<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
Commission file number: 0-8043
SOUTHERN MINERAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
NEVADA 36-2068676
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1201 LOUISIANA STREET, SUITE 3350 77002-5609
HOUSTON, TEXAS (Zip Code)
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (713) 658-9444
Check whether the Registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the Registrant was required to
file such reports) and (2) has been subject to such filing requirements for the
past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: As of 8/11/99, there were
12,932,397 shares of the Registrant's common stock outstanding.
<PAGE>
SOUTHERN MINERAL CORPORATION
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of June 30, 1999 (unaudited) and December 31, 1998 3
Unaudited Consolidated Statements of Operations for the three months and six months ended
June 30, 1999 and 1998 4
Unaudited Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 1998 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition and Results of Operations 12
Liquidity and Capital Resources 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands, except share amounts)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
ASSETS (Unaudited)
CURRENT ASSETS
Cash..................................................................... $ 902 $ 1,541
Receivables.............................................................. 4,653 5,602
Other.................................................................... 696 633
-------- --------
Total current assets..................................................... 6,251 7,776
PROPERTY AND EQUIPMENT, AT COST USING SUCCESSFUL
EFFORTS METHOD FOR OIL AND GAS ACTIVITIES
Oil and gas producing properties......................................... 140,752 136,833
Mineral rights........................................................... --- 167
Unproven properties...................................................... 2,609 3,634
Office equipment......................................................... 545 580
Accumulated depreciation, depletion and amortization .................... (33,326) (27,027)
-------- --------
110,580 114,187
PROPERTIES HELD FOR SALE AND OTHER....................................... 5,948 6,327
-------- --------
Total assets............................................................. $122,779 $128,290
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable......................................................... $ 7,088 $ 10,300
Canadian bank loan....................................................... 20,355 18,490
Current portion of long-term debt........................................ 12,897 13,124
-------- --------
Total current liabilities................................................ 40,340 41,914
LONG-TERM DEBT (LESS CURRENT PORTION).................................... 59,671 64,370
DEFERRED INCOME TAXES.................................................... 7,219 7,279
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share; authorized 5,000,000
shares at June 30, 1999; none issued.................................... --- ---
Common stock, par value $.01 per share; authorized 50,000,000 shares
at June 30, 1999; issued 12,925,397 and 12,884,672 shares
at June 30, 1999 and December 31, 1998, respectively;
outstanding 12,834,174 and 12,793,449 shares at June 30, 1999
and December 31, 1998, respectively.................................... 129 128
Additional paid-in capital............................................... 30,864 30,848
Accumulated other comprehensive loss-foreign currency translation
adjustment.............................................................. (814) (2,304)
Retained deficit......................................................... (14,578) (13,893)
Less: Treasury stock..................................................... (52) (52)
-------- --------
Total stockholders' equity............................................... 15,549 14,727
-------- --------
Total liabilities and stockholders' equity............................... $122,779 $128,290
======== ========
</TABLE>
The accompanying notes to unaudited consolidated financial statements of
Southern Mineral Corporation
and subsidiaries are an integral part of these statements.
3
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- ------------------------
1999 1998 1999 1998
------ ------- ----- ------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE
Oil and gas............................................... $ 6,235 $ 4,367 $11,856 $ 8,777
Gains (loss) on sales of properties and other assets...... (32) (7) 5,041 (3)
------- ------- ------- -------
6,203 4,360 16,897 8,774
EXPENSES
Production................................................ 2,227 2,023 4,308 3,186
Exploration............................................... 1,894 1,527 1,942 1,666
Impairment................................................ 209 --- 209 ---
Depreciation, depletion and amortization.................. 2,728 1,619 5,808 3,229
General and administrative................................ 1,055 842 2,095 1,902
------- ------- ------- -------
8,113 6,011 14,362 9,983
------- ------- ------- -------
Income (loss) from operations............................. (1,910) (1,651) 2,535 (1,209)
Other income, expenses and deductions
Interest and other income................................. 9 48 36 140
Interest and debt expense................................. (1,795) (952) (3,569) (1,786)
------- ------- ------- -------
Loss before income taxes.................................. (3,696) (2,555) (998) (2,855)
Provision (benefit) for foreign, federal and state income
taxes....................................................
Current provision (benefit)............................... 79 (37) 112 (12)
Deferred provision (benefit).............................. (161) 19 (424) (11)
------- ------- ------- -------
(82) (18) (312) (23)
------- ------- ------- -------
Net loss.................................................. $(3,614) $(2,537) $ (686) $(2,832)
======= ======= ======= =======
Net loss per share-basic.................................. $ (.28) $ (0.20) $ (0.05) $ (0.24)
======= ======= ======= =======
Net loss per share-diluted $ (.28) $ (0.20) $ (0.05) $ (0.24)
======= ======= ======= =======
Weighted average number of shares outstanding-basic....... 12,814 12,503 12,807 11,997
======= ======= ======= =======
Weighted average number of shares outstanding-diluted..... 12,814 12,503 12,807 11,997
======= ======= ======= =======
</TABLE>
The accompanying notes to unaudited consolidated financial statements of
Southern Mineral Corporation
and subsidiaries are an integral part of these statements.
4
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------------------
1999 1998
-------- -------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss........................................................................ $ (686) $ (2,832)
Adjustments to net income ...................................................... 101 3,797
------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES............................. (585) 965
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of properties .............................................. 6,410 19
Acquisition of Amerac, net of cash received .................................... --- (2,187)
Acquisition of Neutrino, net of cash received .................................. --- (34,200)
Capital expenditures ........................................................... (1,600) (10,841)
Other........................................................................... --- (2)
------- --------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES............................. 4,810 (47,211)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of long-term debt ..................................................... (3,836) (6,500)
Proceeds from long-term debt.................................................... --- 43,700
Reorganization costs............................................................ (522) ---
Payment on Canadian debentures.................................................. (190) ---
Debenture offering costs ....................................................... --- (12)
Payments on note payable ....................................................... --- (208)
Loan acquisition costs.......................................................... (339) (156)
Proceeds from issuance of common stock.......................................... --- (7)
------- --------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES............................. (4,887) 36,817
EFFECT OF EXCHANGE RATE CHANGES ON CASH ........................................ 23 (20)
------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS....................................... (639) (9,449)
Cash and cash equivalents at beginning of period ............................... 1,541 10,011
------- --------
Cash and cash equivalents at end of period ..................................... $ 902 $ 562
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest.......................................................... $ 3,659 $ 1,609
Cash paid for taxes............................................................. 73 109
NON-CASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock in exchange for Amerac common stock.................... $ --- $ 15,000
Issuance of common stock for property acquisition............................... --- 50
Directors' fees paid in stock................................................... 16 107
</TABLE>
The accompanying notes to unaudited consolidated financial statements of
Southern Mineral Corporation
and subsidiaries are an integral part of these statements.
