-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C7kNULW7YwkRxJHf9xdZNHq+z0D9prkg4mKdIv+q+4bnzlKOkYp8LqTFgrTMoXyq bIXnG+wRWGKi0iDlBjUL0w== 0000867665-06-000031.txt : 20060510 0000867665-06-000031.hdr.sgml : 20060510 20060510091643 ACCESSION NUMBER: 0000867665-06-000031 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060510 DATE AS OF CHANGE: 20060510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ABRAXAS PETROLEUM CORP CENTRAL INDEX KEY: 0000867665 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 742584033 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-16071 FILM NUMBER: 06823531 BUSINESS ADDRESS: STREET 1: 500 N LOOP 1604 E STE 100 CITY: SAN ANTONIO STATE: TX ZIP: 78232 BUSINESS PHONE: 2104904788 MAIL ADDRESS: STREET 1: 500 N LOOP 1604 EAST STE 100 CITY: SAN ANTONIO STATE: TX ZIP: 78232 10-Q 1 abp10q033106.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended March 31, 2006 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-19118 ABRAXAS PETROLEUM CORPORATION (Exact name of Registrant as specified in its charter) Nevada 74-2584033 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 500 N. Loop 1604 East, Suite 100, San Antonio, Texas 78232 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (210) 490-4788 Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the restraint was required to file such reports), and (2) has been subject to such filing requirements for the past 90 daysYes.[X] or No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one) Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] or No [X] The number of shares of the issuer's common stock outstanding as of May 5, 2006 was: Class Shares Outstanding Common Stock, $.01 Par Value 42,605,577 Forward-Looking Information We make forward-looking statements throughout this document. Whenever you read a statement that is not simply a statement of historical fact (such as statements including words like "believe", "expect", "anticipate", "intend", "plan", "seek", "estimate", "could", "potentially" or similar expressions), you must remember that these are forward-looking statements, and that our expectations may not be correct, even though we believe they are reasonable. The forward-looking information contained in this document is generally located in the material set forth under the headings "Management's Discussion and Analysis of Financial Condition and Results of Operations" but may be found in other locations as well. These forward-looking statements generally relate to our plans and objectives for future operations and are based upon our management's reasonable estimates of future results or trends. The factors that may affect our expectations regarding our operations include, among others, the following: o our high debt level; o our success in development, exploitation and exploration activities; o our ability to make planned capital expenditures; o declines in our production of natural gas and crude oil; o prices for natural gas and crude oil; o our ability to raise equity capital or incur additional indebtedness; o political and economic conditions in oil producing countries, especially those in the Middle East; o prices and availability of alternative fuels; o our restrictive debt covenants; o our acquisition and divestiture activities; o results of our hedging activities; and o other factors discussed elsewhere in this report. In addition to these factors, important factors that could cause actual results to differ materially from our expectations ("Cautionary Statements") are disclosed under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2005, which is incorporated by reference herein. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the Cautionary Statements. 2 ABRAXAS PETROLEUM CORPORATION AND SUBSIDIARIES FORM 10 - Q INDEX PART I FINANCIAL INFORMATION
ITEM 1 - Financial Statements Condensed Consolidated Balance Sheets - March 31, 2006 and December 31, 2005................................................4 Condensed Consolidated Statements of Operations - Three Months Ended March 31, 2006 and 2005...........................6 Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2006 and 2005...........................7 Notes to Condensed Consolidated Financial Statements..........................8 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations...............................................12 ITEM 3 - Quantitative and Qualitative Disclosure about Market Risk........................24 ITEM 4 - Controls and Procedures..........................................................24 PART II OTHER INFORMATION ITEM 1 - Legal Proceedings..................................................................25 ITEM 1A- Risk Factors.......................................................................25 ITEM 2 - Unregistered Sales of Equity Securities and Use of Proceeds........................25 ITEM 3 - Defaults Upon Senior Securities....................................................25 ITEM 4 - Submission of Matters to a Vote of Security Holders................................25 ITEM 5 - Other Information..................................................................25 ITEM 6 - Exhibits...........................................................................25 Signatures.........................................................................26
3
Abraxas Petroleum Corporation Condensed Consolidated Balance Sheets (in thousands) March 31, December 31, 2006 2005 (Unaudited) ------------------ ------------------- Assets: Current assets: Cash ....................................................... $ 43 $ 42 Accounts receivable, net: Joint owners.......................................... 1,158 540 Oil and gas production................................ 6,727 7,957 Other................................................. 35 100 ------------------ ------------------- 7,920 8,597 Other current assets.......................................... 1,964 1,638 ------------------ ------------------- Total current assets..................................... 9,927 10,277 Property and equipment: Oil and gas properties, full cost method of accounting: Proved.................................................... 340,481 333,373 Other property and equipment................................. 3,315 3,289 ------------------ ------------------- Total................................................ 343,796 336,662 Less accumulated depreciation, depletion, and amortization............................................ 234,814 231,414 ------------------ ------------------- Total property and equipment - net........................ 108,982 105,248 Deferred financing fees, net.................................... 5,639 6,037 Other assets .................................................. 304 304 ------------------ ------------------- Total assets.................................................. $ 124,852 $ 121,866 ================== ===================
See accompanying notes to condensed consolidated financial statements 4
