3TEC Energy Corporation, a Delaware corporation
("3TEC" or the "Company"), 3TM Acquisition L.L.C., a Delaware limited liability
------------------------
company ("Sub"), Magellan Exploration, LLC, a Delaware limited liability company
-----
("Magellan"), and the entities set forth on the attached Exhibit "A" attached
hereto ("Prepayout Members"). In consideration of the mutual covenants and
agreements contained herein, and intending to be legally bound hereby, 3TEC,
Sub, Magellan and the Prepayout Members do hereby agree as follows:
ARTICLE I
TERMS DEFINED
SECTION 1.1. Definitions. The following terms, as used herein, have
-----------
the following meanings:
"3TEC Disinterested Director Committee" means a committee formed by the
3TEC Board of Directors consisting of 3TEC Disinterested Directors for the
purpose of evaluating the transactions contemplated herein.
"3TEC Disinterested Directors" means Gary R. Christopher and Stephen W.
Herod.
"3TEC Financial Statements" means the audited and unaudited consolidated
financial statements of 3TEC and its Subsidiaries (including the related notes)
included (or incorporated by reference) in the Company's Annual Report on Form
10-KSB for the year ended December 31, 1998, and the Company's Quarterly Report
on Form 10-QSB for the quarterly periods ended March 31, 1999, June 30, 1999 and
September 30, 1999 filed with the Commission.
"Affiliate" means, as to any Person, any Subsidiary of such Person, or any
other Person which, directly or indirectly, controls, is controlled by, or is
under common control with, such Person and, with respect to 3TEC or Magellan,
any executive officer of any Subsidiary or any Person who holds five percent
(5%) or more of the voting stock or membership interests, as the case may be.
For the purposes of this definition, "control" (including, with correlative
meanings, the terms "controlled by" and "under common control with"), as used
with respect to any Person, shall mean the possession, directly or indirectly,
of the power to direct or cause the direction of the management and policies of
such Person, whether through the ownership of voting securities or membership
interests, or by contract or otherwise. 3TEC shall not be considered an
Affiliate of Magellan for purposes of this Agreement or the other Transaction
Documents.
"Agreement" means this Agreement and Plan of Merger, as hereafter modified
or amended in accordance with the terms hereof.
"Assumed Liabilities" means the liabilities assumed by the Prepayout
Members under the Assumption Agreement.
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<PAGE>
"Assumption Agreement" means that agreement by and among Magellan and the
Prepayout Members substantially in the form of Exhibit B attached hereto in all
---------
material respects.
"Authorized Officer" means, as to any Person, its Chairman, its Chief
Executive Officer, its President, its Chief Operating Officer, its Financial
Officer or Vice President, or in the case of a limited liability company, a
Manager.
"Back-In Agreement" means that agreement by and among Magellan and the
Prepayout Members substantially in the form of Exhibit C attached hereto in all
---------
material respects.
"Back-In Working Interest" means a contingent working interest in the
exploration prospects listed on, and subject to the terms and conditions as set
forth in, the Back-In Agreement.
"Business Day" means any day except a Saturday, Sunday or other day on
which national banks in Houston, Texas are authorized by law to close.
"Capital Lease" means, for any Person, as of any date, any lease of
property, real or personal, which would be capitalized on a balance sheet of the
lessee of such lease prepared as of such date in accordance with GAAP.
"Charter Documents" mean, with respect to any Person, its certificate or
articles of incorporation, certificate or articles of organization, bylaws,
partnership agreement, regulations, operating agreement and all other comparable
charter documents.
"Closing" has the meaning given such term in Section 2.2 hereof.
------------
"Closing Date" has the meaning given such term in Section 2.2 hereof.
-----------
"Closing Transactions" means the transactions which will occur on the
Closing Date pursuant to the Transaction Documents.
"COBRA" has the meaning given such term in Section 7.12 hereof.
-------------
"Commission" means the Securities and Exchange Commission or any entity
succeeding to any or all of its functions under the Securities Act or the
Exchange Act.
"Common Stock" means 3TEC's common stock, par value $0.02 per share.
"Common Stock Shares" means the 3,300,000 shares of Common Stock to be
issued to the Prepayout Members pursuant to this Agreement.
"Conversion Shares" means shares of Common Stock issued upon conversion of
the Preferred Stock.
"Current Market Price" has the meaning given such term in Section
-------
12.4(f)(iv) hereof.
- -----------
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<PAGE>
"Debt" means, for any Person, without duplication, (a) all obligations of
such Person for borrowed money, (b) all obligations of such Person evidenced by
bonds, debentures, notes or other similar instruments, (c) all indebtedness of
such Person on which interest charges are customarily paid or accrued, (d) all
Guarantees by such Person, (e) the unfunded or unreimbursed portion of all
letters of credit issued for the account of such Person, (f) the present value
of all obligations in respect of Capital Leases of such Person, (g) any
obligation of such Person representing the deferred purchase price of property
or services purchased by such Person other than trade payables incurred in the
ordinary course of business and which are not more than ninety (90) days past
invoice date, (h) any indebtedness, liability or obligation secured by a Lien on
the assets of such Person whether or not such indebtedness, liability or
obligation is otherwise non-recourse to such Person, (i) liabilities arising
under future contracts, forward contracts, swap, cap or collar contracts, option
contracts, hedging contracts, other derivative contracts and similar agreements,
(j) liabilities with respect to payments received in consideration of oil, gas
or other minerals yet to be acquired or produced at the time of payment,
including obligations under "take-or-pay" contracts to deliver gas in return for
payments already received and the undischarged balance of any production payment
created by such Person or for the creation of which such Person directly or
indirectly received payment, and (k) all liability of such Person as a general
partner or joint venturer for obligations of the nature described in (a) through
(k) preceding.
"Defensible Title" means such right, title and interest that is (a)
evidenced by an instrument or instruments filed of record in accordance with the
conveyance and recording laws of the applicable jurisdiction to the extent
necessary to prevail against competing claims of bona fide purchasers for value
without notice and (b) subject to Permitted Encumbrances, free and clear of all
Liens, claims, infringements, burdens or other defects.
"Delaware Law" has the meaning given such term in Section 2.1.
"Disinterested Shares" means the outstanding shares of Common Stock other
than those held, directly or indirectly, by the Prepayout Members or their
respective Affiliates.
"Effective Time" has the meaning given such term in Section 2.3.
"Environmental Complaint" means any complaint, summons, citation, notice,
directive, order, claim, litigation, investigation, proceeding, judgment, letter
or other communication from any federal, state, municipal or other Governmental
Authority or any other party involving a Hazardous Discharge, Environmental
Contamination or any violation of any order, permit or Environmental Law and
Laws.
"Environmental Contamination" means the presence of any Hazardous
Substances, which presence results from a Hazardous Discharge.
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<PAGE>
"Environmental Law and Laws" means any law, common law, ordinance,
regulation or policy of any Governmental Authority, as well as any order,
decree, permit, judgment or injunction issued, promulgated, approved, or entered
thereunder, relating to the environment, health and safety, Hazardous Substances
(including, without limitation, the use, handling, transportation, production,
disposal, discharge or storage thereof), industrial hygiene, the environmental
conditions on, under, or about any real property owned, leased or operated at
any time by the Company or any of its Subsidiaries or any real property owned,
leased or operated by any other party, including, without limitation, soil,
groundwater, and indoor and ambient air conditions or the reporting or
remediation of Environmental Contamination. Environmental Law and Laws include,
without limitation, the Clean Air Act, as amended, the Federal Water Pollution
Control Act, as amended, the Rivers and Harbors Act of 1899, as amended, the
Safe Drinking Water Act, as amended, the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA"), as amended, the Superfund Amendments
------
and Reauthorization Act of 1986 ("SARA"), as amended, the Resource Conservation
----
and Recovery Act of 1976 ("RCRA"), as amended, the Hazardous and Solid Waste
----
Amendments Act of 1984, as amended, the Toxic Substances Control Act, as
amended, the Occupational Safety and Health Act ("OSHA"), as amended, the
----
Hazardous Materials Transportation Act, as amended, and any other federal, state
and local law whose purpose is to conserve or protect health, the environment,
wildlife or natural resource.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time, and any regulation promulgated thereunder.
"ERISA Affiliate" means Magellan and any other entity or trade or business
under common control with Magellan or treated as a single employer with Magellan
as determined under sections 414(b), (c), (m) or (o) of the IRC.
"Exchange Act" means the Securities Exchange Act of 1934, as amended, or
any successor federal statute.
"Exhibit" refers to an exhibit attached to this Agreement and incorporated
herein by reference, unless specifically provided otherwise.
"Financial Officer" means, as to any Person, its Chief Financial Officer,
or if no Person serves in such capacity, the highest ranking executive officer
or Manager of such Person with responsibility for accounting, financial
reporting, financial compliance and similar functions.
"GAAP" means generally accepted accounting principles, applied on a
consistent basis, set forth in Opinions of the Accounting Principles Board of
the American Institute of Certified Public Accountants and/or in statements of
the Financial Accounting Standards Board and/or their successors which are
applicable in the circumstances as of the date in question; and the requirement
that such principles be applied on a consistent basis means that the accounting
principles observed in a current period are comparable in all material respects
to those applied in a preceding period.
"Governmental Authority" means any national, state or county, municipal
government, domestic or foreign, any agency, board, bureau, commission, court,
department or other instrumentality of any such government, or any arbitrator in
any case that has jurisdiction over Magellan or any of its respective properties
or assets.
C-8
<PAGE>
"Guaranty" by any Person means any obligation, contingent or otherwise, of
such Person directly or indirectly guaranteeing any Debt or other obligation of
any other Person and, without limiting the generality of the foregoing, any
obligation, direct or indirect, contingent or otherwise, of such Person (a) to
purchase or pay (or advance or supply funds for the purchase or payment of) such
Debt or other obligation (whether arising by virtue of partnership arrangements,
by agreements to keep-well, to purchase assets, goods, securities or services,
to take-or-pay, or to maintain financial statement conditions, by "comfort
letter" or other similar undertaking of support of otherwise), or (b) entered
into for the purpose of assuring in any other manner the obligee of such Debt or
other obligation of the payment thereof or to protect such obligee against loss
in respect thereof (in whole or in part); provided, that, the term "Guaranty"
--------
shall not include endorsements for collection or deposit in the ordinary course
of business and responsibilities customarily assumed under operating agreements
generally considered standard in the industry. For purposes of this Agreement,
the amount of any Guaranty shall be the maximum amount that the guarantor could
be legally required to pay under such Guaranty.
"HSR Act" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976,
as amended.
"Hazardous Discharge" means any releasing, spilling, leaking, pumping,
pouring, emitting, emptying, discharging, injecting, escaping, leaching,
disposing or dumping of a Hazardous Substance at, from, onto, under or within
any real property owned, leased or operated at any time by Magellan or any real
property owned, leased or operated by any other Person.
"Hazardous Substance" means any pollutant, toxic substance, hazardous
waste, compound, element or chemical that is defined as hazardous, toxic,
noxious, dangerous or infectious pursuant to any Environmental Law and Laws or
which is otherwise regulated by any Environmental Law and Laws.
"Holder" with respect to any Security, shall mean the record or beneficial
owner of such Security.
"Hydrocarbons" means oil, condensate, gas, casinghead gas and other liquid
or gaseous hydrocarbons.
"Investment" in any Person means any investment, whether by means of
securities purchase (whether by direct purchase from such Person or from an
existing holder of securities of such Person), loan, advance, extension of
credit, capital contribution or otherwise, in or to such Person, the Guaranty of
any Debt or other obligation of such Person, or the subordination of any claim
against such Person to other Debt or other obligation of such Person; provided,
--------
that, "Investments" shall not include advances made to employees of such Person
for reasonable travel, entertainment and similar expenses incurred in the
ordinary course of business.
"IRC" means the Internal Revenue Code of 1986, as amended from time to
time, and any regulation promulgated thereunder.
C-9
<PAGE>
"Knowledge" means actual knowledge after reasonable investigation
consistent with the generally accepted business practices in the oil and gas
industry.
"Laws" means all applicable statutes, laws, ordinances, regulations,
orders, writs, injunctions, or decrees of any state, commonwealth, nation,
territory, possession, county, township, parish, municipality, or Governmental
Authority.
"Lien" means with respect to any asset, any mortgage, lien, pledge, charge,
security interest or encumbrance of any kind in respect of such asset. For the
purposes of this Agreement, a Person shall be deemed to own subject to a Lien
any asset which it has acquired or holds subject to the interest of a vendor or
lessor under any conditional sale agreement or other title retention agreement
relating to such asset.
"Magellan Disclosure Schedule" means the disclosure schedule entitled
Magellan Disclosure Schedule separately provided by Magellan and the Prepayout
Members to 3TEC on or before the date hereof, and any documents listed on such
disclosure schedule and expressly incorporated therein by reference.
"Magellan Financial Statements" means the unaudited financial statements of
Magellan (including the related notes) for the year ended December 31, 1998 and
the unaudited financial statements of Magellan for the ten (10) month period
ended October 31, 1999.
"Magellan Members" shall mean those members of Magellan who are parties to
the Magellan Operating Agreement.
"Magellan Operating Agreement" means the Second Amended and Restated
Limited Liability Company Agreement of Magellan Exploration, LLC dated March 5,
1999.
"Magellan Preferential Rights" means those preferential rights of Magellan
Members as set forth in Section 9 of the Magellan Operating Agreement.
"Magellan Properties" shall mean those properties of Magellan as set forth
on Schedule 7.6 of the Magellan Disclosure Schedule.
-------------
"Majority Warrantholder" means a Warrant Holder or Warrant Holders who hold
more than fifty percent (50%) of the outstanding Warrant Shares.
"Material Adverse Effect" means, with respect to a Person, a material
adverse effect on the business, financial condition, operations, assets or
prospects of such Person or any of its Subsidiaries.
C-10
<PAGE>
"Material Agreement" means any written or oral agreement, contract,
commitment, or understanding to which a Person is a party, by which such Person
is directly or indirectly bound, or to which any assets of such Person may be
subject (a) which is not cancelable by such Person upon notice of sixty (60)
days or less without liability for further payment other than nominal penalty,
(b) pursuant to which such Person acquires any material portion of the raw
materials, supplies or services used or consumed by such Person in the operation
of its business (unless such raw materials, supplies or services are readily
available to such Person from other sources on comparable terms), or (c)
pursuant to which such Person derives any material part of its revenues.
"Merger" has the meaning given such term in Section 2.1.
"Obligations" means all present and future indebtedness, obligations and
liabilities, and all renewals and extensions thereof, or any part thereof, of
Magellan or 3TEC, as the case may be, and any other Person arising pursuant to
the Transaction Documents, and all interest accrued thereon and costs, expenses,
and attorneys' fees incurred in the enforcement or collection thereof,
regardless of whether such indebtedness, obligations and liabilities are direct,
indirect, fixed, contingent, liquidated, unliquidated, joint, several or joint
and several.