5
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and note disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, though the Company believes that the disclosures are adequate to
make the information presented not misleading. These consolidated financial
statements should be read in conjunction with the financial statements and the
notes thereto included in the Company's latest Annual Report to the Securities
and Exchange Commission on Form 10-K, as amended, for the year ended December
31, 1998. In the opinion of the Company, all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial position
as of June 30, 1999 and December 31, 1998, the results of operations for the
three and six months ended June 30, 1999 and 1998 and statements of cash flows
for the six months then ended have been included.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Earnings (loss) 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 and convertible debt.
For the quarter ended June 30, 1999 and 1998, respectively, the issuance or
conversion of potential common shares of 5,012,000 and 5,564,000 and for the six
months ended June 30, 1999 and 1998, respectively, 5,012,000 and 5,599,000
potential common shares would have had an antidilutive effect on the diluted
earnings per share calculation and therefore were not considered in the
calculation of the diluted weighted average number of shares outstanding.
Reclassifications - Certain amounts in prior financial statements may have been
reclassified to conform to the 1999 financial statement presentation.
Comprehensive Income - Comprehensive income includes all changes in a company's
equity, except those resulting from investments by owners and distributions to
owners, including, among other things, foreign currency translation adjustments.
The Company's total comprehensive income (loss) for the six months ended June
30, 1999 and 1998 was as follows (in thousands):
SIX MONTHS ENDED
JUNE 30,
------------------------
1999 1998
---- ----
Net loss $ (686) $(2,832)
Foreign currency translation adjustment 1,490 (133)
------ -------
Total comprehensive income (loss) $ 804 $(2,965)
====== =======
NOTE 2. ACQUISITIONS AND DIVESTITURES
Neutrino
On June 23, 1998, the Company agreed to acquire 92.3% of the outstanding common
shares of Neutrino Resources Inc. ("Neutrino"), which was effective as of June
30, 1998 and funded on July 2, 1998. On July 3, 1998, the Company initiated a
compulsory acquisition of the remaining Neutrino shares outstanding, which was
effective as of June 30, 1998 and funded on July 21, 1998. The Company acquired
Neutrino through a cash tender offer for the common shares outstanding and
assumed
6
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS-(continued)
Neutrino's bank debt and working capital deficit. Neutrino is an independent
oil and gas company located in Calgary, Canada. The merger was accounted for as
a purchase. The total purchase price of approximately $57,198,000 consisted of
the following:
Cash consideration for common stock $34,091,000
Fair value of 324,430 shares of common stock 1,095,000
Debt assumed and working capital deficit 20,307,000
Legal, accounting and transaction costs 1,705,000
-----------
$57,198,000
===========
The allocation of the purchase price is summarized as follows:
Oil and gas properties and other assets (net) $66,760,000
Deferred income taxes (9,562,000)
-----------
$57,198,000
===========
Following the acquisition of Neutrino, the purchase price was reduced to reflect
the proceeds from the sale of non-strategic assets in the amount of $3,390,000.
Amerac
On January 28, 1998, the shareholders of both the Company and Amerac Energy
Corporation ("Amerac") approved the merger of Amerac into a subsidiary of the
Company. Pursuant to the merger agreement, the Company issued 3,333,333 shares
of its Common Stock to acquire all of the outstanding common stock of Amerac and
assumed Amerac's outstanding debt, which was approximately $8,700,000. The debt
was retired upon consummation of the acquisition. The merger was effective on
January 28, 1998, and was accounted for as a purchase. The total purchase price
of approximately $24,820,000 consisted of the following:
Issuance of Common Stock $15,433,000
Debt assumed and working capital 8,714,000
Legal, accounting and transaction costs 673,000
-----------
$24,820,000
===========
Subsequent to the acquisition of Amerac, the purchase price was reduced by
$7,919,000 to reflect the sale of non-strategic assets, including Amerac's
Golden Trend properties for $6,969,000 on June 30, 1998 and the Riffe Field for
$510,000 on July 1, 1998.
On July 21, 1999 the Company announced its intent to sell properties consisting
of certain proven and unproven property interests in Texas to ANR Production
Company for $16.28 million, subject to certain adjustments. The properties
include all of the Company's interest in the Brushy Creek and Texan Gardens
Fields in Dewitt, Lavaca and Hidalgo counties of Texas. On July 30, 1999 the
sale of its interests in the Brushy Creek Field in Lavaca and Dewitt counties of
Texas was closed for $15.2 million. Closing on the Texan Gardens field was
extended for up to 30 days, subject to the satisfaction of certain conditions.
The effect of this divestiture would have had a material effect on the Company's
historical results of operations.
7
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
The following summarizes pro forma (unaudited) results of the Company as though
the disposition of Brushy Creek and the acquisition of Neutrino and Amerac had
occurred on January 1, 1998.
SIX MONTHS SIX MONTHS
ENDED JUNE 30, 1998 ENDED JUNE 30, 1999
------------------- -------------------
Revenues...................... $14,037 $15,957
Net loss...................... (5,753) (544)
Net loss per share--basic..... $ (.42) $ (.04)
Net loss per share--diluted... (.42) (.04)
The preceding pro forma results are not necessarily indicative of those that
would have occurred had the acquisitions and dispositions taken place at the
beginning of 1998. During 1998, the Company made additional acquisitions, none
of which would have had a material effect on the historical results of
operations of the Company. During the first quarter of 1999, the Company sold
its mineral interests and substantially all of its royalty interests in Texas,
Mississippi and New Mexico for approximately $6,000,000. The effect of this
divestiture would not have had a material effect on the Company's historical
results of operations.
NOTE 3. LONG-TERM DEBT
Long-term debt consisted of the following at June 30, 1999 and December 31, 1998
(in thousands):
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
Domestic bank credit facility $ 31,168 $ 35,910
Canadian bank credit facility (U.S. Dollars) 20,355 18,490
Convertible subordinated debentures 41,400 41,400
Other --- 184
-------- --------
Total indebtedness 92,923 95,984
Less: Current maturities of long-term debt 12,897 13,124
Canadian bank credit facility (U.S. Dollars) 20,355 18,490
-------- --------
$ 59,671 $ 64,370
======== ========
Effective May 29, 1998, the Company amended its domestic bank credit facility to
increase the borrowing base from $38,400,000 to $45,000,000. Subsequently, the
credit facility has been reduced and restructured as a result of lower oil and
natural gas price assumptions, the sale of certain domestic assets and the
scheduled reduction. A restructured and amended credit facility ("Amended
Credit Facility") was entered into on March 29, 1999. The Amended Credit
Facility provided for a borrowing base of $19,353,000, plus a principal
tranche of $12,500,000 ("Tranche A") that matures on September 1, 1999.
The borrowing base was reduced to $18,830,000 on April 1, 1999 reflecting the
$6,000,000 received in March and April 1999 for the sale of the Company's
mineral interests in Texas, Mississippi and New Mexico. On July 30, 1999 the
sale of the Company's interests in the Brushy Creek Field in Lavaca and Dewitt
counties of Texas was closed for $15.2 million. The net proceeds after closing
costs were applied to the Company's domestic bank facility with $5 million being
applied to the borrowing base facility and $9.6 million to the Tranche A
obligation. Closing on the Texan Gardens Field was extended for up to 30 days.