Abraxas Petroleum Corporation Condensed Consolidated Balance Sheets (continued) (in thousands) March 31, December 31, 2006 2005 (Unaudited) ------------------- ------------------- Liabilities and Stockholders' Deficit Current liabilities: Accounts payable.............................................. $ 7,355 $ 9,814 Oil and gas production payable................................ 2,649 3,481 Accrued interest.............................................. 5,124 1,368 Other accrued expenses........................................ 861 494 ------------------- ------------------- Total current liabilities................................... 15,989 15,157 Long-term debt.................................................. 129,798 129,527 Future site restoration......................................... 907 883 ------------------- ------------------- Total liabilities.......................................... 146,694 145,567 Stockholders' deficit: Common Stock, par value $.01 per share- authorized 200,000,000 shares; issued, 42,588,327 and, 42,063,167 .................................................. 426 421 Additional paid-in capital................................... 163,328 162,795 Accumulated deficit........................................... (186,973) (188,193) Treasury stock, at cost, 35,552 and 56,477 shares ............ (285) (408) Accumulated other comprehensive income........................ 1,662 1,684 ------------------- ------------------- Total stockholders' deficit............................... (21,842) (23,701) ------------------- ------------------- Total liabilities and stockholders' deficit..................... $ 124,852 $ 121,866 =================== ===================
See accompanying notes to condensed consolidated financial statements 5
Abraxas Petroleum Corporation Condensed Consolidated Statements of Operations (Unaudited) (in thousands except per share data) Three Months Ended March 31, ----------------------------------- 2006 2005 (1) -------------- ----------------- Revenue: Oil and gas production revenues................................... $ 12,926 $ 7,525 Rig revenues...................................................... 376 296 Other............................................................. 3 1 -------------- ----------------- 13,305 7,822 Operating costs and expenses: Lease operating and production taxes.............................. 2,822 2,278 Depreciation, depletion and amortization.......................... 3,399 1,698 Rig operations.................................................... 211 218 General and administrative (including stock-based compensation of $171 and $25)................................................. 1,286 971 -------------- ----------------- 7,718 5,165 -------------- ----------------- Operating income ................................................... 5,587 2,657 Other (income) expense Interest income................................................... (1) (1) Interest expense.................................................. 3,971 3,134 Amortization of deferred financing fees........................... 397 451 Other............................................................. - 9 -------------- ----------------- 4,367 3,593 -------------- ----------------- Income (loss) from continuing operations ............................ 1,220 (936) Income from discontinued operations (net of $6,060 income tax expense in 2005).................................................. - 12,921 -------------- ----------------- Net income .......................................................... $ 1,220 $ 11,985 ============== ================= Basic earnings (loss) per common share: Net earnings (loss) per common from continuing operations......... $ 0.03 $ (0.02) Discontinued operations .......................................... - 0.35 -------------- ----------------- Net income per common share - basic................................. $ 0.03 $ 0.33 ============== ================= Diluted earnings (loss) per common share: Net earnings (loss) from continuing operations.................... $ 0.03 $ (0.02) Discontinued operations .......................................... - 0.35 -------------- ----------------- Net income per common share - diluted.............................. $ 0.03 $ 0.33 ============== =================
(1) Reflects retrospective adoption of SFAS 123R. See accompanying notes to condensed consolidated financial statements 6
Abraxas Petroleum Corporation Condensed Consolidated Statements of Cash Flows (Unaudited) (in thousands) Three Months Ended March 31, ---------------------------------------- 2006 2005 (1) ----------------- ----------------- Cash flows from Operating Activities Net income................................................... $ 1,220 $ 11,985 Income from discontinued operations........................... - (12,921) ----------------- ----------------- Income (loss) from continuing operations...................... 1,220 (936) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amortization................ 3,399 1,698 Accretion of future site restoration..................... 24 20 Amortization of deferred financing fees.................. 397 451 Stock-based compensation................................. 171 25 Changes in operating assets and liabilities: Accounts receivable...................................... 677 1,573 Other ................................................... (348) 1,204 Accounts payable and accrued expenses.................... 832 5,454 ----------------- ----------------- Net cash provided by continuing operations.................... 6,372 9,489 Net cash used in discontinued operations...................... - (4,132) ----------------- ----------------- Net cash provided by operations............................... 6,372 5,357 Cash flows from Investing Activities Capital expenditures, including purchases and development of properties............................................... (7,133) (8,652) ----------------- ----------------- Net cash used in continuing operations........................ (7,133) (8,652) Net cash provided by discontinued operations.................. - 26,572 ----------------- ----------------- Net cash provided by (used in) investing activities........... (7,133) 17,920 Cash flows from Financing Activities Proceeds from long-term borrowings........................... 4,271 553 Payments on long-term borrowings............................. (4,000) (1,971) Issuance of common stock for compensation.................... 116 102 Exercise of stock options .................................. 374 205 Deferred financing fees ..................................... 1 (43) ----------------- ----------------- Net cash provided by (used in) financing operations.......... 762 (1,154) Net cash used in discontinued operations..................... - (23,407) ----------------- ----------------- Net cash (used in) financing activities.......... 762 (24,561) ----------------- ----------------- Increase (decrease) in cash.................................. 1 (1,284) Cash, at beginning of period................................. 42 1,284 ----------------- ----------------- Cash, at end of period....................................... $ 43 $ - ================= ================= Supplemental disclosures of cash flow information: Interest paid ............................................... $ 191 $ 77 ================= ================= Non-cash items: Future site restoration...................................... $ - $ 17 ================= =================