"Oil and Gas Interest(s)" means (a) direct and indirect interests in and
rights with respect to oil, gas, mineral and related properties and assets of
any kind and nature, direct or indirect, including working, royalty and
overriding royalty interests, production payments, operating rights, net profits
interests, other non-working interests and non-operating interests; (b)
interests in and rights with respect to Hydrocarbons and other minerals or
revenues therefrom and contracts in connection therewith and claims and rights
thereto (including oil and gas leases, operating agreements, unitization and
pooling agreements and orders, division orders, transfer orders, mineral deeds,
royalty deeds, oil and gas sales, exchange and processing contracts and
agreements and, in each case, interests thereunder), surface interests, fee
interests, mineral servitudes, reversionary interests, reservations and
concessions; (c) easements, rights of way, licenses, permits, leases, and other
interests associated with, appurtenant to, or necessary for the operation of any
of the foregoing; and (d) interests in equipment and machinery (including well
equipment and machinery), oil and gas production, gathering, transmission,
compression, treating, processing and storage facilities (including tanks, tank
batteries, pipelines and gathering systems), pumps, water plants, electric
plants, gasoline and gas processing plants, refineries and other tangible
personal property and fixtures associated with, appurtenant to, or necessary for
the operation of any of the foregoing.
"Ownership Interests" means the ownership interests of Magellan in its Oil
and Gas Interests, as set forth on Schedule 1.1A of the Magellan Disclosure
-------------
Schedule.
"Pension Plan" means any employee benefit plan or welfare benefit plan
within the meaning of section 3(3) of ERISA maintained by Magellan or any ERISA
Affiliate that is or was previously covered by Title IV of ERISA or subject to
the minimum funding standards under section 412 of the IRC, including a
"multiemployer plan" as such term is defined in section 3(37) of ERISA, under
which Magellan has any current or future obligation or liability and under which
any present or former employee of Magellan or such present or former employee's
dependents or beneficiaries, has any current or future right to benefits.
C-11
<PAGE>
"Permitted Encumbrances" means (a) Liens for Taxes, assessments or other
governmental charges or levies if the same shall not at the particular time in
question be due and delinquent or (if foreclosure, distraint, sale or other
similar proceedings shall not have been commenced or if commenced, shall have
been stayed) are being contested in good faith by appropriate proceedings and if
Magellan shall have set aside on its books such reserves (segregated to the
extent required by sound accounting principles) as may be required by GAAP or
otherwise determined by it to be adequate with respect thereto; (b) Liens of
carriers, warehousemen, mechanics, laborers, materialmen, landlords, vendors,
workmen and operators arising by operation of law in the ordinary course of
business or by a written agreement existing as of the date hereof and necessary
or incident to the exploration, development, operation and maintenance of
Hydrocarbon properties and related facilities and assets for sums not yet due or
being contested in good faith by appropriate proceedings, if Magellan shall
have set aside on its books such reserves segregated to the extent required by
sound accounting practices) as may be required by GAAP or otherwise determined
by it to be adequate with respect thereto; (c) Liens incurred in the ordinary
course of business in connection with worker's compensation, unemployment
insurance and social security legislation (other than ERISA); (d) Liens incurred
in the ordinary course of business to secure the performance of bids, tenders,
trade contracts, leases, statutory obligations, surety and appeal bonds,
performance and repayment bonds and other obligations of a like nature; (e)
Liens, easements, rights-of-way, restrictions, servitudes, permits, conditions,
covenants, exceptions, reservations and other similar encumbrances incurred in
the ordinary course of business or existing on property and not (i) reducing
Magellan's net revenue interest in any Oil and Gas Interests below that set
forth on Schedule 1.1A, (ii) increasing Magellan's Working Interest in any Oil
and Gas Interest above that set forth on Schedule 1.1A or (iii) in the aggregate
materially impairing the value of the assets of Magellan or interfering with the
ordinary conduct of the business of Magellan or rights to any of its assets; (f)
Liens created or arising by operation of law to secure a party's obligations as
a purchaser of oil and gas; (g) all rights to consent by, required notices to,
filings with, or other actions by Governmental Authorities to the extent
customarily obtained subsequent to Closing; (h) farmout, carried working
interest, joint operating, unitization, royalty, overriding royalty, sales and
similar arrangements relating to the exploration, development of, or production
from, Hydrocarbon properties entered into in the ordinary course of business;
and (i) preferential rights to purchase and Third Party Consents (to the extent
not triggered by the consummation of the transactions contemplated herein).
"Person" means an individual, a corporation, a partnership, a limited
liability company, an association, a trust or any other entity or organization,
including a government or political subdivision or an agency or instrumentality
thereof.
"Postpayout Interests" shall have the meaning set forth in Section 3.1 of
the Magellan Operating Agreement.
"Postpayout Members" shall be those Magellan Members entitled to Postpayout
Interests.
"Preferred Stock" means 3TEC Series D Convertible preferred stock, par
value $0.02 per share, with a stated value of $8.00 per share having the rights
and preferences set forth in the Series D Stock Designation.
"Preferred Stock Shares" means the shares of Preferred Stock to be issued
to the Prepayout Members pursuant to this Agreement.
C-12
<PAGE>
"Prepayout Interests" shall have the meaning set forth in Section 3.1 of
the Magellan Operating Agreement.
"Prepayout Members" shall have the meaning set forth in the preamble to
this Agreement.
"Registration Rights Agreement" means that agreement by and among 3TEC, the
Prepayout Members and those Postpayout Members who are signatories thereto
substantially in the form of Exhibit D in all material respects.
----------
"Registration Statement" has the meaning given such term in Section 5.1.
-----------
"Reserve Engineer" has the meaning given such term in Section 7.32.
------------
"Reserve Report" has the meaning given such term in Section 7.32.
-------------
"Schedule" means a Aschedule" attached to this Agreement and incorporated
herein by reference, unless specifically indicated otherwise.
"SEC Documents" has the meaning given such term in Section 8.5.
-------------
"Section" refers to a section or subsection of this Agreement unless
specifically indicated otherwise.
"Securities" means the shares of Common Stock, the Preferred Stock and the
Warrants to be issued to the Prepayout Members.
"Securities Act" means the Securities Act of 1933, as amended, or any
successor federal statute.
"Series D Stock Designation" means the Certificate of Designation of Series
D Convertible Preferred Stock of 3TEC in the form attached as Exhibit "E"
-----------
attached hereto.
"Special Meeting" has the meaning given such term in Section 10.1.
------------
"Subsidiary" means, for any Person, any corporation or other entity of
which securities or other ownership interests having ordinary voting power to
elect a majority of the board of directors or other Persons performing similar
functions (including that of a general partner) are at the time directly or
indirectly owned, collectively, by such Person and any Subsidiaries of such
Person. The term Subsidiary shall include Subsidiaries of Subsidiaries (and so
on).
"Surviving Company" has the meaning given such term in Section 2.1.
-----------
C-13
<PAGE>
"Taxes" means all taxes, assessments, filing or other fees, levies,
imposts, duties, deductions, withholdings, stamp taxes, interest equalization
taxes, capital transaction taxes, foreign exchange taxes or other charges of any
nature whatsoever, from time to time or at any time imposed by law or any
federal, state or local governmental agency. A "Tax" means any one of the
foregoing.
"Third Party Consents" means the consent or approval of any Person other
than Magellan, 3TEC or any Governmental Authority.
"Transaction Documents" means this Agreement, the Warrant Certificates,
the Registration Rights Agreement, the Assumption Agreement, the Back-In
Agreement, and all other agreements, certificates, documents or instruments now
or at any time hereafter delivered in connection with this Agreement, as the
foregoing may be renewed, extended, modified, amended or restated from time to
time.
"Warrant Certificates" means the Warrant Certificates to be issued by 3TEC
evidencing the Warrants which shall be substantially in the form of Exhibit "F"
-----------
attached hereto in all material respects.
"Warrant Exercise Price" means $10.00 per share (subject to adjustment as
provided in Section 4.2).
------------
"Warrant Expiration Date" means 5:00 p.m., Houston, Texas time, four (4)
years following the Closing Date.
"Warrant Holder" means any Person (i) in whose name any Warrant is
registered on the Warrant Register, or (ii) in whose name any Warrant Shares are
registered on the books and records of 3TEC.
"Warrant Register" means a register maintained by 3TEC setting forth the
name and address of each Warrant Holder, the number of Warrants held by such
Warrant Holder and the certificate number of each Warrant Certificate held by
such Warrant Holder.
"Warrant Shares" means the shares of Common Stock issuable upon exercise of
the Warrants.
"Warrants" means the Common Stock Purchase Warrants to be issued by 3TEC
pursuant to Section 2.1 of this Agreement, each of which shall entitle the
------------
holder thereof to purchase one (1) share of Common Stock at the Warrant Exercise
Price (subject to adjustment as provided in Section 4.2).
------------
"Working Interests" means Magellan's share of all of the costs, expenses,
burdens, and obligations of any type or nature attributable to Magellan's
interests in its Oil and Gas Interests.
SECTION 1.2. Accounting Terms and Determinations. Unless otherwise
--------------------------------------
specified herein, all accounting terms used herein shall be interpreted, all
accounting determinations hereunder shall be made, and all financial statements
required to be delivered hereunder shall be prepared in accordance with GAAP as
in effect from time to time, applied on a basis consistent with the most recent
annual audited, consolidated financial statements of Magellan or 3TEC as the
case may be.
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<PAGE>
SECTION 1.3. Gender and Number. Words of any gender used in this
-------------------
Agreement shall be held and construed to include any other gender and words in
the singular number shall be held to include the plural, and vice versa, unless
the context requires otherwise.
SECTION 1.4. References to Agreement. Use of the words "herein",
-------------------------
"hereof", "hereinabove", and the like are and shall be construed as references
to this Agreement.
ARTICLE II
THE MERGER
SECTION 2.1. The Merger. Subject to and in accordance with the terms
-----------
and conditions of this Agreement and in accordance with the Limited Liability
Company Act of the State of Delaware (the "Delaware Law"), at the Effective Time
(as defined in Section 2.3) Sub shall be merged with and into Magellan (the
"Merger"). As a result of the Merger, the separate limited liability company
existence of Sub shall cease and Magellan shall continue as the surviving
limited liability company (sometimes referred to herein as the "Surviving
Company").
SECTION 2.2. Closing Date. The closing of the transactions
-------------
contemplated by this Agree-ment (the "Closing") shall take place at the offices
of 3TEC, Houston, Texas, at 10:00 a.m., local time, on the day which is two
consecutive Business Days after the day on which the last of the conditions to
the obligations of the parties set forth in Article VI is fulfilled or waived
(subject to applicable Law) or is capable of being fulfilled at the Closing or
(ii) at such other time or place or on such other date as the parties hereto
shall agree. The date on which the Closing occurs is herein referred to as the
"Closing Date".
SECTION 2.3. Consummation of the Merger. As soon as practicable on the
--------------------------
Closing Date, the parties hereto will cause the Merger to be consummated by
filing with the Secretary of State of Delaware a certificate of merger in such
form as required by, and executed in accordance with, the relevant provisions of
the Delaware Law. The "Effective Time" of the Merger, as that term is used in
this Agreement, shall mean such time as the certificate of merger is duly filed
with the Secretary of State of Delaware or at such later time as is specified in
the certificate of merger pursuant to the mutual agreement of 3TEC, Sub,
Magellan and Prepayout Members.
SECTION 2.4. Effects of the Merger. The Merger shall have the effects
---------------------
set forth in the applicable provisions of the Delaware Law. Without limiting
the generality of the foregoing, and subject thereto, at the Effective Time, all
the properties, rights, privileges, powers and franchises of Sub and Magellan
shall vest in the Surviving Company, without any transfer or assignment having
occurred, and (except as otherwise provided herein) all debts, liabilities and
duties of Sub and Magellan shall attach to the Surviving Company, all in
accordance with the Delaware Law.
C-15
<PAGE>
SECTION 2.5. Certificate of Formation; LLC Agreement.
-------------------------------------------
(a) The certificate of formation of Sub, as in effect immediately prior
to the Effective Time, shall be the certificate of formation of the Surviving
Company and thereafter shall continue to be its certificate of formation until
amended as provided therein and under Delaware Law.
(b) The limited liability company agreement of Sub, as in effect
immediately prior to the Effective Time, shall be the limited liability company
agreement of the Surviving Company and thereafter shall continue to be its
limited liability company agreement until amended as provided therein and under
Delaware Law.
SECTION 2.6. Managers and Officers. The managers and the officers of
----------------------
the Surviving Company at and after the Effective Time shall consist of the
managers and officers of the Sub at the Effective Time, in each case until their
respective successors are duly elected or appointed and qualified or until their
earlier death, resignation or removal in accordance with the Surviving Company's
certificate of formation and limited liability company agreement.
SECTION 2.7. Conversion of Securities. Subject to the terms and
--------------------------
conditions of this Agreement, at the Effective Time, by virtue of the Merger and
without any action on the part of 3TEC, Sub, Magellan or any holder of the
following securities:
(a) the Prepayout Interests issued and outstanding immediately prior to
the Effective Time shall be converted into the right to receive (i) 3,300,000
shares of Common Stock, (ii) 1,875,000 shares of Preferred Stock and (iii) the
Back-In Working Interest;
(b) the Postpayout Interests issued and outstanding immediately prior
to the Effective Time shall be converted into the right to receive warrants to
purchase 1,000,000 shares of Common Stock, which warrants shall be issued under
the terms hereof; and
(c) each issued and outstanding membership interest of Sub shall be
converted into and become one fully paid and nonassessable membership interest
of the Surviving Company.
SECTION 2.8. Merger Consideration. At the Effective Time, 3TEC will
---------------------
cause Magellan to execute and deliver the Back-In Agreement to the Prepayout
Members and 3TEC will deliver to each of the Magellan Members the shares of
Common Stock, shares of Preferred Stock and Warrants to which they are entitled
under Section 2.7, allocated as set forth on Exhibit "G" hereto.
------------ ------------
ARTICLE III
RESERVATION AND ISSUANCE OF CONVERSION SHARES
The Company will at all times have authorized, and reserve and keep
available, free from preemptive rights, for the purpose of enabling it to
satisfy any obligation to issue Conversion Shares upon the exercise by the
holders of the Preferred Stock Shares of its conversion rights, the number of
shares of Common Stock deliverable upon such conversion rights. The Company
covenants that all Conversion Shares issued by it will, upon issuance in
accordance with the terms of this Agreement, be fully paid and nonassessable.
C-16
<PAGE>
ARTICLE IV
CERTAIN TERMS APPLICABLE TO WARRANTS
SECTION 4.1. Exercise of Warrants.
----------------------
(a) The Warrants may be exercised in whole or in part at any time until
the Warrant Expiration Date at which time the Warrants shall expire and shall
thereafter no longer be exercisable.