The Company is currently in discussions with its lenders regarding a revision to
the Amended Credit Facility. The lenders have proposed that the proceeds from
the sale of the Texan Gardens Field can be retained by the Company and used for
general corporate purposes. In addition, the lenders have indicated that the
new borrowing base will become $15,000,000 to be reduced by principal payment of
$100,000 in August, $40,000 in September and October 1999, and $300,000 each
month thereafter; will be subject to semi-annual redeterminations until maturity
on June 1, 2001; and will be reviewed as of January 1, 2000. The lenders have
further indicated that the Tranche A will be reduced to $1,500,000 and become
due on January 1, 2000. As of June 30, 1999 and December 31, 1998, Tranche A
principal was classified as current portion of long-term debt in the Company's
Consolidated Balance Sheet.
8
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
The proposed revision to the Amended Credit Facility would require the Company,
among other provisions, to: (i) apply the majority of proceeds from asset sales
to reduction in the outstanding principal under the credit facility (to the
extent the assets are not otherwise encumbered), (ii) obtain lender's approval
of the Company's domestic general and administrative expense budget and (iii)
pay a $287,500 restructuring fee. The Amended Credit Facility also reduced the
Company's tangible net worth requirement beginning December 31, 1998. As of
June 30, 1999 and August 10, 1999, the Company was in compliance with the terms
and conditions of the Amended Credit Facility, as revised.
The obligations under the Amended Credit Facility are secured by substantially
all of the assets of the Company and its subsidiaries other than Neutrino. The
Amended Credit Facility prohibits the payment of dividends and contains certain
covenants relating to the financial condition of the Company. Outstanding
borrowings under the domestic bank credit facility were $31,168,000 at June 30,
1999. On August 10, 1999, outstanding borrowings under the Amended Credit
Facility were $16,533,000 with no further borrowing availability. Outstanding
principal under the Amended Credit Facility bears interest at the Bank Index
Rate (7.75% at June 30, 1999) to the extent of the borrowing base utilized and
at Bank Index Rate plus 1% on Tranche A principal.
The Company believes that it may be necessary to sell additional oil and gas
assets or obtain additional borrowing from its current or new lenders to raise
the additional funds necessary to meet the current September 1, 1999 or proposed
revised January 1, 2000 maturity of Tranche A principal. No assurance can be
given that such transactions can be consummated on terms acceptable to the
Company or its lenders, whose approval may be required. If the Company is
unable to raise the necessary funds, further restructuring of its Amended Credit
Facility will be required or the Company could be in default on the full amount
of its indebtedness, as discussed below.
Effective June 25, 1998, Neutrino entered into a new Cdn $40,000,000 (US
$27,155,000) revolving demand loan facility (the "Canadian Credit Facility")
under which it could borrow at bank prime or Bankers Acceptance Rates plus a 1%
stamping fee. At June 30, 1999, the Canadian Bank prime rate was 6.25% and the
Bankers Acceptance Rate for 30-day maturities was 4.62%. Effective July 15,
1999, the borrowing base under the Canadian Credit Facility was reduced to Cdn
$30,500,000 (US $20,706,000) and the interest rate was increased to prime plus
1% and the stamping fee on Bankers Acceptance was increased to 1 1/4% per annum.
These changes were a result of a lender review giving effect to lower world oil
prices, the sale of certain non-strategic oil and gas properties, and the
Company's financial condition. At June 30, 1999, outstanding borrowings under
the Canadian Credit Facility were Cdn $30,051,000 (US $20,443,000). On August
10, 1999, outstanding borrowings under the Canadian Credit Facility were Cdn
$29,725,000 (US $20,221,000). The Canadian Credit Facility contains certain
covenants relating to the financial condition of Neutrino, including, at each
quarter's end, maintenance of a working capital of no more than negative Cdn
$1,500,000 through September 30, 1999 and Cdn $0 through maturity. The borrowing
base under the Canadian Credit Facility reduces Cdn $500,000 per month beginning
August 28, 1999 and is subject to semi-annual redeterminations. The next
borrowing base review is September 30, 1999. As of June 30, 1999 and August 10,
1999, Neutrino was in compliance with the terms of the credit facility. The
outstanding balance under the Canadian Credit Facility is classified as a
current liability because of the demand feature of the loan. However, it is
management's intention that the facility be utilized to provide long-term
financing for the Company.
The Company's financial condition and liquidity are impacted by prices the
Company receives for its oil and natural gas. In the first quarter of 1999, oil
and natural gas prices continued to be weak, but began to strengthen early in
the second quarter and have continued to strengthen through the third quarter.
Judgments by both domestic and Canadian lenders regarding the level of future
oil and natural gas prices, among other things, will impact their borrowing base
determinations for the Company's credit facilities.
On October 2, 1997, the Company issued $41,400,000 of 6.875% convertible
subordinated debentures due on October 1, 2007. The debentures are convertible
into Common Stock of the Company at any time prior to maturity at a conversion
price of $8.26 per share. Proceeds of the offering were used to reduce bank
debt and fund subsequent acquisitions.
The Company's substantial leverage poses certain risks, including the risk that
the Company may not generate sufficient cash
9
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
flow to service its indebtedness or that the Company may be unable to obtain
additional financing in the future and as a result, may not have the necessary
resources to respond to market conditions and opportunities. The Company's high
level of indebtedness, covenant requirements and working capital deficit
subjects it to risks of default, which may significantly impair its ability to
meet its liquidity needs. Failure to make the September 1, 1999 (or January 1,
2000, if extended) payment would be a default under our domestic credit
facility, and the lenders would have the right to demand payment in full of the
debt outstanding under this facility which is currently $16.5 million including
Tranche A. On October 1, 1999, a cash interest payment of approximately $1.4
million is due on the debentures. The Company will most likely not have
sufficient available cash to make this interest payment. Failure to make the
October 1, 1999 payment by October 30, 1999 would be a default under the
indenture governing the debentures, and most likely would result in a demand for
full payment of the debentures. Failure to timely pay the September 1, 1999
payment to the lenders under our domestic credit facility or the October 1, 1999
interest payment on the debentures would be a default under our Canadian credit
facility, and would most likely result in a demand for payment in full of the
debt outstanding under that facility. The Company's Amended Credit Facility
contains provisions whereby a default under the Company's Canadian Credit
Facility or to the 6.875% convertible subordinated debentures would create a
default condition under the Amended Credit Facility. In such a default
condition, the banks may declare amounts outstanding under the Amended Credit
Facility to become immediately due and payable. In addition, the holders of
convertible subordinated debentures have acceleration rights if the Company is
in payment default under either its Amended Credit Facility or Canadian Credit
Facility.