(1) Reflects retrospective adoption of SFAS 123R. See accompanying notes to condensed consolidated financial statements 7 Abraxas Petroleum Corporation Notes to Condensed Consolidated Financial Statements (Unaudited) (tabular amounts in thousands except per share data) Note 1. Basis of Presentation The accounting policies followed by Abraxas Petroleum Corporation and its subsidiaries (the "Company" or "Abraxas") are set forth in the notes to the Company's audited financial statements in the Annual Report on Form 10-K filed for the year ended December 31, 2005. Such policies have been continued without change. Also, refer to the notes to those financial statements for additional details of the Company's financial condition, results of operations, and cash flows. All the material items included in those notes have not changed except as a result of normal transactions in the interim, or as disclosed within this report. The accompanying interim consolidated financial statements have not been audited by independent accountants, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the financial position and results of operations. Any and all adjustments are of a normal and recurring nature. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of results to be expected for the full year. The consolidated financial statements include the accounts of the Company and its wholly-owned foreign subsidiary, Grey Wolf Exploration Inc. ("Grey Wolf") for the 2005 period. On February 28, 2005 Grey Wolf closed an initial public offering, resulting in our substantial divestiture of our capital stock and operations in Grey Wolf. As a result of the disposal of Grey Wolf, the results of operations of Grey Wolf through February 28, 2005 are reflected in our Financial Statements as discontinued operations. Stock-based Compensation In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment". SFAS No. 123R is a revision of SFAS No. 123, "Accounting for Stock Based Compensation", and supersedes APB 25. Among other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The Company adopted SFAS 123R in the fourth quarter of 2005 using the "modified prospective method".Under the "modified retrospective" method entities are permitted to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. This standard requires the cost of all share-based payments, including stock options, to be measured at fair value on the grant date and recognized in the statement of operations. In accordance with this standard, all periods prior to January 1, 2005 were restated to reflect the impact of the standard as if it had been adopted on January 1, 1995, the original effective date of SFAS No. 123, "Accounting for Stock-Based Compensation". Also in accordance with the standard, the amounts that are reported in the statement of operations for the restated periods are the pro forma amounts previously disclosed under SFAS No. 123. The Company currently utilizes a standard option pricing model (i.e., Black-Scholes) to measure the fair value of stock options granted to Employees. While SFAS 123R permits entities to continue to use such a model, the standard also permits the use of a more complex binomial, or "lattice" model. Based upon research done by the Company on the alternative models available to value option grants, and in conjunction with the type and number of stock options expected to be issued in the future, the Company has determined that it will continue to use the Black-Scholes model for option valuation as of the current time. SFAS 123R includes several modifications to the way that income taxes are recorded in the financial statements. The expense for certain types of option grants is only deductible for tax purposes at the time that the taxable event takes place, which could cause variability in the Company's effective tax rates recorded throughout the year. SFAS 123R does not allow companies to "predict" when these taxable events will take place. Furthermore, it requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow 8 as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. These future amounts cannot be estimated, because they depend on, among other things, when employees exercise stock options. The following table summarizes the stock option activities for the three months ended March 31, 2006 (in thousands except per share data):
Weighted Weighted Average Average Option Grant Exercise Date Fair Aggregate Price Per Value Per Intrinsic Shares Share Share Value --------------- -------------- -------------- -------------- Outstanding December 31, 2005....... 3,016 $ 1.75 $ 1.27 $ 3,837 Granted............................ 98 $ 6.05 $ 4.35 426 Exercised.......................... (525) $ 0.71 $ 0.37 (193) Expired or canceled................. - $ - $ - - --------------- -------------- Outstanding March 31, 2006.......... 2,589 $ 2.12 $ 1.57 $ 4,070 =============== ==============
Additional information related to options at March 31, 2006 and December 31, 2005 is as follows:
March 31, December 31, 2006 2005 ---------------------- -------------------- Options exercisable.................................... 1,704,838 2,224,998 ====================== ====================
Note 2. Discontinued operations On February 28, 2005, Grey Wolf completed an IPO resulting in Abraxas substantially divesting itself of its investment in Grey Wolf. The operations of Grey Wolf, previously reported as a business segment, are reported as discontinued operations for all periods presented in the accompanying financial statements and the operating results are reflected separately from the results of continuing operations. Income from discontinued operations for the period ended March 31, 2005 includes a gain on the disposal of Grey Wolf of $21.8 million, less non-cash income tax of $6.1 million, and a loss from operations, including debt retirement costs, of $2.8 million. Note 3. Income Taxes The Company records income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. For the period ended March 31, 2006, there is no current or deferred income tax expense or benefit due to losses and/or loss carryforwards and valuation allowance which has been recorded against such benefits. Note 4. Long-Term Debt Long-term debt consisted of the following:
March 31 December 31 2006 2005 ---------------- ----------------- Floating rate senior secured notes due 2009............................ $ 125,000 $ 125,000 9 Senior secured revolving credit facility............................... 4,798 4,527 ---------------- ----------------- 129,798 129,527 Less current maturities ............................................... - - ---------------- ----------------- $ 129,798 $ 129,527 ================ =================
Floating Rate Senior Secured Notes due 2009. In connection with the October 2004 financial restructuring, Abraxas issued $125 million in aggregate principal amount of floating rate senior secured notes due 2009. The notes will mature on December 1, 2009 interest is payable at a per annum floating rate of six-month LIBOR plus 7.50%. The interest rate was 12.08% per annum as of March 31, 2006. The interest rate is reset semi-annually on each June 1 and December 1. Interest is payable semi-annually in arrears on June 1 and December 1 of each year. Senior Secured Revolving Credit Facility. On October 28, 2004, Abraxas entered into an agreement for a revolving credit facility having a maximum commitment of $15 million, which includes a $2.5 million subfacility for letters of credit. Availability under the revolving credit facility is subject to a borrowing base consistent with normal and customary natural gas and crude oil lending transactions. Outstanding amounts under the revolving credit facility bear interest at the prime rate announced by Wells Fargo Bank, National Association plus 1.00%. The interest rate was 8.75% per annum as of March 31, 2006. Subject to earlier termination rights and events of default, the stated maturity date under the revolving credit facility is October 28, 2008. Note 5. Earnings (Loss) Per Share The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended March 31, ---------------------------------- 2006 2005 -------------- --------------- Numerator: Net income (loss) before effect of discontinued operations........ $ 1,220 $ (936) Discontinued operations........................................... - 12,921 -------------- --------------- Net earnings available to common stockholders .................... $ 1,220 $ 11,985 ============== =============== Denominator: Denominator for basic earnings per share - weighted-average shares. 42,470,802 36,603,592 Effect of dilutive securities: Stock options and warrants...................................... 1,681,042 - -------------- --------------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed Conversions................. 44,151,844 36,603,592 ============== =============== Basic earnings (loss) per share: Net earnings (loss) - continuing operations ....................... $ 0.03 $ (0.02) Discontinued operations............................................. - 0.35 -------------- --------------- Net earnings per common share - basic $ 0.03 $ 0.33 ============== =============== Diluted earnings (loss) per share: Net earnings (loss) - continuing operations......................... $ 0.03 $ (0.02) Discontinued operations ............................................ - 0.35 -------------- --------------- Net earnings per common share - diluted................................. $ 0.03 $ 0.33 ============== ===============