(b) The Warrants shall be exercised by presentation of the Warrant
Certificate evidencing the Warrants to be exercised, with the form of election
to purchase on the reverse thereof duly completed and signed, to the Company at
the offices of the Company as set forth on the signature page of this Agreement,
together with payment of the aggregate Warrant Exercise Price for the number of
Warrant Shares in respect of which such Warrants are being exercised in lawful
money of the United States of America. The Warrants may also be exercised in a
"cashless" or "net-issue" exercise by delivery to the offices of the Company of
(A) a written notice of election to exercise Warrants, duly executed by the
Warrant Holder in the form set forth on the reverse of, or attached to, such
Warrant Certificate, which notice shall specify the number of Warrant Shares to
be delivered to the Warrant Holder and the number of Warrant Shares with respect
to which such Warrants are being surrendered in payment of the aggregate Warrant
Exercise Price for the Warrant Shares to be delivered to the Warrant Holder, and
(B) the Warrant Certificate evidencing such Warrants. For purposes of this
subparagraph (b), each Warrant Share as to which such Warrants are surrendered
in payment of the aggregate Warrant Exercise Price will be attributed a value
equal to (x) the Current Market Price per share of Common Stock minus (y) the
then-current Warrant Exercise Price.
Upon such presentation, the Company shall issue and cause to be delivered
to or upon the written order of the registered Holder of such Warrants and in
such name or names as such registered Holder may designate, a certificate or
certificates for the aggregate number of Warrant Shares issued upon such
exercise of such Warrants. Any Person so designated to be named therein shall
be deemed to have become holder of record of such Warrant Shares as of the date
of exercise of such Warrants; provided, that, no Warrant Holder will be
--------
permitted to designate that such Warrant Shares be issued to any Person other
than such Warrant Holder unless each condition to transfer contained in Article
-------
V hereof which would be applicable to a transfer of Warrants or Warrant Shares
has been satisfied.
C-17
<PAGE>
(c) If less than all of the Warrants evidenced by a Warrant Certificate
are exercised at any time (including those surrendered in payment of the Warrant
Exercise Price), a new Warrant Certificate or Certificates shall be issued for
the remaining number of Warrants evidenced by such Warrant Certificate. All
Warrant Certificates surrendered upon exercise of Warrants shall be canceled.
(d) The Company shall not be required to issue fractional shares of
Common Stock upon exercise of any Warrants issued by it, but shall pay for any
such fraction of a share an amount in cash equal to the value of such fractional
share determined by the Company's board of directors in good faith.
SECTION 4.2. Adjustment of Number of Warrant Shares Purchasable. The
---------------------------------------------------
number of Warrant Shares purchasable upon the exercise of each Warrant is
subject to adjustment from time to time upon the occurrence of any of the events
enumerated in this Section 4.2.
------------
(a) In the event that the Company shall at any time after the date of
this Agreement declare a dividend on the Common Stock in shares of its capital
stock (whether shares of such Common Stock or of capital stock of any other
class of the Company), split or subdivide the outstanding Common Stock, or
combine the outstanding Common Stock into a smaller number of shares, the number
of Warrant Shares purchasable upon an exercise of each Warrant after the time of
the record date for such dividend or of the effective date of such split,
subdivision or combination shall be adjusted to equal the number of shares of
Common Stock which a Holder having the same number of shares of Common Stock as
the number of Warrant Shares into which each Warrant is exercisable immediately
prior to such record date or effective date, as the case may be, would own or be
entitled to receive after such record date or effective date.
(b) In the event of any capital reorganization of the Company, or of
any reclassification of any Common Stock for which any Warrant is exercisable
(other than a subdivision or combination of outstanding shares of such Common
Stock), or in case of the consolidation of the Company with or the merger of the
Company with or into any other corporation or of the sale of the properties and
assets of the Company as, or substantially as, an entirety to any other Person,
each Warrant shall after such capital reorganization, reclassification of such
Common Stock, consolidation, merger or sale be exercisable, upon the terms and
conditions specified in this Agreement, for the number of shares of stock or
other securities or assets to which a Holder of the number of Warrant Shares
purchasable (at the time of such capital reorganization, reclassification of
such Common Stock, consolidation, merger or sale) upon exercise of such Warrant
would have been entitled upon such capital reorganization, reclassification of
such Common Stock, consolidation, merger or sale; and in any such case, if
necessary, the provisions set forth in this Section 4.2 with respect to the
-----------
rights thereafter of such Warrant shall be appropriately adjusted so as to be
applicable, as nearly as may reasonably be, to any shares of stock or other
securities or assets thereafter deliverable on the exercise of such Warrants.
(c) If any question shall at any time arise with respect to the
adjusted number of Warrant Shares, such question shall be determined by an
independent firm of certified public accountants of recognized national standing
selected by the Company.
C-18
<PAGE>
(d) Notwithstanding that the number of Warrant Shares purchasable upon
the exercise of each Warrant may have been adjusted pursuant to the terms
hereof, the Company shall nonetheless not be required to issue fractions of
Warrant Shares upon exercise of each Warrant or to distribute certificates that
evidence fractional shares, but instead shall pay to the holder of each Warrant
the cash value of any such fractional Warrant Shares.
SECTION 4.3 Notices to Warrant Holders. Upon any adjustment of the
-----------------------------
number of Warrant Shares issuable upon an exercise of the Warrants or any
adjustment of the Warrant Exercise Price pursuant to Section 4.2, the Company
-----------
shall promptly, but in any event within thirty (30) days thereafter, cause to be
given to each Warrant Holder, at its address appearing on the Warrant Register,
by first class mail, postage prepaid, a certificate signed by the Company's
Financial Officer setting forth the number of Warrant Shares issuable upon the
exercise of each Warrant as so adjusted and the Warrant Exercise Price as so
adjusted, and describing in reasonable detail the facts accounting for such
adjustment and the method of calculation used. Where appropriate, such
certificate may be given in advance and included as part of the notice required
to be mailed under the other provisions of this Section 4.3.
------------
In the event:
(a) that the Company shall authorize the issuance to all holders of its
Common Stock of rights or warrants to subscribe for or purchase capital stock of
the Company or of any other subscription rights or warrants; or
(b) that the Company shall authorize the distribution to all holders of
its Common Stock of shares of its stock, evidences of its indebtedness, assets,
or rights, options, or warrants to subscribe for or purchase such shares,
evidences of indebtedness or assets; or
(c) of any consolidation or merger to which the Company is a party and
for which approval of any shareholders of the Company is required, or of the
conveyance or transfer of the properties and assets of the Company substantially
as an entirety, or of any capital reorganization or reclassification or change
of the Common Stock (other than a change in par value, or from par value to no
par value, or from no par value to par value, or as a result of a subdivision or
combination); or
(d) of the voluntary dissolution, liquidation or winding up of the
Company; or
(e) that the Company proposes to take any other action which would
require an adjustment of the Warrant Exercise Price of the Warrants issued by it
pursuant to Section 4.2;
------------
C-19
<PAGE>
then the Company shall cause to be given to each Warrant Holder at such
Warrant Holder's address appearing on the Warrant Register, at least twenty (20)
days prior to the applicable date hereinafter specified, by first class mail,
postage prepaid, a written notice stating the date as of which the holders of
record of Common Stock to be entitled to receive any such rights, warrants or
distribution are to be determined, or the date on which any such consolidation,
merger, conveyance, transfer, dissolution, liquidation or winding up is expected
to become effective, and the date as of which it is expected that the holders of
record of Common Stock shall be entitled to exchange their shares for securities
or other property, if any, deliverable upon such reclassification,
consolidation, merger, conveyance, transfer, dissolution, liquidation or winding
up.
SECTION 4.4. Reservation and Issuance of Warrant Shares. The Company
-------------------------------------------
will at all times have authorized, and reserve and keep available, free from
preemptive rights, for the purpose of enabling it to satisfy any obligation to
issue Warrant Shares upon the exercise of the Warrants, the number of shares of
Common Stock deliverable upon exercise of all outstanding Warrants. The Company
covenants that all Warrant Shares issued by it will, upon issuance in accordance
with the terms of this Agreement, be fully paid and nonassessable.
ARTICLE V
TRANSFER OF SECURITIES
SECTION 5.1. Restrictions on Transfer. The Prepayout Members
--------------------------
understand and agree that the Securities have not been registered under the
Securities Act or any state securities Laws, and that accordingly, they will not
be fully transferable except as permitted under various exemptions contained in
the Securities Act and applicable state securities Laws, or upon satisfaction of
the registration and prospectus delivery requirements of the Securities Act and
applicable state securities Laws. The Prepayout Members acknowledge that they
must bear the economic risk of their investment in the Securities for an
indefinite period of time since the Securities have not been registered under
the Securities Act and applicable state securities Laws and therefore cannot be
sold unless they are subsequently registered or an exemption from registration
is available. Absent an effective registration statement under the Securities
Act and applicable state securities Laws covering the disposition of the
Securities, Prepayout Members will not sell, transfer, assign, pledge,
hypothecate or otherwise dispose of any or all of the Securities absent a valid
exemption from the registration and prospectus delivery requirements of the
Securities Act and the registration or qualification requirements of any
applicable state securities Laws.
SECTION 5.2. Registration, Transfer and Exchange of Warrants. (a) The
-----------------------------------------------
Company shall maintain at the offices of the Company as set forth on the
signature pages of this Agreement, the Warrant Register for registration of the
Warrants and Warrant Certificates and transfers thereof. On the Closing Date,
the Company shall register the outstanding Warrants and Warrant Certificates
issued to the Prepayout Members and the other holders of the Postpayout
Interests. The Company may deem and treat the registered Warrant Holders as the
absolute owners of the Warrants registered to such Holders and (notwithstanding
any notation of ownership or other writing on the Warrant Certificates made by
any Person) for the purpose of any exercise thereof or any distribution to the
Warrant Holders, and for all other purposes.
C-20
<PAGE>
(b) Upon satisfaction of each condition set forth in Section 5.1
-----------
hereof, the Company shall register the transfer of any outstanding Warrants in
the Warrant Register upon surrender of the Warrant Certificate(s) evidencing
such Warrants to the Company at the offices of the Company as set forth on the
signature pages of this Agreement, accompanied (if so required by it) by a
written instrument or instruments of transfer in form satisfactory to it, duly
executed by the registered Warrant Holder or by the duly appointed legal
representative thereof. Upon any such registration of transfer, new Warrant
Certificate(s) evidencing such transferred Warrants shall be issued to the
transferee(s) and the surrendered Warrant Certificate(s) shall be canceled. If
less than all the Warrants evidenced by a Warrant Certificate(s) surrendered for
transfer are to be transferred, a new Warrant Certificate(s) shall be issued to
the Warrant Holder surrendering such Warrant Certificate(s) evidencing such
remaining number of Warrants.
(c) Warrant Certificates may be exchanged at the option of the Warrant
Holder(s) thereof, when surrendered to the Company at the offices of the Company
as set forth on the signature pages of this Agreement, for another Warrant
Certificate or other Warrant Certificates of like tenor and representing in the
aggregate a like number of Warrants. Warrant Certificates surrendered for
exchange shall be canceled.
(d) No charge shall be made for any such transfer or exchange except
for any Tax or other governmental charge imposed in connection therewith.
SECTION 5.3. Mutilated or Missing Warrant Certificates. If any Warrant
-----------------------------------------
Certificate shall be mutilated, lost, stolen or destroyed, the Company shall
issue, in exchange and substitution for and upon cancellation of the mutilated
Warrant Certificate, or in lieu of and substitution for the Warrant Certificate
lost, stolen or destroyed, a new Warrant Certificate of like tenor and
representing an equivalent number of Warrants, but only upon receipt of evidence
satisfactory to the Company of such loss, theft or destruction of such Warrant
Certificate and, if requested, indemnity satisfactory to it. No service charge
shall be made for any such substitution, but all expenses and reasonable charges
associated with procuring such indemnity and all stamp, Tax and other
governmental duties that may be imposed in relation thereto shall be borne by
the holder of such Warrant Certificate.
ARTICLE VI
CONDITIONS
SECTION 6.1. Conditions Precedent to Obligations of 3TEC and Sub at
---------------------------------------------------------
Closing. The obligations of 3TEC and Sub to consummate the transactions
- -------
contemplated by this Agreement shall be subject to the fulfillment on or prior
to the Closing Date of each of the following conditions:
(a) Closing Deliveries. 3TEC shall have received the following
-------------------
certificates, instruments and documents listed below:
(i) the Assumption Agreement duly executed by Prepayout Members;
(ii) the Registration Rights Agreement duly executed by Prepayout
Members;
(iii) favorable opinions of counsel for the Prepayout Members and
Magellan, which counsel shall be reasonably acceptable to 3TEC and which
opinions shall be in form and substance reasonably satisfactory to 3TEC and
its counsel;
C-21
<PAGE>
(iv) all resolutions, certificates and documents 3TEC may reasonably
request relating to (A) the organization, existence, good standing and
foreign qualification of Magellan, (B) the authority of Magellan to execute
and deliver this Agreement and consummate the Closing Transactions, (C) the
ownership of the Magellan membership interests, and (D) such other matters
relevant to the foregoing as 3TEC shall reasonably request, all of which
shall be in form and substance reasonably satisfactory to 3TEC and its
counsel;
(v) evidence satisfactory to 3TEC that all Closing Transactions have
been consummated;
(vi) a certificate from a Authorized Officer of Magellan certifying
that each and every representation and warranty of Magellan in the
Transaction Documents is true and correct in all material respects;
(vii) the Back-In Agreement duly executed by Magellan and the
Prepayout Members;
(viii) resignations in form acceptable to 3TEC of each of the Managers
and officers of Magellan;
(ix) such other documents, instruments and agreements as 3TEC shall
reasonably request in light of the transactions contemplated hereunder.
The documents, certificates and opinions referred to in this Section 6.1(a)
--------------
shall be delivered to 3TEC no later than the Closing Date and shall, except as
expressly provided otherwise, be dated the Closing Date.
(b) Legal Matters. All legal matters with respect to Magellan, the
--------------
Transaction Documents and the Closing Transactions shall be reasonably
acceptable to 3TEC.
(c) Representations and Warranties. The representations and warranties
------------------------------
of Prepayout Members and Magellan contained in this Agreement and in the other
Transaction Documents shall be true and correct in all material respects on the
Closing Date as if they were made on such date (however, in determining the
truth and correctness of any representation or warranty no effect shall be given
to any limitation contained in such representation or warranty as to Knowledge),
except as affect by transactions contemplated or permitted by this Agreement or
in the other Transaction Documents and except to the extent that any such
representation and warranty is made as of a specified date, in which cash such
representation and warranty shall have been true and correct in all material
respects as of such specified date.
(d) No Material Adverse Effect. No event has occurred or condition
-----------------------------
exists which has had or would reasonably be expected to have a Material Adverse
Effect on Magellan.