The Company's financial condition at the end of 1998 resulted in the Company's
independent auditors, in their opinion on the 1998 financial statements,
disclosing their substantial doubt about the Company's ability to continue as a
going concern. In February 1999, the Board of Directors of the Company retained
CIBC World Markets Corp. as independent advisors to assist in evaluating various
strategic alternatives for maximizing shareholder value. On July 21, 1999 the
Company announced that its Board of Directors has approved a restructuring of
the Company that involves a $20.6 million equity infusion, the sale of the
Brushy Creek and Texan Gardens Fields and an exchange offer for its 6.875%
convertible subordinated debentures due 2007. The restructuring plan, as
initially filed with the Securities and Exchange Commission, will substantially
reduce the current common stockholders interest in the Company. The
restructuring plan comes after an extensive process by the Company to evaluate
strategic opportunities for the Company to maximize shareholder value. The
Company expects that the restructuring, including the equity infusion and the
asset sale, will improve the Company's financial condition and allow the Company
to pursue new opportunities for growth in the future. There are no assurances
that the restructuring will be completed.
NOTE 4. NATURAL GAS AND OIL HEDGING
The Company has entered into natural gas and oil price swaps with third parties
to hedge a portion of its production from the effects of fluctuations in the
market price of natural gas and oil. While the swaps reduce the Company's
exposure to declines in the market price of natural gas and oil, this also
limits the Company's gains from increases in market price. At June 30, 1999,
the Company had domestic swap contracts on approximately 480 MMcf of natural gas
for the period July through October 1999 at an average price of $2.213 and
approximately 53,750 barrels of oil for the period July 1999 through January
2000 at an average price of $20.04. The Company estimates the fair market value
of the open position to be an unrealized loss of approximately $66,000 at June
30, 1999.
At June 30, 1999 Neutrino had Canadian swap contracts on approximately 111 MMcf
of natural gas for the period July through October 1999 at an average price of
Cdn $3.00 (US $2.00) and approximately 46,000 barrels of oil for the period July
through December 1999 at an average price of Cdn $26.185 (US $17.47). The
Company estimates the fair market value of the open position to be an unrealized
loss of approximately Cdn $45,000 (US $30,000) at June 30, 1999.
NOTE 5. COMMITMENTS AND CONTINGENCIES
The Company is involved in several lawsuits arising in the ordinary course of
business, only one of which management believes presents the possibility of a
material payment. The Company's Canadian subsidiary, Neutrino Resources Inc.,
was sued alleging damages resulting from the calculation of third party facility
and processing fees at its Pine Creek Field, Alberta, Canada. The suit was
filed on January 27, 1999 in the Court of Queen's Bench of Alberta in the
Judicial District of Calgary by EnerMark Inc. The amount of alleged damages
approximated Cdn $1,350,000 (US $900,000). On April 27, 1999 the lawsuit was
discontinued following agreement by both parties to have their dispute dealt
with in a final and binding arbitration. In advance of the arbitration process,
Neutrino disbursed approximately Cdn $500,000 (US $330,000) to EnerMark Inc. and
placed an additional Cdn $500,000 (US $330,000) in a trust account pending the
conclusion of the arbitration process. On July 16, 1999 the Company agreed to
settle the suit. The terms of the settlement provides that EnerMark will receive
the amount held in trust and an additional estimated Cdn $440,000 (US$290,000)
payable in monthly installments of Cdn $100,000 (US $66,000) beginning July 31,
1999. All costs were accrued for at June 30, 1999.
10
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. NASDAQ NATIONAL MARKET LISTING
The Company was advised that it was not in compliance with Nasdaq Stock Market
listing requirements due to the recent low price per share of its Common Stock.
The Company was granted a hearing on May 27, 1999 to present a plan to the
Nasdaq National Market for compliance with the $1.00 per share minimum bid
requirement. Subsequently, the Company was notified that effective with the
close of business on August 4, 1999, its securities including convertible
subordinated debentures were delisted from the Nasdaq National Market. The
Company's securities are now traded on the OTC Bulletin Board. The Company has
requested a review of the delisting decision by the Nasdaq Review Council. The
Company believes the delisting of its Common Stock will impair the liquidity of
the Common Stock and capital raising flexibility of the Company. The Company
cannot assure that it will be successful in its request to Nasdaq to reverse its
delisting decision.
NOTE 7. SUBSEQUENT EVENTS
On July 21, 1999 the Company announced that its Board of Directors has approved
a restructuring of the Company that involves a $20.6 million equity infusion,
the sale of the Brushy Creek and Texan Gardens Fields and an exchange offer for
its 6.875% convertible subordinated debentures due 2007. The restructuring plan
as initially filed with the Securities and Exchange Commission, will
substantially reduce the current common shareholders interest in the Company.
The restructuring plan comes after an extensive process by the Company to
evaluate strategic opportunities for the Company to maximize value for its
shareholders and debenture holders. The Company expects that the restructuring,
including the equity infusion and the asset sale, will improve the Company's
financial condition and allow the Company to pursue new opportunities for growth
in the future. Successful completion of the restructuring is not assured. If
the restructuring does not occur prior to the interest payment in October 1999,
the Company believes that it may be necessary to sell additional oil and gas
properties or secure additional borrowings from its current or new lenders to
fund the payment. There are no assurances that (i) the Company will be able to
complete any such sales, (ii) any such sales will be on terms favorable to
the Company, (iii) the Company will be able to secure additional borrowing or
(iv) the terms of such additional borrowings will be favorable to the Company.
The sale of the Brushy Creek and Texan Gardens Fields consists of the sale of
certain proven and unproven property interests to ANR Production Company for
$16.28 million, subject to certain adjustments. On July 30, 1999 the sale of
its interests in the Brushy Creek Field in Lavaca and Dewitt counties of Texas
was closed for $15.2 million. The net proceeds after closing costs were applied
to the Company's domestic bank facility with $5 million being applied to the
borrowing base facility and $9.6 million to the Tranche A obligation. Closing
on the Texan Gardens field was extended for up to 30 days, subject to the
satisfaction of certain conditions, but is not conditioned on the restructuring
transactions described below. Based on discussions with its lenders, the
Company expects that the proceeds from the remainder of the sale will be used
primarily for general corporate purposes and costs associated with the financial
restructuring.
The financial restructuring involves a $20.6 million equity investment by
affiliates of EnCap Investments L.L.C. (EnCap) in exchange for 43,829,787 newly
issued shares of the Company's Common Stock pursuant to a Stock Purchase
Agreement, which number of shares will represent a controlling interest in the
Company. The EnCap transaction is conditioned upon, among other things, exchange
of at least 98% of the Company's outstanding convertible debentures for a
combination of cash, Common Stock, warrants to purchase Common Stock and receipt
of certain third party consents. For each $1,000 principal amount of convertible
debentures (including accrued interest), the Company will offer to exchange (1)
377.8 shares of Common Stock, (2) warrants to purchase 188.9 shares of Common
Stock for a period of three years for an exercise price of $1.50 per share, and
(3) $241.50 in cash. Consummation of the restructuring is also conditioned upon
shareholder approval of the issuance of the additional shares to EnCap and the
shares and warrants to the debentureholders. Certain fees will be payable to
EnCap in connection with the transactions.