For the three months ended March 31, 2005 none of the shares issuable in connection with stock options or warrants are included in diluted shares. Inclusion of these shares would be antidilutive due to losses from continuing 10 operations incurred in the periods. Had there not been a loss in this period, dilutive shares would have been 1,660,480 shares for the three months ended March 31, 2005. Note 6. Hedging Program and Derivatives On January 1, 2001, the Company adopted SFAS 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") as amended by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS 133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities. In 2003, the Company elected out of hedge accounting as prescribed by SFAS 133. Accordingly, instruments are recorded on the balance sheet at their fair value with adjustments to the carrying value of the instruments being recognized in oil and gas income in the current period. Under the terms of our revolving credit facility, we are required to maintain hedging positions with respect to not less than 25% nor more than 75% of our crude oil and natural gas production for a rolling six month period. The following table sets forth the Company's current hedge position:
Time Period Notional Quantities Price - ---------------------------------- -------------------------------------------- ---------------------- May 2006 10,000 MMbtu of production per day Floor of $8.00 June 2006 10,000 MMbtu of production per day Floor of $7.00 July 2006 10,000 MMbtu of production per day Floor of $7.00 August 2006 10,000 MMbtu of production per day Floor of $6.00 September 2006 10,000 MMbtu of production per day Floor of $5.00 October 2006 10,000 MMbtu of production per day Floor of $5.00 November 2006 10,000 MMbtu of production per day Floor of $6.00
Note 7. Contingencies - Litigation From time to time, the Company is involved in litigation relating to claims arising out of its operations in the normal course of business. At March 31, 2006, the Company was not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on its operations. 11 ABRAXAS PETROLEUM CORPORATION PART I Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Prior to February 2005, Grey Wolf Exploration Inc. was a wholly-owned Canadian subsidiary of Abraxas. In February 2005, Grey Wolf, closed an initial public offering resulting in the substantial divestiture of our capital stock in Grey Wolf. As a result of the Grey Wolf IPO and the significant divestiture of our interest in Grey Wolf, the results of operations of Grey Wolf are reflected in our Financial Statements and in this document as "Discontinued Operations" and our remaining operations are referred to in our Financial Statements and in this document as "Continuing Operations" or "Continued Operations". Unless otherwise noted, all disclosures are for continuing operations. The following is a discussion of our financial condition, results of operations, liquidity and capital resources. This discussion should be read in conjunction with our consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K filed for the year ended December 31, 2005. Critical Accounting Policies There have been no changes from the Critical Accounting Polices described in our Annual Report on Form 10-K for the year ended December 31, 2005. General We are an independent energy company primarily engaged in the development and production of natural gas and crude oil. Historically we have grown through the acquisition and subsequent development and exploitation of producing properties, principally through the redevelopment of old fields utilizing new technologies such as modern log analysis and reservoir modeling techniques as well as 3-D seismic surveys and horizontal drilling. As a result of these activities, we believe that we have a substantial inventory of low risk development opportunities, which provide a basis for significant production and reserve increases. In addition, we intend to expand upon our exploitation and development activities with complementary low risk exploration projects in our core areas of operation. Our financial results depend upon many factors which significantly affect our results of operations including the following: o the sales prices of natural gas and crude oil; o the level of total sales volumes of natural gas and crude oil; o the availability of, and our ability to raise additional capital resources and provide liquidity to meet cash flow needs; o the level of and interest rates on borrowings; and o the level and success of exploitation, exploration and development activity. COMMODITY PRICES AND HEDGING ACTIVITIES. Our results of operations are significantly affected by fluctuations in commodity prices. Price volatility in the natural gas market has remained prevalent in the last few years. In January 2001, our realized price for natural gas and crude oil were at high levels. However, over the course of 2001 and the beginning of the first quarter of 2002, prices again became depressed, primarily due to the economic downturn. Beginning in March 2002, commodity prices began to increase and continued higher through December 2005. Prices have continued to remain strong during the first quarter of 2006 compared to historical levels, but have weakened from levels during the 12 latter part of 2005 and early 2006. If prices continue to weaken, our cash flow from operations will be adversely affected. The table below illustrates how natural gas prices have fluctuated over the eight quarters prior to and including the quarter ended March 31, 2006 and contains the last three day average of NYMEX traded contracts price and the prices we realized during each quarter presented, including the impact of our hedging activities.
Natural Gas Prices by Quarter (in $ per Mcf) Quarter Ended ---------------------------------------------------------------------------------------------------------------- June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, 2004 2004 2004 2005 2005 2005 2005 2006 ---------- ---------- ----------- ---------- ---------- ---------- ---------- ----------- Index $5.97 $5.85 $6.77 $6.30 $ 6.80 $ 8.21 $ 12.85 $ 9.18 Realized $5.52 $5.24 $6.14 $5.26 $ 6.33 $ 8.15 $ 9.12 $ 6.52
The NYMEX natural gas price on May 5, 2006 was $6.78 per Mcf. The table below illustrates how crude oil prices have fluctuated over the eight quarters prior to and including the quarter ended March 31, 2006 and contains the last three day average of NYMEX traded contracts price and the prices we realized during each quarter presented, including the impact of our hedging activities.