C-22
<PAGE>
(e) HSR. If applicable, the waiting period applicable to the
---
transactions contemplated hereby under the HSR Act shall have expired or been
terminated and all filings required to be made prior to the Closing Date, and
all consents, approvals, permits and authorizations required to be obtained
prior to the Closing Date from any Governmental Authority in connection with
execution and delivery of this Agreement and the consummation of the
transactions contemplated hereby shall have been made or obtained.
(f) Approval of 3TEC Disinterested Directors. A majority of the 3TEC
-----------------------------------------
Disinterested Directors shall have approved the transactions contemplated herein
by formal action of the 3TEC Disinterested Director Committee.
(g) Receipt of Fairness Opinion. The 3TEC Disinterested Director
-------------------------------
Committee shall have received a "fairness opinion" from the financial firm of
its choice, in form and substance satisfactory to it, and such opinion shall not
have been withdrawn.
(h) 3TEC Shareholder Approval. The holders of a majority of the
---------------------------
Disinterested Shares voting at the Special Meeting shall have duly and validly
approved the issuance of the Securities.
(i) Consent of 3TEC Lenders. 3TEC shall have received the written
---------------------------
consent and approval of the Lenders (defined below) to the Merger as required
under Section 13(d) of that certain Restated Credit Agreement dated November 23,
1999, among 3TEC, Enex Resources Corporation, and Middle Bay Production Company,
Inc., as Borrowers, and Bank One, Texas, N.A., The Bank of Nova Scotia, Union
Bank of California, N.A., Wells Fargo Bank, CIBC, Inc., as Lenders
(collectively, the "Lenders"), Bank One Texas, N.A., as Administrative Agent,
and Union Bank of California, N.A., as Syndication Agent, and Banc One Capital
Markets, Inc., as Arranger.
(j) Covenants and Agreements Performed. Magellan and the Prepayout
-------------------------------------
Members shall have performed and complied with in all material respects all
covenants and agreements required by this Agreement to be performed or complied
with by them on or prior to the Closing Date.
(k) Actions or Proceedings. No action or proceeding shall, on the
------------------------
Closing Date, be pending or threatened to restrain, prohibit or obtain damages
or other relief in connection with this Agreement or the other Transaction
Documents or the consummation of the transactions contemplated thereby.
SECTION 6.2. Conditions Precedent to Magellan's and Prepayout Members'
---------------------------------------------------------
Obligations at Closing. The obligations of the Prepayout Members and Magellan
- ------------------------
to consummate the transactions contemplated by this Agreement shall be subject
to the fulfillment on or prior to the Closing Date of each of the following
conditions:
(a) Closing Deliveries. 3TEC shall have delivered to Prepayout
-------------------
Members, in form and substance satisfactory to the Prepayout Members each of the
following:
(i) the Registration Rights Agreement duly executed by 3TEC;
(ii) the Back-In Agreement duly executed by Magellan;
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<PAGE>
(iii) all resolutions, certificates and documents the Prepayout
Members may reasonably request relating to (A) the organization, existence,
good standing and foreign qualification of 3TEC and Sub, (B) the authority
3TEC and Sub to execute and deliver this Agreement and consummate the
Closing Transactions, and (C) such other matters relevant to the foregoing
as the Prepayout Members shall reasonably request, all of which shall be in
form and substance reasonably satisfactory to the Prepayout Members and
their counsel;
(iv) evidence reasonably satisfactory to the Prepayout Members that
all Closing Transactions have been consummated;
(v) a certificate from an Authorized Officer of 3TEC certifying that
(a) each and every representation and warranty of the Company and Sub in
the Transaction Documents is true and correct in all material respects and
(b) 3TEC and Sub have each performed and complied with in all material
respects all covenants and agreements required by this Agreement to be
performed or complied with by it on or prior to the Closing Date;
(vi) an opinion of Hinkle Elkouri Law Firm L.L.C., counsel for 3TEC,
in form and substance reasonably satisfactory to the Prepayout Members and
their counsel; and
(vii) such other documents, instruments and agreements as the
Prepayout Members shall reasonably request.
The documents and certificates referred to in this Section 6.2(a) shall be
--------------
delivered to the Prepayout Members no later than the Closing Date and shall,
except as expressly provided otherwise, be dated the Closing Date.
(b) Representations and Warranties. The representations and warranties of
------------------------------
3TEC and Sub contained in this Agreement and in the other Transaction Documents
shall be true and correct in all material respects on the Closing Date as if
they were made on such date except as affect by transactions contemplated or
permitted by this Agreement or in the other Transaction Documents and except to
the extent that any such representation and warranty is made as of a specified
date, in which cash such representation and warranty shall have been true and
correct in all material respects as of such specified date.
(c) Legal Matters. All legal matters with respect to 3TEC, the
--------------
Transaction Documents and the Closing Transactions shall be reasonably
acceptable to the Prepayout Members and Magellan.
(d) No Material Adverse Effect. No event has occurred or condition
-----------------------------
exists which has had or would reasonably be expected to have a Material Adverse
Effect on 3TEC.
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<PAGE>
(e) HSR. If applicable, the waiting period applicable to the
---
transactions contemplated hereby under the HSR Act shall have expired or been
terminated and all filings required to be made prior to the Closing Date, and
all consents, approvals, permits and authorizations required to be obtained
prior to the Closing Date from any Governmental Authority in connection with
execution and delivery of this Agreement and the consummation of the
transactions contemplated hereby shall have been made or obtained.
(f) Approval of 3TEC Disinterested Directors. A majority of the 3TEC
-----------------------------------------
Disinterested Directors shall have approved the transactions contemplated herein
by formal action of the 3TEC Disinterested Director Committee.
(g) Receipt of Fairness Opinion. The 3TEC Disinterested Director
-------------------------------
Committee shall have received a "fairness opinion" from the financial firm of
its choice, in form and substance satisfactory to it, and such opinion shall not
have been withdrawn.
(h) 3TEC Shareholder Approval. The holders of a majority of the
---------------------------
Disinterested Shares voting at the Special Meeting shall have duly and validly
approved the issuance of the Securities.
(i) Consents. Magellan shall have received all third-party consents
--------
and approvals required to make the representation set forth in Section 7.2 true
-----------
as of the Closing Date.
(j) Covenants and Agreements Performed. 3TEC and Sub shall have
-------------------------------------
performed and complied with in all material respects all covenants and
agreements required by this Agreement to be performed or complied with by it on
or prior to the Closing Date.
(k) Actions or Proceedings. No action or proceeding shall, on the
------------------------
Closing Date, be pending or threatened to restrain, prohibit or obtain damages
or other relief in connection with this Agreement or the other Transaction
Documents or the consummation of the transactions contemplated thereby.
(l) Preferential Rights. None of the Magellan Members shall have
--------------------
validly exercised any Magellan Preferential Rights.
ARTICLE VII
REPRESENTATIONS AND WARRANTIES OF MAGELLAN
AND THE PREPAYOUT MEMBERS
Subject to the Magellan Disclosure Schedule, Magellan hereby represents and
warrants, and each Prepayout Member severally (and not jointly and severally)
represents and warrants (except with respect to a representation and warranty in
Section 7.2, 7.3 and 7.19 to the extent that it relates specifically to a
Prepayout Member, which are made by each Prepayout Member only as to such
Prepayout Member and not as to any other Prepayout Member), as follows:
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<PAGE>
SECTION 7.1. Existence and Power. Magellan (a) is a limited liability
--------------------
company, duly organized, validly existing and in good standing under the Laws
of its jurisdiction of formation set forth on Schedule 7.1 of the Magellan
------------
Disclosure Schedule, (b) has all requisite limited liability company power and
authority necessary to carry on its business as it is now conducted, and (c) is
duly qualified as a foreign limited liability company in each jurisdiction set
forth on Schedule 7.1 on the Magellan Disclosure Schedule which constitutes all
------------
jurisdictions where a failure to be so qualified would reasonably be expected to
have a Material Adverse Effect on Magellan.
SECTION 7.2. Authorization; Contravention. The execution, delivery and
----------------------------
performance of this Agreement and the other Transaction Documents by Magellan
and each Prepayout Member are within Magellan's and such Prepayout Member's
powers, have been duly authorized by all necessary action, require no action by
or in respect of, or filing with, any Governmental Authority, and, except for
matters which have been waived in writing by the appropriate Person, do not
contravene, or constitute a default under, any provision of applicable Law or of
the Charter Documents of Magellan or of any material judgment, injunction,
order, decree or Material Agreement binding upon such Prepayout Member or
Magellan or their respective assets, or result in the creation or imposition of
any Lien on any asset of Magellan.
SECTION 7.3. Binding Effect. This Agreement constitutes the valid and
--------------
binding agreement of Magellan and each Prepayout Member; each other Transaction
Document when executed and delivered in accordance with this Agreement, will
constitute the valid and binding obligation of Magellan and each Prepayout
Member, in each case enforceable against it in accordance with its terms except
as (i) the enforceability thereof may be limited by bankruptcy, insolvency or
similar Laws affecting creditors rights generally, and (ii) the availability of
equitable remedies may be limited by equitable principles of general
applicability.
SECTION 7.4. Ownership. Schedule 7.4 of the Magellan Disclosure
--------- -------------
Schedule accurately and completely sets forth for Magellan (a) its outstanding
membership interests, (b) the names of the record, and to each Prepayout
Member's Knowledge, beneficial owner, of its membership interests, and (c) each
Magellan Member's Prepayout Interests and Postpayout Interests. Except for the
Magellan Preferential Rights and as set forth in Schedule 7.4 of the Magellan
------------
Disclosure Schedule (x) there are not outstanding any options, warrants or other
rights to acquire membership interests of any kind in Magellan or securities
convertible into membership interests in Magellan (y) no Person has any
preemptive or similar rights with respect to any subsequent issue of membership
interests by Magellan, and (z) no Person has any right to require Magellan to
register any membership interests under the Securities Act.
SECTION 7.5. Financial Statements. The Magellan Financial Statements
---------------------
were prepared in accordance with GAAP applied on a consistent basis during the
periods involved and fairly present in all material respects, in accordance with
applicable requirements of GAAP (in the case of unaudited statements, subject to
normal, recurring adjustments), the financial position of Magellan as of their
respective dates and the consolidated results of operations and the cash flows
of Magellan for the periods presented therein. Except as set forth on Schedule
--------
7.5, there are no material liabilities of Magellan (contingent or otherwise),
- ---
other than as disclosed in the Magellan Financial Statements. There are no
material imbalances of production from the oil and gas properties of Magellan
whether required to be disclosed pursuant to GAAP or otherwise. Since December
31, 1998, no event has occurred or condition exists which has had or could be
expected to have a Material Adverse Effect on Magellan. As of the Closing Date,
Magellan will have no long term Debt and current assets will exceed or be equal
to current liabilities.
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<PAGE>
SECTION 7.6. Material Agreements. Schedule 7.6 of the Magellan
-------------------- -------------
Disclosure Schedule contains a complete and accurate description of every
Material Agreement to which Magellan is a party (other than the Transaction
Documents) or by which Magellan or any of its assets are bound (including all
amendments and modifications thereto). The Prepayout Members have made
available to 3TEC or provided 3TEC with a true and correct copy of all such
Material Agreements, including all amendments and modifications thereof.
Magellan has not breached any material provision of, nor is in material default
under the terms of, any Material Agreement, nor has any event occurred nor does
any condition exist which, with the giving of notice or the passage of time or
both, could constitute any such material breach or material default. To each
Prepayout Member's Knowledge, no other party to any Material Agreement is in
default thereunder in any material respect.
SECTION 7.7. Investments. Except as set forth on Schedule 7.7 of the
----------- ------------
Magellan Disclosure Schedule, Magellan has no outstanding Investments.
SECTION 7.8. Outstanding Debt. Schedule 7.8 of the Magellan Disclosure
---------------- ------------
Schedule contains a complete and accurate description of all Debt of Magellan
outstanding on the date hereof. Magellan is not in default in payment of any
Debt with respect to which it is an obligor or in default of any covenant,
agreement, representation, warranty or other term of any document, instrument or
agreement evidencing, securing or otherwise pertaining to any such Debt.
SECTION 7.9. Transactions with Affiliates. Schedule 7.9 of the
------------------------------ -------------
Magellan Disclosure Schedule contains a complete and accurate description of all
contracts, agreements and other arrangements (whether written, oral, express or
implied) between Magellan and any Affiliate of Magellan in existence on the date
hereof, including, without limitation, a complete and accurate description of
all Investments of Magellan in any Affiliate of Magellan.
SECTION 7.10. Employment Matters. Schedule 7.10 of the Magellan
------------------- --------------
Disclosure Schedule contains a complete and accurate list of all employees of
Magellan. Such schedule also sets forth for the current fiscal year the annual
salary (including projected bonuses and other cash compensation) of all such
employees and all benefits (other than health insurance benefits and other
similar benefits which are both customary in the industry in which Magellan is
engaged) and provided to all full time employees of Magellan provided to such
employees. Schedule 7.10 of the Magellan Disclosure Schedule also contains a
--------------
complete and accurate description of all employment contracts, consulting
agreements, management agreements, non-compete and similar agreements to which
Magellan is a party on the date hereof.
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<PAGE>
SECTION 7.11. Litigation. Except as set forth on Schedule 7.11 of the
---------- -------------
Magellan Disclosure Schedule, there is no action, suit or proceeding pending
against, or to the Knowledge of Magellan and the Prepayout Members, threatened
against or involving Magellan before any court or arbitrator or any Governmental
Authority.
SECTION 7.12. ERISA. Neither Magellan nor any ERISA Affiliate
-----
maintains or contributes to any Pension Plan other than those disclosed on
Schedule 7.12 of the Magellan Disclosure Schedule. Each such Pension Plan is in
- -------------
compliance in all material respects with its terms and the applicable provisions
of ERISA and the IRC. Except as required by law, neither Magellan or any ERISA
Affiliate has any commitment to create any additional Pension Plans. Except as
set forth on Schedule 7.12, neither Magellan or any ERISA Affiliate has ever
-------- ----
sponsored, adopted, maintained or been obligated to contribute to, or had any
liability under, any Pension Plan. There is no material violation of ERISA with
respect to the filing of applicable reports, documents and notices regarding the
Pension Plans with the Secretary of the Treasury or the furnishing of such
documents to the participants and beneficiaries of the Pension Plans, and, to
the Knowledge of Magellan and the Prepayout Members, with respect to each
Pension Plan all other reports required under ERISA or the IRC to be filed with
any Governmental Authority have been duly filed and all such reports are true
and correct in all material respects as of the dates given. Each Pension Plan
that is intended to be "qualified" within the meaning of section 401(a) of the
IRC is, and has been during the period from its adoption to date, so qualified,
both as to form and, to the Knowledge of Magellan and the Prepayout Members has
been qualified, and all necessary governmental approvals, including a favorable
determination as to the qualification under the IRC of each of such Pension
Plans and each amendment thereto, have been timely obtained or application for a
favorable determination will be filed prior to the applicable filing deadlines.