If the exchange offer is unsuccessful, but certain other conditions are met, the
Company may proceed with the EnCap investment and the restructuring of its
capital structure through a prepackaged plan of reorganization under Chapter 11
of the U. S. Bankruptcy Code. No assurance can be given that such transactions
can be consummated on acceptable terms.
11
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE QUARTER ENDED JUNE 30, 1999
AS COMPARED TO THE QUARTER ENDED JUNE 30, 1998
Oil and gas revenues for the quarter ended June 30, 1999 were $6,235,000
compared to oil and gas revenues of $4,367,000 for the same period in 1998. The
increase in revenues reflects an increase in oil and NGL production of 49% to
206,835 barrels and an increase in natural gas production of 37% to 1,426 MMcf
in the second quarter of 1999 compared to the second quarter of 1998. The
higher production levels in the second quarter of 1999 are due primarily to the
acquisition of Neutrino Resources Inc. in July 1998 ("the Neutrino Acquisition")
and the development of a discovery at the Brushy Creek Field in Texas during
1998.
The average realized oil price increased 12% from $13.10 per barrel in the
second quarter of 1998 to $14.70 per barrel in the second quarter of 1999.
Average realized natural gas prices declined 5% to $2.12 per Mcf during the
second quarter of 1999 compared to $2.24 per Mcf in same period a year earlier.
Second quarter 1999 production costs, including production and ad valorem taxes,
rose 10% to $2,227,000 compared to $2,023,000 in the second quarter of 1998 but
on an energy equivalent unit basis declined 22% quarter-over-quarter.
Contributing to the increased production costs were the Neutrino Acquisition and
the development of a discovery at the Brushy Creek Field in Texas during 1998.
General and administrative expenses were $1,055,000 in the second quarter of
1999, an increase of 25% from $842,000 in the prior year's second quarter
resulting primarily from general and administrative expenses associated with the
Neutrino Acquisition. However, on an energy equivalent unit basis, costs
declined 11% from the second quarter of 1998 to the same period in 1999.
Depreciation, depletion and amortization ("DD&A") increased 68% to $2,728,000 in
the second quarter of 1999 compared to $1,619,000 in 1998. On a unit of
equivalent production basis, DD&A increased 19% from $0.86 per Mcfe to $1.02 per
Mcfe. The increase reflects the Neutrino Acquisition during 1998 at a higher
per unit average depletion cost.
Exploration, dry hole and lease impairment expenses increased to $2,103,000 from
$1,527,000 in the three months ended June 30, 1999 compared to 1998. The 1998
expense is due primarily to a dry hole drilled in Lafourche Parish, Louisiana in
which the Company had a 93% working interest. The 1999 expense is a primarily
from impairments of a portion of the property held for resale and non-producing
properties.
Interest and debt expense in the quarter ended June 30, 1999 was $1,795,000
compared to $952,000 in the same period in 1998. The increase primarily
reflects the additional indebtedness incurred and acquired in July 1998 as a
result of the Neutrino Acquisition.
Tax benefits in the second quarter of 1999 were $82,000 compared to $18,000 in
the same period in 1998. The increase primarily reflects the increased pre-tax
loss from the Company's Canadian operations in the second quarter of 1999
compared to the same period in 1998.
The Company recorded a net loss of $3,614,000, or a loss of $0.28 per basic
share for the quarter ended June 30, 1999, compared to a net loss of $2,537,000
or a loss of $0.20 per basic share for the quarter ended June 30, 1998.
12
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1999
AS COMPARED TO THE SIX MONTHS ENDED JUNE, 1998
Oil and gas revenues for the six months ended June 30, 1999, were $11,856,000,
compared to oil and gas revenues for the same period in 1998 of $8,777,000. The
increase in revenues reflects higher production volumes of both natural gas and
crude oil, which are partially offset by lower commodity prices for both natural
gas and crude oil. High production volumes were primarily due to the Neutrino
Acquisition in July 1998.
Natural gas production in the six months ended June 30, 1999 was 3,148 MMcf, a
38% increase as compared to production for the same period in 1998 of
2,277 MMcf. The Company's crude oil and NGL production for the six months
ended June 30, 1999 increased 65% to 442,619 barrels as compared to 267,655
barrels for the same period in 1998.
Average realized natural gas prices in the six months ended June 30, 1999
decreased 9% to $1.90 per Mcf compared to $2.09 per Mcf in the same six months
of 1998. During the six months of 1999, crude oil prices decreased 9% to $12.45
per barrel, compared to $13.75 per barrel in the same period in 1998.
Gas production costs, including production and ad valorem taxes, increased in
the six months June 30, 1999 to $4,308,000, up 35% from $3,186,000 in the same
period in 1998, due in part to the Neutrino Acquisition. On a cost per Mcfe
basis, production costs for the six months ended June 30, 1999 decreased to
$0.74 per Mcfe, or 10% from $0.82 per Mcfe in 1998.
General and administrative expenses increased to $2,095,000 in the six months
ended June 30, 1999, up 10% from $1,902,000 in the six months of 1998. However,
on a cost per Mcfe basis, general and administrative expenses decreased 27% in
the first six months of 1999 to $0.36 per Mcfe from $0.49 per Mcfe in the same
period of 1998. The increase in general and administrative expenses for 1999
when compared to 1998 is not as great as would have been expected due to the
Neutrino acquisition because 1998 included accrued and paid bonuses of
$360,000 with no corresponding amounts in 1999.
Exploration, dry hole and lease impairment expenses increased in the six months
ended June 30, 1999 to $2,151,000, compared to $1,666,000 in the same period of
1998. The amount recorded in the six months ended June 30, 1998 was due
primarily to a dry hole drilled in Lafourche Parish, Louisiana in which the
Company had a 93% working interest. The 1999 expense is primarily from
impairments of a portion of the property held for sale and non-producing
properties. Since the Company uses the successful efforts method of accounting,
exploration expenses may vary greatly from period to period based upon the level
of exploration activity.
DD&A expense for the six months ended June 30, 1999 increased to $5,808,000, up
80% from $3,229,000 in the six months ended June 1998. The Company computes
depreciation and depletion on each producing property using the unit-of-
production method. Since this method employs estimates of remaining reserves,
depreciation and depletion expenses may vary from period to period because of
revisions to reserve estimates, production rates and other factors. DD&A
expenses increased in the first six months of 1999 to $1.00 per Mcfe, up 20%
from $0.83 per Mcfe in the same period of 1998. The increase reflects the
Neutrino Acquisition during 1998 at a higher per unit average depletion cost.
Interest and debt expense in the six months ended June 30, 1999 was $3,569,000,
compared to $1,786,000 in the same period in 1998. Interest expense increased
as a result of an increase in the outstanding bank debt incurred and assumed
with the Neutrino Acquisition in July 1998.