Crude Oil Prices by Quarter (in $ per Bbl) Quarter Ended ---------------------------------------------------------------------------------------------------------------- June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, 2004 2004 2004 2005 2005 2005 2005 2006 ---------- ---------- ----------- ---------- ---------- ---------- ---------- ----------- Index $38.48 $42.32 $49.46 $47.33 $ 51.76 $ 60.26 $ 61.51 $ 61.53 Realized $37.29 $42.43 $46.81 $47.13 $ 49.43 $ 60.24 $ 57.18 $ 59.57
The NYMEX crude oil price on May 5, 2006 was $70.19 per Bbl. We seek to reduce our exposure to price volatility by hedging our production through price floors. Under the terms of our revolving credit facility, we are required to maintain hedging positions with respect to not less than 25% nor more than 75% of our crude oil and natural gas production, on an equivalent basis, for a rolling six-month period. We currently have the following hedges in place:
Time Period Notional Quantities Price - ---------------------------------- -------------------------------------------- ---------------------- May 2006 10,000 MMbtu of production per day Floor of $8.00 June 2006 10,000 MMbtu of production per day Floor of $7.00 July 2006 10,000 MMbtu of production per day Floor of $7.00 August 2006 10,000 MMbtu of production per day Floor of $6.00 September 2006 10,000 MMbtu of production per day Floor of $5.00 October 2006 10,000 MMbtu of production per day Floor of $5.00 November 2006 10,000 MMbtu of production per day Floor of $6.00
At March 31, 2006, the aggregate fair market value of our hedges was approximately $385,000. PRODUCTION VOLUMES. Because our proved reserves will decline as natural gas and crude oil are produced, unless we acquire additional properties containing proved reserves or conduct successful exploitation, exploration and development activities, our reserves and production will decrease. Our ability to acquire or find additional reserves in the near future will be dependent, in part, upon the amount of available funds for acquisition, exploitation and development projects. 13 We had capital expenditures of $7.1 million in the first quarter of 2006. As a result of the capital spending limitations included in our previous credit agreement and our 11 1/2 notes due 2007 which were eliminated in connection with our October 2004 refinancing, we were limited for most of 2004 in our ability to replace existing production and, consequently, our production volumes decreased during 2004 and continued to decrease in the first quarter of 2005. Beginning in the second quarter of 2005, our production volumes began to increase. If crude oil and natural gas prices return to depressed levels or if our production levels decrease, our revenues, cash flow from operations and financial condition will be materially adversely affected. AVAILABILITY OF CAPITAL. As described more fully under "Liquidity and Capital Resources" below, our sources of capital going forward will primarily be cash from operating activities, funding under our revolving credit facility, cash on hand, and if an appropriate opportunity presents itself, proceeds from the sale of properties. We currently have approximately $10.2 million of availability under our revolving credit facility. EXPLOITATION, EXPLORATION AND DEVELOPMENT ACTIVITY. We believe that our high quality asset base, high degree of operational control and large inventory of drilling projects position us for future growth. Our properties are concentrated in locations that facilitate substantial economies of scale in drilling and production operations and more efficient reservoir management practices. We operate 95% of the properties accounting for approximately 94% of our PV-10, giving us substantial control over the timing and incurrence of operating and capital expenditures. In addition, we have 53 proved undeveloped locations and have identified over 184 drilling and recompletion opportunities on our existing acreage, the successful development of which we believe could significantly increase our daily production and proved reserves. During the first quarter of 2006, we made capital expenditures of approximately $7.1 million for wells in south Texas, west Texas and Wyoming. We are currently completing and/or testing Woodford, Atoka and Wolfcamp wells in west Texas and continue to recomplete various wells in south Texas. We have one horizontal well and one vertical well drilling in west Texas. In the latter part of 2005, we drilled and are currently completing and testing four vertical wells in Wyoming. Our future natural gas and crude oil production, and therefore our success, is highly dependent upon our ability to find, acquire and develop additional reserves that are profitable to produce. The rate of production from our natural gas and crude oil properties and our proved reserves will decline as our reserves are produced unless we acquire additional properties containing proved reserves, conduct successful development, exploitation and exploration activities or, through engineering studies, identify additional behind-pipe zones or secondary recovery reserves. We cannot assure you that our exploitation and development activities will result in increases in our proved reserves. In addition, approximately 52% of our total estimated proved reserves at December 31, 2005 were undeveloped. By their nature, estimates of undeveloped reserves are less certain. Recovery of such reserves will require significant capital expenditures and successful drilling operations. BORROWINGS AND INTEREST. We currently have indebtedness of approximately $129.8 million and availability of $10.2 million under our revolving credit facility. Our cash interest expense will require us to increase our production and cash flow from operations in order to meet our debt service requirements, as well as to fund the development of our numerous drilling opportunities. OUTLOOK FOR 2006. As a result of final 2005 financial results and current market conditions, we have updated our operating and financial guidance for 2006 as follows: Production: BCFE (approximately 80% gas)....................... 7.5 - 8.5 Exit Rate (Mmcfe/d)................................... 22 - 24 Price Differentials (Pre Hedge): Gas (% Mcf)........................................ 15% Oil ($/Bbl)........................................ 2.00 Production taxes (% of Revenue)....................... 10% Direct Lease Operating Expenses ($/ Mcfe)............. 1.10 G&A ($/ Mcfe)......................................... 0.55 Interest ($/Mcfe)..................................... 2.00 DD&A ($/Mcfe)......................................... 1.80 Capital Expenditures ($ Millions)..................... 40.0 14 RESULTS OF OPERATIONS The following table sets forth certain of our operating data for the periods presented. All data is for continuing operations.