Except as disclosed on Schedule 7.12 of the Magellan Disclosure Schedule, each
-------------
trust created under any such Pension Plan intended to be qualified within the
meaning of section 401(a) of the IRC and each trust described in section
501(c)(9) of the IRC is exempt from federal income taxation under section 501(a)
of the IRC and has been so exempt during the period from creation to date.
Magellan has no pending or, to the Knowledge of Magellan and the Prepayout
Members, threatened claims, lawsuits or actions (other than routine claims for
benefits in the ordinary course) asserted or instituted against, and neither
Magellan nor the Prepayout Members have Knowledge of any threatened litigation
or claims against, the assets of any Pension Plan or its related trust or
against any fiduciary of a Pension Plan with respect to the operation of such
Pension Plan. Neither Magellan or any Prepayout Member has received notice of
any pending investigations, inquiries or audits with respect to any Pension Plan
by any regulatory agency. Magellan has not engaged in any prohibited
transactions, within the meaning of section 406 of ERISA or section 4975 of the
IRC, in connection with any Pension Plan. Magellan does not maintain nor has it
established any Pension Plan which is a welfare benefit plan within the meaning
of section 3(1) of ERISA which provides for retiree medical liabilities or
continuing benefits or coverage for any participant or any beneficiary of any
participant after such participant's termination of employment except as may be
required by the Consolidated Omnibus Budget Reconciliation Act of 1985, as
amended ("COBRA") and the regulations thereunder, and at the expense of the
-----
participant or the beneficiary of the participant. If Magellan has or does
maintain a Pension Plan that is a welfare benefit plan within the meaning of
section 3(1) of ERISA it has complied with any applicable notice and
continuation requirements of COBRA and the regulations thereunder. Magellan has
not maintained, or established, or has ever participated in, a multiple employer
welfare benefit arrangement within the meaning of section 3(40)(A) of ERISA.
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<PAGE>
SECTION 7.13. Taxes and Filing of Tax Returns. Magellan has filed all
-------------------------------
Tax returns required to have been filed by it or has legally extended such
returns and has paid all Taxes shown to be due and payable on such returns,
including interest and penalties, and all other Taxes which are payable by
Magellan. None of Magellan or the Prepayout Members has any Knowledge of any
proposed Tax assessment against Magellan and all Tax liabilities of Magellan are
adequately provided for and no Tax liability of Magellan has been asserted by
the Internal Revenue Service or any other Governmental Authority for Taxes in
excess of those already paid.
SECTION 7.14. Title to Assets. Magellan has Defensible Title to all
------------------
Oil and Gas Interests of Magellan included or reflected in the Ownership
Interests and all of their material other assets, subject only to Permitted
Encumbrances. Each Oil and Gas Interest included or reflected in the Ownership
Interests entitles Magellan to receive not less than the undivided interest set
forth in (or derived from) the Ownership Interests of all Hydrocarbons produced,
saved and sold from or attributable to such Oil and Gas Interest, and the
portion of such costs and expenses of operation and development of such Oil and
Gas Interest that is borne or to be borne by Magellan is not greater than the
undivided interest set forth in (or derived from) the Ownership Interests. All
proceeds from the sale of Magellan's share of the Hydrocarbons being produced
from its Oil and Gas Interests are currently being paid in full to such party by
the purchasers thereof on a timely basis and none of such proceeds are currently
being held in suspense by such purchaser or any other party, except as set forth
on Schedule 7.14 of the Magellan Disclosure Schedule.
--------------
SECTION 7.15. Licenses, Permits, Etc. Magellan possesses all
------------------------
franchises, certificates, licenses, permits, consents, authorizations,
exemptions and orders of Governmental Authorities as are necessary to carry on
its business as now being conducted and as proposed to be conducted, except to
the extent a failure to have such franchises, certificates, licenses, permits,
consents, authorizations, exemptions and orders would reasonably be expected to
not have a Material Adverse Effect on Magellan.
SECTION 7.16. Proprietary Rights. Magellan has ownership of, or valid
------------------
licenses to use, all trademarks, copyrights, patents and other proprietary
rights used in its business. The operation of the businesses of Magellan does
not infringe any patent, copyright, trademark or other proprietary rights of
others, and no Prepayout Member nor Magellan has received any notice from any
third party of any such alleged infringement by Magellan. Magellan has taken
reasonable steps to establish and preserve its respective ownership of all
patents, copyrights, trademarks, trade secrets and other proprietary rights.
Neither Magellan nor any Prepayout Member is aware of any infringement by others
of Magellan's patents, copyrights, trademarks or other proprietary rights.
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<PAGE>
SECTION 7.17. Compliance with Law. The business and operations of
---------------------
Magellan have been and are being conducted in material compliance with all
applicable Laws.
SECTION 7.18. Environmental Matters.
----------------------
(a) Except as set forth on Schedule 7.18 of the Magellan Disclosure
-------------
Schedule, the reserves reflected in Magellan's Financial Statements relating to
environmental matters were adequate under GAAP as of the date of such financial
statements, and Magellan has not incurred any material liability in respect of
any environmental matter since that date.
(b) Except as set forth in Schedule 7.18 of the Magellan Disclosure
-------------
Schedule:
(i) Magellan has conducted its business and operated its assets, and
is conducting its business and operating its assets, in material compliance
with all Environmental Laws.
(ii) Magellan has not been notified by any Governmental Authority that
any of the operations or assets of Magellan is the subject of any
investigation or inquiry by any Governmental Authority evaluating whether
any material remedial action is needed to respond to a release of Hazardous
Substance or to the improper storage or disposal (including storage or
disposal at offsite locations) of any Hazardous Substance.
(iii) No Authorized Officer of Magellan or any other Person has filed
any notice under any federal, state or local law indicating that (i)
Magellan is responsible for the improper release into the environment, or
the improper storage or disposal of any Hazardous Substance, or (ii) any
Hazardous Substance is improperly stored or disposed of upon any property
of Magellan.
(iv) Magellan does not have any Hazardous Substance contingent
liability in connection with (i) release into the environment at or on the
property now or previously owned or leased by Magellan, or (ii) the storage
or disposal of any Hazardous Substance.
(v) Magellan has not received any claim, complaint, notice, inquiry or
request for information which remains unresolved as of the date hereof with
respect to any alleged violation of any Environmental Laws or regarding
potential liability under any Environmental Laws relating to operations or
conditions of any facilities or property owned, leased or operated by
Magellan.
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<PAGE>
(vi) There are no sites, locations or operations at which Magellan is
currently undertaking, or have completed, any remedial or response action
relating to any such disposal or release, as required by Environmental
Laws.
(vii) There are no physical or environmental conditions existing on
any property owned or leased by Magellan resulting from Magellan's
operations or activities, past or present, at any location, that would give
rise to any on-site or off-site remedial obligations under any applicable
Environmental Laws, other than normal and ordinary remedial work associated
with plugging and abandoning of oil and gas facilities.
SECTION 7.19. Investment Representation. Each Prepayout Member
--------------------------
understands that the Securities have not been registered under the Securities
Act of 1933 and that the Securities are being offered and sold pursuant to an
exemption from registration contained in the Securities Act based in part upon
such Prepayout Member's representations contained in this Agreement. Taking
into account its respective personnel and resources, each Prepayout Member is
knowledgeable, sophisticated and experienced in making , and is qualified to
make, decisions with respect to investments in securities presenting an
investment decision like that involved in the purchase of the Securities, and
has requested, received, reviewed and considered all information such Prepayout
Member deems relevant in making an informed decision to purchase the Securities.
Each Prepayout Member is acquiring the Securities for its own account for
investment only and, except as described in Section 7.19 of the Magellan
Disclosure Schedule, with no present intention of distributing any of the
Securities and has no arrangement or understanding with any other persons
regarding the distribution of the Securities. No Prepayout Member will,
directly or indirectly, offer, sell, pledge, transfer or otherwise dispose of
(or solicit any offers to buy, purchase or otherwise acquire or take a pledge
of) any of the Securities except in compliance with the Securities Act and
applicable state securities laws, the rules and regulations promulgated
thereunder and the terms and conditions hereof. Each Prepayout Member is an
"accredited investor" within the meaning of Rule 501 of Regulation D promulgated
under the Securities Act.
SECTION 7.20. Fiscal Year. Magellan's fiscal year is from January 1 to
-----------
December 31.
SECTION 7.21. Insurance. Schedule 7.21 of the Magellan Disclosure
--------- --------------
Schedule contains a complete and accurate list and description of all insurance
policies maintained by Magellan as of the date hereof.
SECTION 7.22. Government Regulation. Magellan is not subject to
----------------------
regulation under the Public Utility Holding Company Act of 1935, the Interstate
Commerce Act (as either of the preceding acts have been amended), or any other
Law which regulates the incurring by Magellan of Debt, including, but not
limited to, Laws relating to common contract carriers of the sale of
electricity, gas, steam, water or other public utility services.
SECTION 7.23. Brokers and Finders. No Person engaged by Magellan or
--------------------
any Prepayout Member has or will have any right or valid claim against 3TEC for
any commission, fee or other compensation resulting from or relating to the
transactions set forth in this Agreement. The Prepayout Members will indemnify
and hold 3TEC harmless against any liability or expense arising out of, or in
connection with, any such right or claim.
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<PAGE>
SECTION 7.24. Oil and Gas Operations. Except as set forth on Schedule
----------------------- --------
7.24 of the Magellan Disclosure Schedule:
- ----
(a) All wells included in the Oil and Gas Interests of Magellan (the
"Wells") have been drilled and (if completed) completed, operated and produced
in accordance with generally accepted oil and gas field practices and in
compliance in all material respects with applicable oil and gas leases and
applicable laws, rules, regulations. The Wells have been drilled and completed
within the limits permitted by contract, pooling or unit agreement, and by law;
and all drilling and completion of the Wells and all development and operations
have been conducted in material compliance with all applicable laws, ordinances,
rules, regulations and permits, and judgments, orders and decrees of any court
or governmental body or agency. No Well is subject to penalties on allowables
because of any overproduction or any other violation of applicable laws, rules,
regulations or permits or judgments, orders or decrees of any court or
governmental body or agency that would prevent such Well from being entitled to
its full legal and regular allowable from and after the Closing Date as
prescribed by any court or governmental body or agency.
(b) There are no Wells that
(i) Magellan is currently obligated by law or contract to plug and
abandon;
(ii) Magellan will be obligated by law or contract to plug and abandon
with the lapse of time or notice or both because the Well is not currently
capable of producing in commercial quantities;
(iii) are subject to exceptions to a requirement to plug and abandon
issued by a regulatory authority having jurisdiction over the applicable
lease; or
(iv) have been plugged and abandoned but have not been plugged in
accordance with all applicable requirements of each regulatory authority
having jurisdiction over the Oil and Gas Interests.
(c) With respect to the oil, gas and other mineral leases, unit
agreements, pooling agreements, communitization agreements and other documents
creating interests comprising the Oil and Gas Interests: (a) Magellan has
fulfilled all requirements in all material respects for filings, certificates,
disclosures of parties in interest, and other similar matters contained in (or
otherwise applicable thereto by law, rule or regulation) such leases or other
documents and are fully qualified to own and hold all such leases or other
interests; (b) there are no provisions applicable to such leases or other
documents which increase the royalty share of the lessor thereunder, and (c)
upon the establishment and maintenance of production in commercial quantities,
the leases and other interest are to be in full force and effect over the
economic life of the property involved and do not have terms fixed by a certain
number of years.
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<PAGE>
(d) Proceeds from the sale of Hydrocarbons produced from Magellan's Oil
and Gas Interests are being received by Magellan in a timely manner and are not
being held in suspense for any reason (except for amounts, individually or in
the aggregate, not in excess of $10,000 and held in suspense in the ordinary
course of business).
(e) Magellan is not obligated, by virtue of a prepayment arrangement, a
"take or pay" arrangement, a production payment or any other arrangement to
deliver Hydrocarbons produced from the Oil and Gas Interests at some future time
without then or thereafter receiving full payment therefor.
SECTION 7.25. Financial and Commodity Hedging. Schedule7.25 of the
----------------------------------- ------------
Magellan Disclosure Schedule accurately summarizes the outstanding Hydrocarbon
and financial hedging positions of Magellan (including fixed price controls,
collars, swaps, caps, hedges and puts) as of the date reflected on said
Schedule. From the date of this Agreement to the date of Closing, Magellan will
not enter into any new hedging positions without 3TEC's prior written consent.
SECTION 7.26. Books and Records. All books, records and files of
--------------------
Magellan (including those pertaining to Magellan's Oil and Gas Interests, wells
and other assets, those pertaining to the production, gathering, transportation
and sale of Hydrocarbons, and corporate, accounting, financial and employee
records) (a) have been prepared, assembled and maintained in accordance with
usual and customary policies and procedures and (b) fairly and accurately
reflect the ownership, use, enjoyment and operation by the Magellan of its
assets in all material respects.
SECTION 7.27. Reserve Report. To the Knowledge of Magellan and the
----------------
Prepayout Members, the estimates of proved reserves of oil and natural gas
prepared by Ryder Scott Company ( the "Reserve Engineer") as of October 1, 1999
(the "Reserve Report"): (i) are reasonable; and (ii) were prepared in accordance
with generally accepted petroleum engineering and evaluation principles as set
forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas
Reserve Information promulgated by the Society of Petroleum Engineers. The
engineering information and production data used in the preparation of the
Reserve Report, which information and data have been available to 3TEC, are the
information and data which are used by Magellan in good faith in the ordinary
course of business. The factual information underlying the estimates of the
reserves of Magellan, which was supplied by Magellan to the Reserve Engineers
for the purpose of preparing the Reserve Report, including, without limitation,
production, volumes, sales prices for production, contractual pricing provisions
under oil or gas sales or marketing contracts under hedging arrangements, costs
of operations and development, and working interest and net revenue information
relating to the Magellan's ownership interests in properties, was true and
correct in all material respects on the date of such Reserve Report; the
estimates of future capital expenditures and other future exploration and
development costs supplied to the Reserve Engineers were prepared in good faith
and with a reasonable basis; the information provided to the Reserve Engineers
for purposes of preparing the Reserve Report was prepared in accordance with
customary industry practices; other than normal production of the reserves and
intervening oil and gas price fluctuations, neither Prepayout Members or
Magellan is aware as of the date hereof and as of the Closing Date will not be,
aware of any facts or circumstances that would result in a materially adverse
change in the reserves in the aggregate, or the aggregate present value of
future net cash flows therefrom, as described in the Reserve Report.