Tax benefit in the six months ended June 30, 1999 and 1998 was $312,000 and
$23,000, respectively. The increase primarily reflects the increased pre-tax
loss from the Company's Canadian operations compared to same period in 1998.
The Company reported a loss in the six months ended June 30, 1999, of $686,000,
or loss of $.05 per basic share, compared to loss of $2,832,000, or loss of
$0.24 per basic share, in the same period in 1998.
13
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its operations, acquisitions, exploration
and development expenditures from cash flows from operating activities, bank
borrowing, issuance of common stock and debt securities and the sale of non-
strategic assets.
The Company's cash flow (deficit) used in operating activities for the six
months ended June 30, 1999 and 1998 was ($585,000) and $965,000, respectively.
Effective May 29, 1998, the Company amended its domestic bank credit facility to
increase the borrowing base from $38,400,000 to $45,000,000. Subsequently, the
credit facility has been reduced and restructured as a result of lower oil and
natural gas price assumptions, the sale of certain domestic assets and the
scheduled reduction discussed below. A restructured and amended credit facility
("Amended Credit Facility") was entered into on March 29, 1999. The Amended
Credit Facility provided for a borrowing base of $19,353,000, plus a principal
tranche of $12,500,000 ("Tranche A") that matures on September 1, 1999. The
borrowing base was reduced to $18,830,000 on April 1, 1999, reflecting the
$6,000,000 received in March and April 1999 for the sale of the Company's
mineral interests in Texas, Mississippi and New Mexico. On July 30, 1999 the
sale of the Company's interests in the Brushy Creek Field in Lavaca and Dewitt
counties of Texas was closed for $15.2 million. The net proceeds after closing
costs were applied to the Company's domestic bank facility with $5 million being
applied to the borrowing base facility and $9.6 million to the Tranche A
obligation. Closing on the Texan Gardens Field was extended for up to 30 days.
The Company is currently in discussions with its lenders regarding a revision to
the Amended Credit Facility. The lenders have proposed that the proceeds from
the sale of the Texan Gardens Field can be retained by the Company and used for
general corporate purposes. In addition, the lenders have indicated that the
new borrowing base will become $15,000,000 to be reduced by principal payment of
$100,000 in August, $40,000 in September and October 1999, and $300,000 each
month thereafter; will be subject to semi-annual redeterminations until maturity
on June 1, 2001; and will be reviewed as of January 1, 2000. The lenders have
further indicated that the Tranche A will be reduced to $1,500,000 and become
due on January 1, 2000. As of June 30, 1999 and December 31, 1998, Tranche A
principal was classified as current portion of long-term debt in the Company's
Consolidated Balance Sheet.
The proposed revision to the Amended Credit Facility would require the Company,
among other provisions, to: (i) apply the majority of proceeds from asset sales
to reduction in the outstanding principal under the credit facility (to the
extent the assets are not otherwise encumbered), (ii) obtain lender's approval
of the Company's domestic general and administrative expense budget and (iii)
pay a $287,500 restructuring fee. The Amended Credit Facility also reduced the
Company's tangible net worth requirement beginning December 31, 1998. As of
June 30, 1999 and August 10, 1999, the Company was in compliance with the terms
and conditions of the Amended Credit Facility, as revised.
The obligations under the Amended Credit Facility are secured by substantially
all of the assets of the Company and its subsidiaries other than Neutrino. The
Amended Credit Facility prohibits the payment of dividends and contains certain
covenants relating to the financial condition of the Company. Outstanding
borrowings under the domestic bank credit facility were $31,168,000 at June 30,
1999. On August 10, 1999, outstanding borrowings under the Amended Credit
Facility were $16,533,000 with no further borrowing availability. Outstanding
principal under the Amended Credit Facility bears interest at the Bank Index
Rate (7.75% at June 30, 1999) to the extent of the borrowing base and at Bank
Index Rate plus 1% on Tranche A principal.
The Company believes that it may be necessary to sell additional oil and gas
assets or obtain additional borrowing from its current or new lenders to raise
the additional funds necessary to meet the September 1, 1999 or proposed revised
January 1, 2000 maturity of Tranche A principal. No assurance can be given that
such transactions can be consummated on terms acceptable to the Company or its
lenders, whose approval may be required. If the Company is unable to raise the
necessary funds, further restructuring of its Amended Credit Facility will be
required or the Company could become in default on the full amount of its
indebtedness, as discussed below.
14
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Effective June 25, 1998, Neutrino entered into a new Cdn $40,000,000 (US
$27,155,000) revolving demand loan facility (the "Canadian Credit Facility")
under which it could borrow at bank prime or Bankers Acceptance Rates plus a 1%
stamping fee.
At June 30, 1999, the Canadian Bank prime rate was 6.25% and the Bankers
Acceptance Rate for 30-day maturities was 4.62%. Effective July 15, 1999, the
borrowing base under the Canadian Credit Facility was reduced to Cdn $30,500,000
(US $20,706,000) and the interest rate was increased to prime plus 1% and the
stamping fee on Bankers Acceptance was increased to 1 1/4% per annum. These
changes were a result of a lender review giving effect to lower world oil
prices, the sale of certain non-strategic oil and gas properties and the
Company's financial condition. At June 30, 1999, outstanding borrowings under
the Canadian Credit Facility were Cdn $30,051,000 (US $20,443,000). On August
10, 1999, outstanding borrowings under the Canadian Credit Facility were Cdn
$29,725,000 (US $20,221,000). The Canadian Credit Facility contains certain
covenants relating to the financial condition of Neutrino including, at each
quarter's end, maintenance of working capital of no more than negative Cdn
$1,500,000 through September 30, 1999 and Cdn $0 through maturity. The borrowing
base under the Canadian Credit Facility reduces by Cdn $500,000 per month
beginning August 28, 1999 and is subject to semi-annual redeterminations. The
next borrowing base review is September 30, 1999. As of June 30, 1999 and
August 10, 1999, Neutrino was in compliance with the terms of the credit
facility. The outstanding balance under the Canadian Credit Facility is
classified as a current liability because of the demand feature of the loan.
However, it is management's intention that the facility be utilized to provide
long-term financing for the Company.
The Company's financial condition and liquidity are impacted by prices the
Company receives for its oil and natural gas. In the first quarter of 1999, oil
and natural gas prices continued to be weak, but began to strengthen early in
the second quarter. Judgments by both domestic and Canadian lenders regarding
the level of future oil and natural gas prices, among other things, will impact
their borrowing base determinations for the Company's credit facilities.
On October 2, 1997, the Company issued $41,400,000 of 6.875% convertible
subordinated debentures due on October 1, 2007. The debentures are convertible
into Common Stock of the Company at any time prior to maturity at a conversion
price of $8.26 per share. Proceeds of the offering were used to reduce bank
debt and fund subsequent acquisitions.
The Company's substantial leverage poses certain risks, including the risk that
the Company may not generate sufficient cash flow to service its indebtedness or
that the Company may be unable to obtain additional financing in the future and
as a result, may not have the necessary resources to respond to market
conditions and opportunities. The Company's high level of indebtedness,
covenant requirements and working capital deficit subjects it to risks of
default, which may significantly impair its ability to meet its liquidity needs.