Three Months Ended March 31, --------------------------------- 2006 2005 ----------- ------------ Operating Revenue: (1) Crude oil sales................................................... $ 2,783 $ 2,437 Natural gas sales ................................................ 10,143 5,088 Rig operations.................................................... 376 296 Other............................................................. 3 1 ----------- ------------ $ 13,305 $ 7,822 =========== ============ Operating Income ................................................. $ 5,587 $ 2,657 Crude oil production (MBbl)....................................... 46.7 51.7 Natural gas production (MMcf)..................................... 1,555.6 967.0 Average crude oil sales price ($/Bbl)............................. $ 59.57 $ 47.13 Average natural gas sales price ($/Mcf)........................... $ 6.52 $ 5.26
(1) Revenue and average sales prices are net of hedging activities. COMPARISON OF THREE MONTHS ENDED MARCH 31, 2006 TO THREE MONTHS ENDED MARCH 31, 2005 OPERATING REVENUE. During the three months ended March 31, 2006, operating revenue from crude oil, natural gas and natural gas liquid sales increased to $12.9 million from $7.5 millon for the first quarter of 2005. The increase in revenue was primarily due to an increase in production volumes as well as increased realized prices for natural gas and crude oil. The increase in production volumes was primarily due to new production from wells drilled in 2005 offset by natural field declines. Increased production contributed $3.5 million while increased realized prices contributed $1.9 million to revenue during the first quarter of 2006 as compared to the first quarter of 2005. Average sales prices net of hedging cost for the quarter ended March 31, 2006 were: o $59.57 per Bbl of crude oil, o $ 6.52 per Mcf of natural gas Average sales prices net of hedging cost for the quarter ended March 31, 2005 were: o $47.13 per Bbl of crude oil, o $ 5.26 per Mcf of natural gas Crude oil production volumes decreased from 51.7 MBbls during the quarter ended March 31, 2005 to 46.7 MBbls for the same period of 2006. Natural gas production volumes increased from 967.0 MMcf for the three months ended March 31, 2005 to 1,555.6 MMcf for the same period of 2006. There was no significant crude oil brought on production during 2005 or the first quarter of 2006. The decrease in crude oil production was primarily due to natural field declines. The increase in natural gas production was primarily due to new production brought on line in 2005. New production contributed 691.1 MMcf during the first quarter of 2006. The increase in production attributable to new wells was partially offset by natural field declines. A single well in west Texas contributed 514.6 MMcf of the new production for the quarter. LEASE OPERATING EXPENSES. Lease operating expenses ("LOE") for the three months ended March 31, 2006 increased to $2.8 million compared to $2.3 million in 2005. The increase in LOE was primarily due to higher production taxes associated with increased production volumes and higher commodity prices for the quarter ended March 31, 2006 as compared to the same period of 2005 as well as a general increase in the cost of field services and the amount of services required by us as we increased our drilling activity during 2006 as compared to 15 2005. LOE on a per Mcfe basis for the three months ended March 31, 2006 was $1.54 per Mcfe compared to $1.78 for the same period of 2005. The decrease in per Mcfe cost was attributable to the increase in production volumes during the first quarter of 2006 as compared to 2005. GENERAL AND ADMINISTRATIVE ("G&A") Expenses. G&A expenses increased to $1.3 million during the quarter ended March 31, 2006 from $971,000 for the first three months of 2005. The increase in G&A expense was due to increased cost relating to Sarbanes Oxley compliance, including increased audit fees. G&A expense on a per Mcfe basis was $0.61 for the first quarter of 2006 compared to $0.74 for the same period of 2005. The decrease in G&A expense on a per Mcfe basis was primarily due to increased production volumes during the first quarter of 2006 compared to the same period in 2005. STOCK-BASED COMPENSATION. In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment". SFAS No. 123R is a revision of SFAS No. 123, "Accounting for Stock Based Compensation", and supersedes APB 25. Among other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The Company adopted SFAS 123R in the fourth quarter of 2005 using the "modified prospective method".Under the "modified retrospective" entities are permitted to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. This standard requires the cost of all share-based payments, including stock options, to be measured at fair value on the grant date and recognized in the statement of operations. In accordance with this standard, all periods prior to January 1, 2005 were restated to reflect the impact of the standard as if it had been adopted on January 1, 1995, the original effective date of SFAS No. 123, "Accounting for Stock-Based Compensation". Also in accordance with the standard, the amounts that are reported in the statement of operations for the restated periods are the pro forma amounts previously disclosed under SFAS No. 123. As a result of the retrospective adoption of SFAS 123R, the expenses previously recognized under the rules of variable accounting were reversed and a compensation expense measured according to SFAS 123R was recorded. As a result, we recognized stock-based compensation expense of $171,000 during the first quarter of 2006 as a result of the adoption of this accounting change compared to $25,000 in 2005, as adjusted. Stock-based compensation expense is included as a component of G&A expense in the accompanying financial statements. We currently utilize a standard option pricing model (i.e., Black-Scholes) to measure the fair value of stock options granted to employees. While SFAS 123R permits entities to continue to use such a model, the standard also permits the use of a more complex binomial, or "lattice" model. Based upon research done by us on the alternative models available to value option grants, and in conjunction with the type and number of stock options expected to be issued in the future, we have determined that we will continue to use the Black-Scholes model for option valuation as of the current time. DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSES. Depreciation, depletion and amortization ("DD&A") expense increased to $3.4 million for the three months ended March 31, 2006 from $1.7 million for the same period of 2005. The increase in DD&A was primarily due to increased production volumes in the first quarter of 2006 as compared to the same period of 2005 as well as an increase in future development cost in 2006 as compared to 2005. Our DD&A on a per Mcfe basis for the three months ended March 31, 2006 was $1.85 per Mcfe compared to $1.33 per Mcfe in 2005. INTEREST EXPENSE. Interest expense increased to $4.0 million for the first three months of 2006 from $3.1 million for the same period of 2005. The increase in interest expense was due to an increase in our long-term debt from $125.0 million at March 31, 2005 to $129.8 million at March 31, 2006 as well as an increase in the interest rate on our floating rate senior secured notes. DISCONTINUED OPERATIONS. Income from discontinued operations was $12.9 million in the first quarter of 2005. Income in 2005 includes a loss from operations, including debt retirement costs, of $2.8 million and the gain from the disposal of Grey Wolf of $21.8 million offset by $6.1 million of non-cash income tax expense. There was no income from discontinued operations during the quarter ended March 31, 2006. 16 LIQUIDITY AND CAPITAL RESOURCES GENERAL. The natural gas and crude oil industry is a highly capital intensive and cyclical business. Our capital requirements are driven principally by our obligations to service debt and to fund the following costs: o the development of existing properties, including drilling and completion costs of wells; o acquisition of interests in additional natural gas and crude oil properties; and o production and transportation facilities. The amount of capital expenditures we are able to make has a direct impact on our ability to increase cash flow from operations and, thereby, will directly affect our ability to service our debt obligations and to continue to grow the business through the development of existing properties and the acquisition of new properties. Our sources of capital going forward will primarily be cash from operating activities, funding under our revolving credit facility, cash on hand, and if an appropriate opportunity presents itself, proceeds from the sale of properties. However, under the terms of the notes, proceeds of optional sales of our assets that are not timely reinvested in new natural gas and crude oil assets will be required to be used to reduce indebtedness and proceeds of mandatory sales must be used to repay or redeem indebtedness. WORKING CAPITAL (DEFICIT). At March 31, 2006, our current liabilities of approximately $16.0 million exceeded our current assets of $9.9 million resulting in a working capital deficit of $6.1 million. This compares to a working capital deficit of approximately $4.9 million at December 31, 2005. Current liabilities at March 31, 2006 consisted of trade payables of $7.4 million, revenues due third parties of $2.6 million, accrued interest of $5.1 million and other accrued liabilities of $0.9 million. CAPITAL EXPENDITURES. Capital expenditures during the first three months of 2006 were $7.1 million compared to $8.7 million during the same period of 2005. The table below sets forth the components of these capital expenditures on a historical basis for the three months ended March 31, 2006 and 2005.