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<PAGE>
SECTION 7.28. Nature of Magellan Assets. The assets of Magellan consist
--------------------------
solely of (i) reserves of oil and gas, rights to reserves of oil and gas and
associated exploration and production assets with a fair market value not
exceeding $500 million and (ii) other assets with a fair market value not
exceeding $15 million. For purposes of this Section 7.28, the term "associated
exploration and production assets" shall have the meaning set forth in Section
802.3 of the Rules promulgated pursuant to HSR Act.
SECTION 7.29. Full Disclosure. No information heretofore furnished by or
---------------
on behalf of the Prepayout Members or Magellan to 3TEC for the purposes of this
Agreement or any other Transaction Document or any transaction contemplated
hereby or thereby, contained, and no written information hereafter furnished by
or on behalf of the Prepayout Members or Magellan to 3TEC for purposes of this
Agreement or any other Transaction Document or any transaction contemplated
hereby or thereby will contain at the time of delivery, any untrue statement of
a material fact or omit a material fact necessary to make the statements therein
not misleading. To the Knowledge of Magellan and the Prepayout Members, there
is no fact or circumstance which would reasonably be expected to have a Material
Adverse Effect on Magellan which has not been disclosed to 3TEC.
SECTION 7.30. Year 2000 Compliance. Any reasonable reprogramming required
--------------------
to permit the proper functioning in and following the year 2000 of computer
systems and other equipment containing embedded microchips, in either case owned
or operated by Magellan or used or relied upon in the conduct of its business,
and the reasonable testing of all such systems and other equipment as so
reprogrammed, will be completed prior to December 31, 1999.
SECTION 7.31. Disclaimer of Warranties. Other than those expressly set
--------------------------
out in this Article VII, Magellan and the Prepayout Members hereby expressly
------------
disclaim any and all representations or warranties with respect to Magellan, its
business or assets or the transactions contemplated hereby and under the other
Transaction Documents, and 3TEC agrees that the business and assets of Magellan
are being sold on a "where is" and "as is" basis. Without limiting the
foregoing, but except as otherwise expressly set forth in this Agreement,
Magellan and the Prepayout Members hereby expressly disclaim any representation
or warranty (express, implied, under common law, by statute or otherwise) as to
the condition of Magellan's assets or properties (INCLUDING WITHOUT LIMITATION,
MAGELLAN AND THE PREPAYOUT MEMBERS DISCLAIM ANY IMPLIED OR EXPRESS WARRANTY OF
MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, OR CONFORMITY TO MODELS OR
SAMPLES OF MATERIALS).
ARTICLE VIII
REPRESENTATIONS AND WARRANTIES OF 3TEC AND SUB
3TEC and Sub hereby jointly and severally represent and warrant to Magellan
and the Prepayout Members as follows:
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<PAGE>
SECTION 8.1. Corporate Existence and Power. 3TEC (a) is a corporation,
-----------------------------
duly organized, validly existing and in good standing under the Laws of its
jurisdiction of incorporation, (b) has all corporate power and authority
necessary to carry on its business as now conducted and as proposed to be
conducted, and (c) is duly qualified as a foreign corporation in all
jurisdictions where such qualification is necessary to conduct its business.
Sub is a limited liability company, duly organized, validly existing and in good
standing under the Laws of the State of Delaware, and has all limited liability
company power and authority necessary to carry on its business as now conducted
and as proposed to be conducted.
SECTION 8.2. Corporate and Governmental Authorization; Contravention.
--------------------------------------------------------
The execution, delivery and performance of this Agreement and the other
Transaction Documents by 3TEC and Sub are within its respective corporate
powers, have been duly authorized by all necessary corporate action, require no
action by or in respect of, or filing with, any Governmental Authority (other
than the Proxy Statement as defined in Section 10.1 and the shareholder vote
required for the approval of the issuance of the Securities), and, except for
matters which have been waived in writing by the appropriate Person, do not
contravene, or constitute a default under, any provision of applicable Law or of
3TEC's or Sub's (as applicable) Charter Documents or of any material judgment,
injunction, order, decree or Material Agreement binding upon 3TEC or Sub or
their respective assets, or result in the creation or imposition of any Lien on
any asset of 3TEC or Sub.
SECTION 8.3. Binding Effect. This Agreement constitutes the valid and
--------------
binding agreement of each of 3TEC and Sub; each other Transaction Document when
executed and delivered in accordance with this Agreement, will constitute the
valid and binding obligation of 3TEC and Sub, in each case enforceable in
accordance with its terms except as (i) the enforceability thereof may be
limited by bankruptcy, insolvency or similar Laws affecting creditors rights
generally, and (ii) the availability of equitable remedies may be limited by
equitable principles of general applicability.
SECTION 8.4. Brokers and Finders. No Person engaged by 3TEC or Sub has
-------------------
or will have any right or valid claim against the Prepayout Members or Magellan
for any commission, fee or other compensation. 3TEC will indemnify and hold
Prepayout Members and Magellan harmless against any liability or expense arising
out of, or in connection with, any such right or claim.
SECTION 8.5. SEC Documents. The Company is current in its obligations
-------------
to file all periodic reports and proxy statements with the Commission required
to be filed under the Exchange Act. The Prepayout Members have had available to
them true and correct complete copies of each report, schedule, Registration
Statement and definitive proxy statement filed by the Company with the
Commission since January 1, 1999, and prior to the date of this Agreement (the
"SEC Documents"), which are all the documents (other than preliminary material)
that the Company was required to file with the Commission since such date. As
of their respective dates, the SEC Documents complied in all material respects
with the requirements of the Securities Act or the Exchange Act as the case may
be, and the rules and regulations of the Commission thereunder applicable to
such SEC Documents, and none of the SEC Documents contained any untrue statement
of a material fact or omitted to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading. The 3TEC Financial
Statements included in the SEC Documents comply in all material respects with
the published rules and regulations of the Commission with respect thereto, and
such 3TEC Financial Statements (i) were prepared from the books and records of
3TEC and its consolidated subsidiaries, (ii) were prepared in accordance with
GAAP applied on a consistent basis (except as may be indicated therein or in the
notes or schedules thereto) and (iii) present fairly the financial position of
3TEC as at the dates thereof.
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<PAGE>
SECTION 8.6. Absence of Undisclosed Liabilities. Except as and to the
----------------------------------
extent disclosed in the SEC Filings filed prior to the date hereof, as of
September 30, 1999, the Company has no material liabilities or obligations
(whether accrued, absolute, contingent, unliquidated, or otherwise, whether or
not known to the Company, and whether due or to become due) of a nature required
by generally accepted accounting principles to be recognized or disclosed in
consolidated financial statements of the Company. Since September 30, 1999, the
Company has not incurred any such liabilities or obligations, other than those
incurred in the ordinary course of business consistent with past practice or
pursuant to or as contemplated by this Agreement.
SECTION 8.7. Absence of Certain Changes. Except as disclosed in the
----------------------------
SEC Documents filed prior to the date hereof, since September 30, 1999 (i) there
has not been any material adverse change in, or any event or condition that
might reasonably be expected to result in any material adverse change in, the
business, assets, results of operations, condition (financial or otherwise), or
prospects of the Company; (ii) the business of the Company has been conducted
only in the ordinary course consistent with past practice; (iii) the Company has
not incurred any material liability, engaged in any material transaction, or
entered into any material agreement outside the ordinary course of business
consistent with past practice; and (iv) the Company has not suffered any
material loss, damage, destruction, or other casualty to any of its assets
(whether or not covered by insurance).
SECTION 8.8. Securities. The Securities to be issued by the Company at
----------
the Closing will have been duly authorized for such issuance and, when issued
and delivered by the Company in accordance with the provisions of this
Agreement, will be validly issued, fully paid, and nonassessable. The issuance
of the Securities under this Agreement is not subject to any preemptive or
similar rights.
ARTICLE IX
COVENANTS OF MAGELLAN
Magellan hereby covenants and agrees, and each Prepayout Member severally
(and not jointly and severally) covenants and agrees, as follows:
SECTION 9.1. Maintenance of Insurance. Magellan will, at all times
--------------------------
prior to Closing, maintain or cause to be maintained insurance issued by
insurers of recognized responsibility covering such risks and in such amounts as
are customary in the case of companies of established reputation engaged in the
same or similar business and similarly situated.
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<PAGE>
SECTION 9.2. Payment of Taxes and Claims. Magellan will, at all times
---------------------------
prior to Closing, pay when due (a) all Taxes imposed upon it or its respective
assets and, with respect to its respective franchises, business, income or
profits, pay such Taxes before any material penalty or interest accrues thereon,
and (b) all material claims (including, without limitation, claims for labor,
services, materials and supplies) for sums which have become due and payable;
provided, however, no payment of Taxes or claims shall be required if the
- --------
amount, applicability or validity thereof is being contested in good faith by
appropriate action promptly initiated and diligently conducted in accordance
with good business practices.
SECTION 9.3. Compliance with Laws and Documents. Magellan will, at all
----------------------------------
times prior to Closing, comply in all material respects with the provisions of
(a) all Laws, (b) its Charter Documents, and (c) every Material Agreement to
which the Magellan is a party or by which it is bound.
SECTION 9.4. Operation of Properties and Equipment. Magellan will, at
-------------------------------------
all times prior to Closing, maintain, preserve and keep all operating equipment
used or useful in the operation of its business in proper repair, working order
and condition, and make all necessary or appropriate repairs, renewals,
replacements, additions and improvements thereto so that the efficiency of such
equipment shall at all times be properly preserved and maintained; provided,
--------
that, no item of operating equipment need be so repaired, renewed, replaced,
added to or improved, if Magellan shall in good faith determine that such action
is not necessary or desirable for the continued efficient and profitable
operation of its business.
SECTION 9.5. Maintenance of Books and Records. Magellan will, at all
---------------------------------
times prior to Closing, maintain proper books of record and account in which
true and correct entries in conformity with GAAP shall be made on a timely basis
of all dealings and transactions in relation to its business and activities.
SECTION 9.6. Environmental Matters. Magellan will, at all times prior
---------------------
to Closing, comply in all material respects with all Environmental Law and Laws
applicable to their respective properties and operations, including, without
limitation, all Hazardous Substances transportation, storage, disposal,
remediation and similar requirements of applicable Environmental Law and Laws.
SECTION 9.7 Access to Information.
-----------------------
(a) Magellan will afford 3TEC and its representatives (including
without limitation directors, officers and employees of 3TEC and its Affiliates,
and counsel, accountants and other professionals retained by 3TEC) such access,
during normal business hours throughout the period to the Closing Date, to
Magellan's books, records (including without limitation Tax returns and
non-restricted work papers of Magellan's independent auditors), properties,
personnel and to such other information as 3TEC may reasonably request and will
permit 3TEC to make such inspections as 3TEC may reasonably request and will
cause the officers and employees of Magellan to furnish 3TEC with such financial
and operating data and other information with respect to the business,
properties and personnel of Magellan as 3TEC may from time to time reasonably
request, provided, however, that no investigation pursuant to this section will
affect or be deemed to modify any of the representations or warranties made by
Magellan or the Prepayout Members in this Agreement.
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<PAGE>
(b) 3TEC agrees that all Confidential Information (as defined below)
shall be kept confidential by 3TEC as required by this Section; provided,
however, that (i) any of such Confidential Information may be disclosed to such
directors, officers, employees, and authorized representatives of 3TEC
(collectively, for purposes of this Section, "3TEC Representatives") as need to
know such information for the purpose of evaluating the transactions
contemplated hereby (it being understood that such 3TEC Representatives shall be
informed by 3TEC of the confidential nature of such information and shall be
required to treat such information confidentially), (ii) any disclosure of
Confidential Information may be made to the extent to which Prepayout Members
and Magellan consent in writing, or (iii) Confidential Information may be
disclosed by 3TEC or any 3TEC Representative to the extent that , in the opinion
of counsel for 3TEC or such 3TEC Representative, 3TEC or such 3TEC
Representative is legally compelled to do so, provided that, prior to making
such disclosure, 3TEC or such 3TEC Representative, as the case may be, advises
and consults with Prepayout Members and Magellan regarding such disclosure and
provided further that 3TEC or such 3TEC Representative, as the case may be,
discloses only that portion of the Confidential Information as is legally
required. 3TEC agrees that none of the Confidential Information will be used
for any purpose other than in connection with the transactions contemplated
hereby. The term "Confidential Information", as used herein, means all
information obtained by or on behalf of 3TEC from Prepayout Members or Magellan
pursuant to this Section and all similar information obtained from Prepayout
Members or Magellan by or on behalf of 3TEC prior to the date of this Agreement,
other than information which (i) was or becomes generally available to the
public other than as a result of disclosure by 3TEC or any 3TEC Representative,
(ii) was or becomes available to 3TEC on a nonconfidential basis prior to
disclosure to 3TEC by Prepayout Members or Magellan or their respective
representatives, or (iii) was or becomes available to 3TEC from a source other
than Prepayout Members or Magellan and their respective representatives,
provided that such source is not known by 3TEC to be bound by a confidentiality
agreement with Prepayout Members or Magellan.
(c) If this Agreement is terminated, 3TEC shall promptly return, and
shall use its reasonable best efforts to cause all 3TEC Representatives to
promptly return, all Confidential Information to Prepayout Members or Magellan
without retaining any copies thereof, provided that such portion of the
Confidential Information as consists of notes, compilations, analyses, reports,
or other documents prepared by 3TEC or 3TEC Representatives shall be destroyed.
SECTION 9.8 Conduct of the Business of Magellan. Except as
----------------------------------------
contemplated by this Agreement or to the extent that 3TEC shall otherwise
consent in writing, during the period from the date of this Agreement to the
Closing, Magellan will conduct its operations only in, and Magellan will not
take any action except in the ordinary course of business and Magellan will use
all reasonable efforts to preserve intact in all material respects its business
organizations, assets, prospects and advantageous business relationships, to
keep available the services of its officers and key employees and to maintain
satisfactory relationships with its licensors, licensees, suppliers,
contractors, distributors, customers and others having advantageous business
relationships with it. Without limiting the generality of the foregoing, except
as contemplated by this Agreement, Magellan will not, without the prior written
consent of 3TEC:
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<PAGE>
(a) amend its Charter Documents;
(b) make any distribution in respect of its membership interests, or
directly or indirectly, redeem, purchase or otherwise acquire any of its
membership interests;
(c) authorize for issuance, issue, sell or deliver or agree or commit
to issue, sell, or deliver (whether through the issuance or granting of any
options, warrants, commitments, subscriptions, rights to purchase or otherwise)
any of its membership interests or any securities convertible into or
exercisable or exchangeable for shares of its membership interests;
(d) incur any material liability or obligation (absolute, accrued,
contingent or otherwise) other than in the ordinary course of business or issue
any debt securities or assume, guarantee, endorse or otherwise as an
accommodation become responsible for, the obligations of any other individual or
entity, or change any assumption underlying, or methods of calculating, any bad
debt, contingency or other reserve;
(e) enter into, adopt, or amend any employment agreement or Pension
Plan, or grant, or become obligated to grant, any increase in the compensation
payable or to become payable to any of its officers, managers or directors or
any general increase in the compensation payable or to become payable to its
employees;
(f) acquire (by merger, consolidation, or acquisition of stock or
assets) any corporation, partnership or other business organization or division
thereof or make any investment either by purchase of stock or securities,
contributions to capital, property transfer, or purchase of properties or assets
of any Person;
(g) pay, discharge or satisfy any material claims, liabilities or
obligations (absolute, accrued, contingent or otherwise), other than the
payment, discharge or satisfaction in the ordinary course of business of
liabilities reflected or reserved against on the Magellan Financial Statements
or subsequently incurred in the ordinary course of business, or disclosed
pursuant to this Agreement;
(h) acquire (including by lease) any material assets or properties or
dispose of, mortgage or encumber any material assets or properties, other than
in the ordinary course of business;
(i) waive, release, grant or transfer any material rights or modify or
change in any material respect any material existing license, lease, contract or
other document, other than in the ordinary course of business and consistent
with past practice; or
C-39
<PAGE>
(j) take any action or agree, in writing or otherwise, to take any of
the foregoing actions or any action which would at any time make any
representation or warranty in Article VII untrue or incorrect in any material
respect.