The Company's Amended Credit Facility contains provisions whereby a default
under the Company's Canadian Credit Facility or to the 6.875% Convertible
Subordinated Debentures would create a default condition under the Amended
Credit Facility. In such a default condition, the banks may declare amounts
outstanding under the Amended Credit Facility to become immediately due and
payable. In addition, the holders of convertible subordinated debentures have
acceleration rights if the Company is in payment default under either its
amended credit facility or canadian Credit Facility.
The Company's financial condition at the end of 1998 resulted in the Company's
independent auditors, in their opinion on the 1998 financial statements,
disclosing their substantial doubt about the Company's ability to continue as a
going concern. In February 1999, the Board of Directors of the Company retained
CIBC World Markets Corp. as independent advisors to assist in evaluating various
strategic alternatives for maximizing shareholder value. On July 21, 1999 the
Company announced that its Board of Directors has approved a restructuring of
the Company that involves a $20.6 million equity infusion, the sale of the
Brushy Creek and Texan Garden Fields and an exchange offer for its 6.875%
convertible subordinated debentures due 2007. The restructuring plan, as
initially filed with the Securities and Exchange Commission, will substantially
reduce the current common stockholders interest in the Company. The
restructuring plan comes after an extensive process by the Company to evaluate
strategic opportunities for the Company to maximize shareholder value. The
Company expects that the restructuring, including the equity infusion and the
asset sale, will improve the Company's financial condition and allow the Company
to pursue new opportunities for growth in the future. Successful completion of
the restructuring is not assured.
15
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The Company was notified that effective with the close of business on August 4,
1999, its securities including convertible subordinated debentures were delisted
from the Nasdaq National Market. This action was attributable to its inability
to satisfy the Nasdaq National Market maintenance standards for the continued
listing of its securities. Following the delisting the Company's Common Stock
will continue to be quoted and traded on the OTC Bulletin Board under the same
symbol, SMIN and the convertible subordinated debentures under SMING.
Additionally, the Company intends to request a review of the delisting decision
by the Nasdaq Review Council. The Company believes a permanent delisting of its
Common Stock would impair the liquidity of the Common Stock and capital raising
flexibility of the Company. The Company cannot assure that it will be
successful in its request to Nasdaq to reverse its delisting decision.
Since the trading of our securities will be conducted on the OTC Bulletin Board,
the Company expects the spreads between the "bid and "asked" prices of the
securities quoted by market makers will likely be greater than are at present
and shareholders will likely experience a greater degree of difficulty in
trading the securities. In addition, there are significant restrictions imposed
by most brokerage houses on the ability of their brokers to solicit orders or
recommend the purchase of securities that trade on the OTC Bulletin Board. In
the majority of the cases, the purchase of the securities is limited to
unsolicited offers from private investors, who have to comply with policies and
practices involving the completion of time-consuming forms that can make the
handling of lower-prices securities economically unattractive. Moreover, most
brokerage houses do not permit lower priced securities to be used as
collateral for margin accounts or to be purchased on margin. The Company
believes that the current market price of our securities may limit the effective
marketability because of the reluctance of many brokerage firms and
institutional investors to recommend lower-priced securities to their clients or
to hold them in their own portfolios. The brokerage commission on the purchase
or sale of a lower-prices securities may also represent a higher percentage of
the price than the brokerage commission on a higher-priced issue.
Capital spending in the first six months of 1999 for development and exploration
totaled $1,600,000 and was funded from cash flows from operating activities and
bank debt. The Company's capital spending during 1999 is expected to be reduced
significantly from 1998. Capital spending will be greatly influenced by the
level of oil and gas prices, the availability of excess funds, if any, beyond
repayment of the proposed January 1, 2000 Tranche A maturity and excess
availability under the Company's domestic and Canadian credit facilities.
Capital availability from outside sources, including debt and equity markets, is
expected to be limited.
The Company did not declare dividends in the six months ended June 30, 1999 and
1998. The Company does not expect, under its existing capital structure, to be
able to pay dividends for the foreseeable future. Payment of dividends is
currently prohibited by the terms of the Company's Amended Credit Facility.
The Company's recent operating results have been seriously hurt by a number of
factors, including low commodity prices for oil and natural gas. During the
third quarter of 1998, the Company borrowed approximately $34.2 million under
the domestic credit facility in connection with the acquisition of Neutrino. As
a result of the additional Neutrino acquisition debt, the Company had an
aggregate of approximately $96.0 million of debt outstanding as of December 31,
1998. Due to lower commodity prices for oil and gas in late 1998 and early 1999,
the lenders under both our domestic and Canadian credit facilities reduced our
borrowing bases. The reduced borrowing bases coupled with our level of debt has
materially and adversely impacted our liquidity and capital resources.
Consequently, the Company began developing during the first quarter of 1999 a
comprehensive financial and operating plan to return the Company to
profitability. The Company downsized staff, cut administrative expenses and
improved working capital through the sale of non-core assets. Although operating
cash flow improved, the Company still is not generating sufficient cash flow to
fund operations and service debt. As a result, the Company hired CIBC World
Markets Corp. in February 1999 to explore strategic alternatives.
The Company currently has outstanding $2.9 million under Tranche A of the
domestic credit facility due September 1, 1999 which the lenders have proposed
reducing to $1.5 million and extending the maturity to January 1, 2000. Failure
to make the September 1, 1999 (or January 1, 2000, if extended) payment would be
a default under our domestic credit facility, and the lenders would have the
right to demand payment in full of the debt outstanding under this facility
which is currently $16.5 million including Tranche A. On October 1, 1999, a cash
interest payment of approximately $1.4 million is due on
16
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
the debentures. The Company will most likely not have sufficient available cash
to make this interest payment. Failure to make the October 1, 1999 payment by
October 30, 1999 would be a default under the indenture governing the
debentures, and most likely would result in a demand for full payment of the
debentures. Failure to timely pay the September 1, 1999 payment to the lenders
under our domestic credit facility or the October 1, 1999 interest payment on
the debentures would be a default under our Canadian credit facility, and would
most likely result in a demand for payment in full of the debt outstanding under
that facility.
After an extensive process, the Company announced the approval by the Board of
Directors of a financial restructuring as outlined in Note 7. Subsequent Events
to the Unaudited Consolidated Financial Statements.
If the financial restructuring is not consummated and the Company is
unsuccessful in obtaining additional borrowings from its current lenders, the
Company will consider all alternatives including but not limited to mergers with
other entities, obtaining additional sources of financing or equity, and
significant reductions in general and administrative costs. In addition, the
Company may be forced to petition to reorganize or liquidate under the
Bankruptcy Code of the United States.