Three Months Ended March 31, -------------------------------------------- 2006 2005 ------------------- ----------------- Expenditure category (in thousands): Development................................................. $ 7,108 $ 8,560 Facilities and other........................................ 25 92 --------------- ----------------- Total................................................... $ 7,133 $ 8,652 =============== =================
During the three months ended March 31, 2006 and 2005, capital expenditures were primarily for the development of existing properties. We anticipate making capital expenditures for 2006 of approximately $40.0 million which will be used primarily for the development of our current properties. These anticipated expenditures are subject to adequate cash flow from operations and availability under our revolving credit facility. If these sources of funding do not prove to be sufficient, we may also issue additional shares of equity securities although we may not be able to complete equity financings on terms acceptable to us, if at all. Our ability to make all of our budgeted capital expenditures will also be subject to availability of drilling rigs and other field equipment and services. Our capital expenditures could also include expenditures for acquisition of producing properties if such opportunities arise, but we currently have no agreements, arrangements or undertakings regarding any material acquisitions. We have no material long-term capital commitments and are consequently able to adjust the level of our expenditures as circumstances dictate. Additionally, the level of capital expenditures will vary during future periods depending on market conditions and other related economic factors. Should the prices of natural gas and crude oil continue to decline and if our costs of operations continue to increase as a result of the scarcity of drilling rigs or if our production volumes decrease, our cash flows will decrease which may result in a reduction of the capital expenditures budget. If we decrease our capital expenditures budget, we may not be able to offset natural gas and crude oil production volumes decreases caused by natural field declines and sales of producing properties, if any. 17 SOURCES OF CAPITAL. The net funds provided by and/or used in each of the operating, investing and financing activities relating to continuing operations are summarized in the following table and discussed in further detail below:
Three Months Ended March 31, ---------------------------------------------- 2006 2005 ------------------- ---------------------- Net cash provided by operating activities $ 6,372 $ 9,489 Net cash used in investing activities (7,133) (8,652) Net cash provided by (used in) financing activities 762 (1,154) ------------------- ---------------------- Total $ 1 $ (317) =================== ======================
Operating activities during the three months ended March 31, 2006 provided us $6.4 million of cash compared to providing $9.5 million in the same period in 2005. Net income plus non-cash expense items during 2005 and 2006 and net changes in operating assets and liabilities accounted for most of these funds. Financing activities provided $762,000 for the first three months of 2006 compared to using $1.2 million for the same period of 2005. Most of the funds provided in 2006 were net proceeds from our revolving line of credit and proceeds from the exercise of employee stock options. In 2005, most of the funds were used to reduce our long-term debt and for financing fees. Investing activities used $7.1 million during the three months ended March 31, 2006 compared to using $8.7 million for the quarter ended March 31, 2005. Expenditures during the quarter ended March 31, 2006 and March 31, 2005 were primarily for the development of existing properties. FUTURE CAPITAL RESOURCES. We currently have three principal sources of liquidity going forward: (i) cash from operating activities, (ii) funding under our revolving credit facility, and (iii) if an appropriate opportunity presents itself, the sale of producing properties. If these sources of liquidity do not prove to be sufficient, we may also issue additional shares of equity securities although we may not be able to complete equity financings on terms acceptable to us, if at all. Covenants under the indenture for the notes and the revolving credit facility restrict our use of cash from operating activities, cash on hand and any proceeds from asset sales. Under the terms of the notes, proceeds of optional sales of our assets that are not timely reinvested in new natural gas and crude oil assets will be required to be used to reduce indebtedness and proceeds of mandatory sales must be used to redeem indebtedness. The terms of the notes and the revolving credit facility also substantially restrict our ability to: o incur additional indebtedness; o grant liens; o pay dividends or make certain other restricted payments; o merge or consolidate with any other person; or o sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets. Our cash flow from operations depends heavily on the prevailing prices of natural gas and crude oil and our production volumes of natural gas and crude oil. Although we have hedged a portion of our natural gas and crude oil production and will continue this practice as required pursuant to the revolving credit facility, future natural gas and crude oil price declines would have a material adverse effect on our overall results, and therefore, our liquidity. Low natural gas and crude oil prices could also negatively affect our ability to raise capital on terms favorable to us or at all. Our cash flow from operations will also depend upon the volume of natural gas and crude oil that we produce. Unless we otherwise expand reserves, our production volumes may decline as reserves are produced. Due to sales of properties in 2002 and 2003, the divestiture of Grey Wolf during the first quarter of 2005, and restrictions on capital expenditures under the terms of our 11 1/2% secured notes due 2007 (which were refinanced in October 2004), we now have significantly reduced reserves and production as compared with pre-2003 levels. In the future, if an appropriate opportunity presents itself, we may sell additional properties, which could further reduce our production volumes. To offset the loss in production volumes resulting from natural field declines and sales of producing properties, we must conduct successful, exploitation, exploration and development activities, acquire