ARTICLE X
COVENANTS OF 3TEC
SECTION 10.1 Meeting; Proxy Statement
--------------------------
(a) The Company shall take all action necessary in accordance with
applicable Law and the Company's Certificate of Incorporation and Bylaws to duly
call, give notice of, convene and hold an annual or special meeting of its
shareholders (the "Special Meeting") as promptly as practicable after the date
hereof to consider and vote upon the adoption and approval of this Agreement and
the transactions contemplated hereby (including, without limitation, amendments
to the Certificate of Incorporation of the Company), to the extent such
shareholder approval is necessary with respect to the effectuation of any part
of the transactions contemplated by this Agreement. The shareholder vote
required for the transactions contemplated hereby shall be the vote required by
applicable Law, the Company's Certificate of Incorporation, and the rules of the
Nasdaq Small Cap Market. The Board of Directors of the Company shall, subject
to its fiduciary obligations to the Company's shareholders under applicable Law,
(i) recommend to the shareholders of the Company that they vote in favor of the
adoption and approval of all matters necessary to effectuate this Agreement and
the transactions contemplated hereby, (ii) use its reasonable best efforts to
solicit from the shareholders of the Company proxies in favor of such adoption
and approval, and (iii) take all other action reasonably necessary to secure a
vote of the shareholders of the Company in favor of such adoption and approval.
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<PAGE>
(b) As promptly as practicable after the date hereof, the Company shall
prepare, shall file with the Commission under the Exchange Act, shall use all
reasonable best efforts to have cleared by the Commission, and promptly
thereafter shall mail to its shareholders, a proxy statement with respect to the
Special Meeting. The term "Proxy Statement", as used herein, means such proxy
statement and all related proxy materials and all amendments and supplements
thereto, if any. Except to the extent otherwise determined in good faith by the
Board of Directors of the Company in the exercise of its fiduciary duties, the
Proxy Statement shall contain the recommendation of the Board that shareholders
of the Company vote in favor of the adoption and approval of all matters
necessary to effectuate the transactions contemplated by the Agreement. The
Company shall notify Magellan and the Prepayout Members promptly of the receipt
of any comments on, or any requests for amendments or supplements to, the Proxy
Statement by the Commission, and the Company shall supply Magellan and Prepayout
Members with copies of all correspondence between it and its representatives, on
the one hand, and the Commission or members of its staff, on the other, with
respect to the Proxy Statement. The Company, after consultation with Magellan
and Prepayout Members, shall use its reasonable best efforts to respond promptly
to any comments made by the Commission with respect to the Proxy Statement. The
Company, Magellan and Prepayout Members shall cooperate with each other in
preparing the Proxy Statement, and the Company, Magellan and Prepayout Members
shall each use their reasonable best efforts to obtain and furnish the
information required to be included in the Proxy Statement. The Company,
Magellan and Prepayout Members agree promptly to correct any information
provided by it for use in the Proxy Statement if and to the extent that such
information shall have become false or misleading in any material respect, and
the Company further agrees to take all steps necessary to cause the Proxy
Statement as so corrected to be filed with the Commission and to be disseminated
promptly to holders of shares of the Common Stock, in each case as and to the
extent required by applicable Law.
ARTICLE XI
TERMINATION
SECTION 11.1 Termination. This Agreement may be terminated, whether
-----------
before or after approval of this Agreement by the stockholders of the Company,
at any time prior to the Closing:
(a) By mutual written consent of 3TEC and Prepayout Members;
(b) By 3TEC, if 3TEC is not satisfied with the results of its due diligence
investigation (including but not limited to due diligence with respect to the
matters described in the Magellan Disclosure Schedule) and gives written notice
of its election by 5:00 p.m., local time, on January 14, 2000;
(c) By 3TEC if (i) there has been a breach of the representations and
warranties made by Magellan and the Prepayout Members in this Agreement or (ii)
the Prepayout Members or Magellan has failed to comply in any material respect
with any of its covenants or agreements contained in this Agreement and such
failure has not been, or cannot be, cured within a reasonable time after notice
and demand for cure thereof;
(d) By the Prepayout Members if (i) there has been a breach of the
representations and warranties made by 3TEC in this Agreement or (ii) 3TEC has
failed to comply in any material respect with any of its covenants or agreements
contained in this Agreement and such failure has not been, or cannot be, cured
within a reasonable time after notice and demand for cure thereof; or
(e) by the Company, Magellan or any Prepayout Member if the Closing shall
not have occurred on or before February 29, 2000.
SECTION 11.2. Effect of Termination. If this Agreement is terminated
----------------------
by either the Company or Magellan pursuant to the provisions of Section 11.1,
------------
this Agreement shall forthwith become void and there shall be no further
obligation on the part of any party hereto or its respective Affiliates,
directors, officers, or stockholders, except pursuant to the provisions of
Sections 7.23, 8.4, 9.7, 12.3 and 12.12; provided, however, that a termination
of this Agreement shall not relieve any party hereto from any liability for
damages incurred as a result of a breach by such party of its representations,
warranties, covenants, agreements or other obligations hereunder occurring prior
to such termination.
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<PAGE>
ARTICLE XII
MISCELLANEOUS
SECTION 12.1. Notices. All notices, requests and other communications
-------
to any party hereunder shall be in writing (including bank wire, telex, telecopy
or similar writing) and shall be given to such party at its address, telex or
telecopy number set forth on the signature pages hereof or such other address,
telex or telecopy number as such party may hereafter specify for the purpose by
notice to the other party. Each such notice, request or other communication
shall be effective (i) if given by telex or telecopy, when such telex or
telecopy is transmitted to the telex or telecopy number specified in this
Section 12.1 and the appropriate answer back is received or receipt is otherwise
- ------------
confirmed, (ii) if given by mail, three (3) Business Days after deposit in the
mails with first class postage prepaid, addressed as aforesaid, or (iii) if
given by any other means, when delivered at the address specified in this
Section 12.1.
- --------------
SECTION 12.2. Amendment and Waivers. This Agreement may not be
-----------------------
modified or amended except by an instrument or instruments in writing signed by
the party against whom enforcement of any such modification or amendment is
sought. No failure or delay by any holder of Securities in exercising any
right, power or privilege hereunder or under any other Transaction Document
shall operate as a waiver thereof nor shall any single or partial exercise
thereof preclude any other or further exercise thereof or the exercise of any
other right, power or privilege. The rights and remedies herein provided shall
be cumulative and not exclusive of any rights or remedies provided by Law or in
any of the other Transaction Documents.
SECTION 12.3. Expenses. Subject to Section 12.4(b), all expenses
-------- ----------------
incurred in connection with this Agreement shall be paid by the party incurring
such expenses.
SECTION 12.4. Indemnification.
---------------
(a) Subject to the terms of this Section 12.4, Prepayout Members
severally (and expressly not jointly and severally) agree to indemnify and hold
harmless, 3TEC, its shareholders and its directors, officers, employees, agents,
successors and assigns (collectively, the "3TEC Indemnified Parties") from and
against any and all liabilities, losses, damages, costs and expenses of any kind
(including, without limitation, reasonable attorneys' fees and disbursements
("Damages") which may be incurred by any 3TEC Indemnified Party relating to or
arising out any breach by Prepayout Members of any of their representations,
warranties, covenants or agreements contained in this Agreement or the other
Transaction Documents ("3TEC Claims").
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<PAGE>
(b) Subject to the terms of this Section 12.4, the Prepayout Members
severally (and expressly not joint and severally) agree to reimburse 3TEC for
all of its Transaction Costs (as defined below) if (i) any Member of Magellan
(x) exercises the Magellan Preferential Right set forth in Section 9.7(a) of the
Magellan Operating Agreement (i.e., the right to "adjust the Prepayout
Interests" as described in Section 9.6(c) of the Magellan Operating Agreement)
or (y) commences an action or proceeding of the type described in Section
6.1(k), and as a result any party hereto terminates this Agreement pursuant to
Section 11.1 due to the failure of a condition precedent described in Section
6.1(k), Section 6.2(k), or Section 6.2(l), or (ii) Eugene Offshore Holdings, LLC
exercises a preferential right to purchase under Article XV.J of the Joint
Operating Agreement dated March 23, 1994 relating to leases at Breton Sound and
then 3TEC terminates this Agreement pursuant to Section 11.1 as a result.
Subject to the terms of this Section 12.4, the Prepayout Members severally (and
expressly not joint and severally) agree to reimburse 3TEC for one-half of its
Transaction Costs if the Prepayout Members terminate this Agreement pursuant to
Section 11.1 due to the failure of the condition described in Section 6.2(h).
For purposes of this Section, "Transaction Costs" mean all documented and
reasonable out-of-pocket expenses and disbursements incurred by 3TEC in
connection with the Merger Agreement and the investigation and negotiation
hereof, including, without limitation, all fees and expenses of counsel to 3TEC,
engineering costs, accounting and land due diligence costs (including the out-of
- -pocket costs of 3TEC employees performing such work) and costs associated with
the fairness opinion referred to in Section 6.1.
(c) Subject to the terms of this Section 12.4, Prepayout Members
severally (and expressly not jointly and severally) agree to indemnify and hold
harmless the 3TEC Indemnified Parties and, after the Closing, Magellan, from and
against any and all Damages which may be incurred by any 3TEC Indemnified Party
or Magellan relating to or arising out of any actions or proceedings brought by
members of Magellan (other than Prepayout Members) against 3TEC or Magellan
arising out of or in connection with the Merger or the Magellan Preferential
Rights. Notwithstanding any other provisions of this Agreement, the
indemnification obligations under this Section 12.4(c) (i) shall survive the
Closing until the expiration of the applicable statutes of limitations, and (ii)
shall not be subject to Section 12.4(f)(iii).
(d) Subject to the terms of this Section 12.4, 3TEC agrees to indemnify
and hold harmless, each Prepayout Member and their respective partners,
shareholders, members, directors, officers, managers, employees, agents,
successors and assigns (collectively, the "Prepayout Member Indemnified
Parties") from and against any and all Damages which may be incurred by any
Prepayout Member Indemnified Party relating to or arising out any breach by 3TEC
of any of its representations, warranties, covenants or agreements contained in
this Agreement or the other Transaction Documents ("Prepayout Member Claims").
(e) The liability of Prepayout Members under this Section 12.4 shall be
several (and expressly not joint and several), except in the instance of a 3TEC
Claim relating to or out of any breach by a Prepayout Member of a representation
and warranty in Section 7.2, Section 7.3 or Section 7.19 that applies
------------ ------------ -------------
specifically to such Prepayout Member (in which event such Prepayout Member, and
no other Prepayout Member, shall have liability). With respect to any
indemnification obligation under this Section 12.4 for which Prepayout Members
have several liability, the several share of each Prepayout Member shall be as
set forth in Exhibit A and in no event shall such Prepayout Member's share of
any such indemnification obligation exceed such several share.
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(f) Notwithstanding the foregoing or anything else herein to the
contrary, the indemnification obligation of the Prepayout Members pursuant to
this Section 12.4 shall be subject to the following:
(i) No indemnification shall be required to be made by Prepayout
Members pursuant to this Section 12.4 with respect to any 3TEC Claims
arising out or resulting from the breach of the representations and
warranties set forth in Article VII (exclusive of the representations set
forth in Section 7.18)), except to the extent that the aggregate amount of
the Damages incurred by the 3TEC Indemnified Parties with respect to all
such 3TEC Claims exceeds $100,000.
(ii) No indemnification shall be required to be made by Prepayout
Members pursuant to this Section 12.4 with respect to any 3TEC Claims
arising out or resulting from the breach of the representations and
warranties set forth in Section 7.18, except to the extent that the
aggregate amount of the Damages incurred by the 3TEC Indemnified Parties
with respect to all such 3TEC Claims exceeds $100,000.
(iii) No Prepayout Member shall be obligated to pay the 3TEC
Indemnified Parties pursuant to this Section 12.4 (excluding for this
purpose, Section 12.4(c)) an aggregate amount in excess of (x) the amount
stipulated for such Prepayout Member in Exhibit A minus (y) all amounts
previously paid by such Prepayout Member pursuant to Section 12.4(c). The
deduction described in the preceding sentence relating to amounts paid
pursuant to Section 12.4(c) shall not be construed to require any 3TEC
Indemnified Party to return any amounts previously received by it pursuant
to this Section 12.4 from the Prepayout Members or to put any cap on the
liability of the Prepayout Members under Section 12.4(c).
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<PAGE>
(iv) A Prepayout Member shall have the right to satisfy any
indemnification obligation under this Section 12.4 (other than obligations
under Section 12.4(b)) by delivering, at its election, Common Stock Shares
or Preferred Stock Shares, as provided in this subsection (f)(iv). If a
Prepayout Member so exercises its right, the number of Common Stock Shares
or Preferred Stock Shares so delivered shall be equal to the amount (or
portion thereof) of the obligation so owed to be paid with Common Stock
Shares or Preferred Stock Shares (as applicable) divided by (A) in the
instance of the Common Stock Shares, the Current Market Price (as defined
below) and (B) in the instance of the Preferred Stock Shares, the greater
of (x) $6.00 and (y) the aggregate Current Market Price of the shares of
Common Stock into which such Preferred Stock Shares are then convertible
divided by the number of Preferred Stock Shares to be delivered. As used
herein, the term "Current Market Price" shall mean the average of the last
reported sales prices for the Common Stock for the 10 consecutive Trading
Days ending on the second Trading Day prior to delivery in satisfaction of
the indemnification obligation. The last reported sales price for each day
shall be the last reported sales price of the Common Stock on such date on
the exchange where it is primarily traded, or, if the Common Stock is not
traded on an exchange, the Common Stock shall be valued at the last
reported sales price on such date on the NASDAQ National Market System, or,
if the Common Stock is not traded on the NASDAQ National Market System or
any similar system of automated dissemination of quotations of securities
prices, the Common Stock shall be valued at the closing bid price (or
average of bid prices) last quoted on such date as reported on an
established quotation service for over-the-counter securities. As used in
this subsection (f)(iv), the term "Trading Days" shall mean (1) if the
Common Stock is listed or admitted for trading on any generally recognized
U.S. securities exchange, days on which such securities exchange is open
for business and (2) if the Common Stock is quoted on the NASDAQ National
Market System or any similar system of automated dissemination of
quotations of securities prices, days on which trades may be made on such
system.