YEAR 2000 COMPLIANCE
The Company's State of Readiness
The "Year 2000" problem concerns the ability of technology to properly recognize
and process date sensitive information beyond December 31, 1999. The Company is
in the process of evaluating its information technology (IT) and non-information
technology. Year 2000 Committees have been formed at the Company's office in
Houston and at the Company's Canadian subsidiary headquarters in Calgary. The
Committees include members of senior management and key employees from major
business units. The Committees assess Year 2000 issues; direct remedial actions
necessary to minimize systems disruptions and other risks; contact significant
third party purchasers, suppliers, vendors and operators with whom there are
material transactions and data exchange; test internal hardware and software;
and make appropriate contingency plans. Neutrino has engaged a consulting firm
which has prepared a report on the Year 2000 readiness of Neutrino, including a
detailed inventory of hardware and software priorities for action and an
implementation plan. Additionally, the Company, on behalf of itself and its
other subsidiaries, has contacted principal software vendors. Thus far, the
Company has received a letter of compliance for its accounting and payroll
systems and product conformity assurance for its reservoir engineering system.
Additionally, the land lease record systems vendor has informed the Company that
the system is Year 2000 compatible. The Company has no proprietary software.
Purchased software and hardware systems have been installed and assembled by
third party vendors that provide network and software IT services to the
Company. Vendors have been engaged to evaluate the systems for Year 2000
compliance.
Costs to Address the Company's Year 2000 Issues
Management expects the costs of compliance, excluding internal costs, will not
exceed $120,000, which includes the evaluation, planning, replacement of the
land and lease records systems at Neutrino and the replacement of several
desktop computers and other hardware. Approximately $9,000 was expended in
1998, with the balance to be incurred in 1999. The amount spent during the
first half of 1999 was not significant.
17
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Risks of the Company's Year 2000 Issues
Risks associated with the Year 2000 problem are potentially significant.
Failure to remedy a critical system problem could have a material affect on the
results of operations and financial condition. The Company has interests in
operated and non-operated properties in the United States, Canada and Ecuador.
The Company will continue to review and monitor software and equipment within
its control. The Company will continue to contact operators of its non-operated
properties and other third parties to determine their Year 2000 compliance
procedures, but cannot warrant the readiness of those systems. As the Company
is in the process of collecting this information from third parties, the Company
cannot currently state whether its operations will be materially affected by
third party compliance. However, the Company is not currently aware of any
third party that could cause a significant business disruption. While there can
be no assurance, the Company believes that it will be able to achieve Year 2000
compliance by the end of 1999 with respect to the Company's internal systems,
and does not currently anticipate any disruption in its operations or any
materially adverse effects to its financial condition, results of operations or
cash flows as the result of any failure by the Company to be in compliance.
In a recent Securities and Exchange Commission ("SEC") release regarding Year
2000 disclosures, the SEC required public companies to disclose the most likely
worst case Year 2000 scenario. Situations which must be included in any worst
case scenario include: the possibility of widespread failure of oil and gas
transportation systems, the inability of Company personnel to gain access to
offices and other facilities, and the inability of customers to make payment for
purchases. The effects of such occurrences would have a cumulative material
adverse impact on the Company, although not quantifiable at this time.
The Company's Contingency Plan
Contingency plans are being developed at this time, and will be monitored and
modified after the initial evaluation by the Year 2000 Committees is complete.
The Company intends to have such plans in place by September 30, 1999.
DEFINITIONS
As used herein:
Thousand cubic feet ("Mcf")
Million cubic feet ("MMcf")
Natural gas liquids ("NGL")
Energy Equivalents Units (1 barrel of liquids = 6 Mcf of natural gas)
Thousand cubic feet of gas equivalent ("Mcfe")
Recent Accounting Pronouncements
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), was issued by the Financial
Accounting Standards Board in June 1998. SFAS 133 standardizes the accounting
for derivative instruments, including certain derivative instruments embedded in
other contracts. Under the standard, entities are required to carry all
derivative instruments in the statement of financial position at fair value.
The Company will adopt SFAS 133, as amended, beginning in fiscal year 2001. The
Company has not yet determined the impact that SFAS 133 will have on its
financial statements.
18
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS-(CONTINUED)
FORWARD-LOOKING STATEMENTS
All statements other than statements of historical fact contained in this
report, including statements in Management's Discussion and Analysis of
Financial Condition and Results of Operations, are forward-looking statements.
When used herein, the words "budget", "expressions", "anticipate", "expects",
"believes", "seeks", "goals", "plans", "strategy", "intends", or "projects" and
similar expressions are intended to identify forward-looking statements. It is
important to note that the Company's actual results could differ materially from
those projected by such forward-looking statements and no assurance can be given
that the expectations will prove correct. In reliance upon the Private
Securities Litigation Reform Act of 1995, factors identified by the Company that
could cause the Company's future results to differ materially from the results
discussed in such forward-looking statements include the risks described under
"Risk Factors" in Item 1 of its Annual Report on Form 10-K, as amended, for the
year ended December 31, 1998. All forward-looking statements in this report are
expressly qualified in their entirety by the cautionary statements in this
paragraph and shall be deemed in the future to be modified in their entirety by
the Company's public pronouncements, including those contained in all future
reports and other documents filed by the Company with the Securities and
Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of market risks including the potential for
adverse changes in oil and gas prices, foreign currency exchange rated and
interest rates. There have been no material changes to the Company's
disclosures about market risk from those contained in its 10-K, as amended, for
the year ended December 31, 1998.
19
<PAGE>
SOUTHERN MINERAL CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in several lawsuits arising in the ordinary course of
business, only one of which management believes presents the possibility of a
material payment. The Company's Canadian subsidiary, Neutrino Resources Inc.,
was sued alleging damages resulting from the calculation of third party facility
and processing fees at its Pine Creek Field, Alberta, Canada. The suit was
filed on January 27, 1999 in the Court of Queen's Bench of Alberta in the
Judicial District of Calgary by EnerMark Inc. The amount of alleged damages
approximated Cdn $1,350,000 (US $900,000). On April 27, 1999 the lawsuit was
discontinued following agreement by both parties to have their dispute dealt
with in a final and binding arbitration. In advance of the arbitration process,
Neutrino disbursed approximately Cdn $500,000 (US $330,000) to EnerMark Inc. and
placed an additional Cdn $500,000 (US $330,000) in a trust account pending the
conclusion of the arbitration process. On July 16, 1999 the Company agreed to
settle the suit. The terms of the settlement provides that EnerMark will receive
the amount held in trust and an additional estimated Cdn $440,000 (US$290,000)
payable in monthly installments of Cdn $100,000 (US $66,000) beginning July 31,
1999. All costs were accrued for at June 30, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
27.1 Financial Data Schedule
(B) REPORT ON FORM 8-K:
None
20
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SOUTHERN MINERAL CORPORATION
By /s/ Michael E. Luttrell
------------------------------------------
Date: August 20, 1999
Michael E. Luttrell
Vice President-Finance and Chief
Financial Officer
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
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THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
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<ALLOWANCES> 0
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<PP&E> 143,906
<DEPRECIATION> (33,326)
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<CURRENT-LIABILITIES> 40,340
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