(g) Promptly after receipt by an indemnified party under Section
12.4(a), Section 12.4(c) or 12.4(d) of notice of the commencement of any action,
such indemnified party shall, if a claim in respect thereof is to be made
against an indemnifying party under such Section, give written notice to the
indemnifying party of the commencement thereof, but the failure so to notify the
indemnifying party shall not relieve it of any liability that it may have to any
indemnified party except to the extent the indemnifying party demonstrates that
the defense of such action is prejudiced thereby. In case any such action shall
be brought against an indemnified party and it shall give written notice to the
indemnifying party of the commencement thereof, the indemnifying party shall be
entitled to participate therein and, to the extent that it may wish, to assume
the defense thereof with counsel reasonably satisfactory to such indemnified
party. If the indemnifying party elects to assume the defense of such action,
the indemnified party shall have the right to employ separate counsel at its own
expense and to participate in the defense thereof. If the indemnifying party
elects not to assume (or fails to assume) the defense of such action, the
indemnified party shall be entitled to assume the defense of such action with
counsel of its own choice, at the expense of the indemnifying party. If the
action is asserted against both the indemnifying party and the indemnified party
and there is a conflict of interests which renders it inappropriate for the same
counsel to represent both the indemnifying party and the indemnified party, the
indemnifying party shall be responsible for paying for separate counsel for the
indemnified party; provided, however, that if there is more than one indemnified
party, the indemnifying party shall not be responsible for paying for more than
one separate firm of attorneys to represent the indemnified parties, regardless
of the number of indemnified parties. If the indemnifying party elects to
assume the defense of such action, (i) no compromise or settlement thereof may
be effected by the indemnifying party without the indemnified party's written
consent (which shall not be unreasonably withheld) unless the sole relief
provided is monetary damages that are paid in full by the indemnifying party and
(ii) the indemnifying party shall have no liability with respect to any
compromise or settlement thereof effected without its written consent (which
shall not be unreasonably withheld).
(h) THE PARTIES RECOGNIZE THAT AN INDEMNITEE MAY BE ENTITLED TO
INDEMNIFICATION HEREUNDER FROM ACTS OR OMISSIONS THAT ARISE OUT OF OR RESULT
FROM THE ORDINARY, STRICT, SOLE OR CONTRIBUTORY NEGLIGENCE OF SUCH INDEMNITEE.
C-45
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(i) In relation to any breach, default or nonperformance of any
representation, warranty, covenant or agreement made by a party hereto in this
Agreement, the exclusive relief and remedy available to the other parties hereto
in respect of said breach, default or nonperformance shall be (i) termination,
but only if said termination is expressly permitted under the provisions of
Section 11.1, or (ii) indemnification as provided in this Section 12.4, but only
- ------------ ------------
to the extent properly claimable hereunder and as limited pursuant hereto.
SECTION 12.5. Survival.
--------
(a) All representations, warranties and covenants made by Magellan or
the Prepayout Members herein or in any certificate or other instrument delivered
by them or on their behalf under the Transaction Documents shall be considered
to have been relied upon by 3TEC and shall survive the delivery to 3TEC of such
Transaction Documents regardless of any investigation made by or on behalf of
3TEC, subject to the following: (i) the representations and warranties of
Magellan and Prepayout Members contained in Article VII (exclusive of the
representations and warranties set forth in Section 7.18) shall survive the
Closing until the first anniversary date of the Closing Date; and (ii) the
representations and warranties of Magellan and Prepayout Members contained in
Section 7.18 shall survive the Closing until the third anniversary date of the
Closing Date (the anniversary dates referenced in clauses (i) and (ii) being
called the "Survival Dates"). Magellan and the Prepayout Members shall not have
any indemnification obligation pursuant to Section 12.4 in respect of any
representation and warranty referred to in clause (i) or clause (ii) of the
immediately preceding sentence unless on or before the applicable Survival Date
for such representation and warranty they shall have received from the party
seeking indemnification written notice of the existence of the claim for or in
respect of which indemnification is sought.
(b) All representations, warranties and covenants made by 3TEC herein
or in any certificate or other instrument delivered by it or in its behalf under
the Transaction Documents shall be considered to have been relied upon by the
Prepayout Members and shall survive the delivery to Prepayout Members of such
Transaction Documents and the delivery of the Securities, regardless of any
investigation made by or on behalf of the Prepayout Members.
SECTION 12.6. Invalid Provisions. If any provision of the Transaction
------------------
Documents is held to be illegal, invalid, or unenforceable under present or
future Laws effective during the term thereof, such provision shall be fully
severable, the Transaction Documents shall be construed and enforced as if such
illegal, invalid, or unenforceable provision had never comprised a part thereof,
and the remaining provisions thereof shall remain in full force and effect and
shall not be affected by the illegal, invalid, or unenforceable provision or by
its severance therefrom. Furthermore, in lieu of such illegal, invalid, or
unenforceable provision there shall be added automatically as a part of the
Transaction Documents a provision as similar in terms to such illegal, invalid,
or unenforceable provision as may be possible and be legal, valid and
enforceable.
SECTION 12.7. Successors and Assigns. The provisions of this Agreement
----------------------
shall be binding upon and inure to the benefit of the parties hereto and their
respective successors, heirs, personal representatives and permitted assigns,
except that (a) no Prepayout Member may assign or otherwise transfer any of
its rights or obligations under this Agreement without the prior written consent
of the other Prepayout Members and 3TEC and (b) 3TEC may not assign or otherwise
transfer any of its rights or obligations under this Agreement without the prior
written consent of the Prepayout Members.
C-46
<PAGE>
SECTION 12.8. GOVERNING LAW. THIS AGREEMENT AND THE TRANSACTION
--------------
DOCUMENTS SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE
STATE OF TEXAS.
SECTION 12.9. Counterparts. This Agreement may be signed in any number
------------
of counterparts, each of which shall be an original, with the same effect as if
the signatures thereto and hereto were upon the same instrument.
SECTION 12.10. No Third Party Beneficiaries. Except as provided in
-------------------------------
Section 12.4, it is expressly intended that there shall be no third party
- -------------
beneficiaries of the covenants, agreements, representations or warranties herein
contained.
SECTION 12.11. FINAL AGREEMENT. THIS AGREEMENT AND THE OTHER
----------------
TRANSACTION DOCUMENTS COLLECTIVELY REPRESENT THE FINAL AGREEMENT BETWEEN THE
PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR
SUBSEQUENT ORAL AGREEMENTS BETWEEN THE PARTIES. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS BETWEEN THE PARTIES.
SECTION 12.12. WAIVER OF RIGHT TO TRIAL BY JURY. 3TEC AND THE
--------------------------------------
PREPAYOUT MEMBERS EACH HEREBY WAIVE ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM,
DEMAND, ACTION OR CAUSE OF ACTION (A) ARISING UNDER THIS AGREEMENT, ANY
TRANSACTION DOCUMENT OR ANY OTHER INSTRUMENT, DOCUMENT OR AGREEMENT EXECUTED OR
DELIVERED IN CONNECTION HEREWITH OR THEREWITH, OR (B) IN ANY WAY CONNECTED WITH
OR RELATED OR INCIDENTAL TO THE DEALINGS OF THE PARTIES HERETO OR ANY OF THEM IN
RESPECT TO THIS AGREEMENT. 3TEC AND THE PREPAYOUT MEMBERS EACH AGREE THAT THE
OTHER MAY FILE A COPY OF THIS AGREEMENT WITH ANY COURT AS WRITTEN EVIDENCE OF
THE CONSENT OF THE PARTIES HERETO TO THE WAIVER OF THEIR RIGHT TO TRIAL BY JURY.
SECTION 12.13. DTPA Waiver. To the extent applicable to the
------------
transactions contemplated by this Agreement, the Company waives the provisions
of the Texas Deceptive Trade Practices Act, Chapter 17, Subchapter E, Sections
17.41 through 17.63, inclusive (other than Section 17.555, which is not waived),
Tex. Bus. & Comm. Code. In order to evidence its ability to grant such waiver,
the Company hereby represents and warrants to the Prepayout Members that the
Company (i) is in the business of seeking or acquiring, by purchase or lease,
goods or services for commercial or business use, (ii) has assets of $5 million
or more according to its most recent financial statement prepared in accordance
with generally accepted accounting principles, (iii) has knowledge and
experience in financial and business matters that enable it to evaluate the
merits and risks of the transactions contemplated by this Agreement, and (iv) is
not in a significantly disparate bargaining position.
SECTION 12.14. Public Announcements. Except as may be required by
---------------------
applicable Law or this Section neither 3TEC nor Sub, on the one hand, and
neither the Prepayout Members nor Magellan, on the other, shall issue any press
release or otherwise make any public statement with respect to this Agreement or
the transactions contemplated hereby without the prior written consent of the
other parties (which consent shall not be unreasonably withheld). Any such
press release or public statement required by applicable Law shall only be made
after reasonable notice to the other party. Upon execution of this Agreement,
3TEC shall make a press release in a form previously approved by Prepayout
Members and promptly file a report on Form 8-K with the Commission.
[Signature Page to Follow]
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<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed by their respective Authorized Officers on the day and year first
above written.
COMPANY:
3TEC ENERGY CORPORATION
By: _____________________________
Name: Floyd C. Wilson
Title: President and Chief Executive Officer
Address for Notice:
3TEC Energy Corporation
Two Shell Plaza
777 Walker
Suite 2400
Houston, TX 77002
Fax: (713) 222-6418
SUB:
3TM ACQUISITION L.L.C.
By: _____________________________
Name: Floyd C. Wilson
Title: Manager
Address for Notice:
c/o 3TEC Energy Corporation
Two Shell Plaza
777 Walker
Suite 2400
Houston, TX 77002
Fax: (713) 222-6418
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<PAGE>
MAGELLAN EXPLORATION, LLC
By: _____________________________
Name: Wynne M. Snoots, Jr.
Title: President
Address For Notice:
Five Post Oak Park
Suite 1500
Houston, Texas 77027
Attention: Wynne M. Snoots, Jr.
Fax: (713) 622-5511
ECIC CORPORATION
By: _____________________________
Name: Robert L. Zorich
Title: President
Address for Notice:
c/o EnCap Investments L.L.C.
1100 Louisiana
Suite 3150
Houston, Texas
Attention: Garry A. Tanner
Fax: (713) 659-6130
C-49
<PAGE>
ENCAP ENERGY CAPITAL FUND III, L.P.
By: ENCAP INVESTMENTS L.L.C., General Partner
By: _____________________________
Name: D. Martin Phillips
Title: Managing Director
Address For Notice:
c/o EnCap Investments L.L.C.
1100 Louisiana
Suite 3150
Houston, Texas
Attention: Garry A. Tanner
Fax: (713) 659-6130
ENCAP ENERGY ACQUISITION III-B, INC.
By: _____________________________
Name: D. Martin Phillips
Title: Vice President
Address For Notice:
c/o EnCap Investments L.L.C.
1100 Louisiana
Suite 3150
Houston, Texas
Attention: Garry A. Tanner
Fax: (713) 659-6130
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<PAGE>
BOCP ENERGY PARTNERS, L.P.
By: ENCAP INVESTMENTS L.L.C., Manager
By: _____________________________
Name: D. Martin Phillips
Title: Managing Director
Address For Notice:
c/o EnCap Investments L.L.C.
1100 Louisiana
Suite 3150
Houston, Texas
Attention: Garry A. Tanner
Fax: (713) 659-6130
PEL-TEX PARTNERS, L.L.C.
By: _____________________________
Name: Townes G. Pressler, Jr.
Title: Manager
By: DLJ LBO PLANS MANAGEMENT CORP., Manager
By: _____________________________
Name: Ivy Dodes
Title: Vice President
Address For Notice:
277 Park Avenue
New York, New York 10172
Attn: Ivy Dodes
Fax: (212) 892-7512
C-51
<PAGE>
PROXY
3TEC ENERGY CORPORATION
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF
3TEC ENERGY CORPORATION
The undersigned hereby appoints each of Floyd C. Wilson and Stephen W.
Herod as proxies for the undersigned, with full power to appoint a substitute,
and hereby authorizes each to represent and to vote, as designated below, all
shares of the $.02 par value common stock of 3TEC Energy Corporation ("3TEC" or
the "Company"), which the undersigned is entitled to vote at the Special Meeting
of the Shareholders of the Company to be held at the principal office of the
Company, Two Shell Plaza, 777 Walker Street, Suite 2400, Houston, Texas 77002 on
Friday, January 28, 2000, at 10:00 a.m., local time (the "Meeting"), or at any
and all postponements, continuations or adjournments thereof.
Only holders of record of the Company's common stock at the close of
business on December 9, 1999, will be entitled to notice of and to vote at the
Special Meeting or any adjournments thereof, notwithstanding the transfer of any
stock on the books of the Company after such record date. This proxy when
properly executed will be voted in the manner directed herein by the undersigned
Shareholder. If no direction is made, this proxy will be voted FOR the
proposal.
The Special Committee recommends a vote FOR Proposal I.
1. To consider and authorize the issuance of 3,300,000 shares of the
Company's common stock, $.02 par value, warrants to purchase up to 1,000,000
shares of the Company's common stock, $.02 par value, and 1,875,000 shares of
the Company's preferred stock, $.02 par value, designated as Series D Preferred
Stock, in connection with the merger of a wholly owned subsidiary of the Company
with Magellan Exploration, L.L.C.
FOR |_| AGAINST |_| ABSTAIN |_|
|_| Mark here for address change and note below.
PLEASE READ INSTRUCTIONS ON THE REVERSE SIDE AND EXECUTE
<PAGE>
IMPORTANT: Before returning the Proxy, please sign your name or names on the
line(s) below exactly as shown hereon. Executors, administrators, trustees,
guardians or corporate officers should indicate their full titles when signing.
When shares are registered in the name of joint tenants or trustees, each joint
tenant or trustee should sign.
Dated: January ____, 2000
________________________________________
Authorized Signature
________________________________________
Title
________________________________________
Authorized Signature
________________________________________
Title
Please mark boxes /X/ in ink. Sign, date and return this Proxy Card promptly
using the enclosed envelope.
Change of Address:
______________________________
______________________________
______________________________
<PAGE>