additional producing properties or identify additional behind-pipe zones or secondary recovery reserves. We believe our numerous drilling opportunities will allow us to increase our 18 production volumes; however, our drilling activities are subject to numerous risks, including the risk that no commercially productive natural gas or crude oil reservoirs will be found. The risk of not finding commercially productive reservoirs will be compounded by the fact that 52% of our total estimated proved reserves at December 31, 2005 were undeveloped. During the first quarter of 2006, we expended approximately $7.1 million for wells in south Texas, west Texas and Wyoming. We are currently completing and/or testing Woodford, Atoka and Wolfcamp wells in west Texas and continue to recomplete various wells in south Texas. We have one horizontal well and one vertical well drilling in west Texas. In the latter part of 2005, we drilled and are currently completing and testing four vertical wells in Wyoming. In addition, approximately 30% of our production at March 31, 2006 was from a single well in west Texas. If production from this well decreases, the volume of our production would also decrease which, in turn, would likely cause our cash flow from operations to decrease. Our total indebtedness and cash interest expense as a result of issuing the notes and entering into the revolving credit facility require us to increase our production and cash flow from operations in order to meet our debt service requirements, as well as to fund the development of our numerous drilling opportunities. The ability to satisfy these new obligations will depend upon our drilling success as well as prevailing commodity prices. CONTRACTUAL OBLIGATIONS We are committed to making cash payments in the future on the following types of agreements: o Long-term debt o Operating leases for office facilities We have no off-balance sheet debt or unrecorded obligations and we have not guaranteed the debt of any other party. Below is a schedule of the future payments that we are obligated to make based on agreements in place as of March 31, 2006:
Payments due in twelve month periods ended: ------------------------------------------------------------------------- Contractual Obligations (dollars March 31, March 31, March 31, (dollars in thousands) Total 2007 2008-2009 2010-2011 Thereafter - ---------------------------------- --------------- ------------- ------------- -------------- ------------- Long-Term Debt (1) $ 129,798 $ - $ 4,798 $ 125,000 $ - Interest on long-term debt (2) 56,452 15,520 30,865 10,067 - Operating Leases (3) 716 254 462 - - --------------- ------------- ------------- -------------- ------------- Total $ 186,966 $ 15,774 $ 36,125 $ 135,067 $ - =============== ============= ============= ============== =============
(1) These amounts represent the balances outstanding under the revolving credit facility and the notes. These repayments assume that we will not draw down additional funds (2) Interest expense assumes the balances of long-term debt at the end of the period and current effective interest rates. (3) Office lease obligations. The lease for office space for Abraxas expires in 2009 OTHER OBLIGATIONS. We make and will continue to make substantial capital expenditures for the acquisition, exploitation, development, exploration and production of crude oil and natural gas. In the past, we have funded our 9perations and capital expenditures primarily through cash flow from operations, sales of properties, sales of production payments and borrowings under our bank credit facilities and other sources. Given our high degree of operating control, the timing and incurrence of operating and capital expenditures is largely within our discretion. Long-Term Indebtedness.
March 31, December 31, 2006 2005 ---------------- ----------------- (In thousands) Floating rate senior secured notes due 2009............................ $ 125,000 $ 125,000 19 Senior secured revolving credit facility............................... 4,798 4,527 ---------------- ----------------- 129,798 129,527 Less current maturities ............................................... - - ---------------- ----------------- $ 129,798 $ 129,527 ================ =================
Floating Rate Senior Secured Notes due 2009. In connection with the October 2004 financial restructuring, Abraxas issued $125 million in principal aggregate amount of Floating Rate Senior Secured Notes due 2009. The notes will mature on December 1, 2009 and began accruing interest from the date of issuance, October 28, 2004 at a per annum floating rate of six-month LIBOR plus 7.50%. The current interest rate is 12.08% per annum. The interest rate is reset semi-annually on each June 1 and December 1. Interest is payable semi-annually in arrears on June 1 and December 1 of each year. The notes rank equally among themselves and with all of our unsubordinated and unsecured indebtedness, including our credit facility and senior in right of payment to our existing and future subordinated indebtedness. Each of our subsidiaries, Eastside Coal Company, Inc., Sandia Oil & Gas Corporation, Sandia Operating Corp., Wamsutter Holdings, Inc. and Western Associated Energy Corporation (collectively, the "Subsidiary Guarantors"), has unconditionally guaranteed, jointly and severally, the payment of the principal, premium and interest on the notes on a senior secured basis. In addition, any other subsidiary or affiliate of ours, that in the future guarantees any other indebtedness with us, or our restricted subsidiaries, will also be required to guarantee the notes. The notes and the Subsidiary Guarantors' guarantees thereof, together with our credit facility and the Subsidiary Guarantors' guarantees thereof, are secured by shared first priority perfected security interests, subject to certain permitted encumbrances, in all of our and each of our restricted subsidiaries' material property and assets, including substantially all of our and their natural gas and crude oil properties and all of the capital stock (or in the case of an unrestricted subsidiary that is a controlled foreign corporation, up to 65% of the outstanding capital stock) of any entity, owned by us and our restricted subsidiaries (collectively, the "Collateral"). The notes may be redeemed, at our election, as a whole or from time to time in part, at any time after April 28, 2007, upon not less than 30 nor more that 60 days' notice to each holder of notes to be redeemed, subject to the conditions and at the redemption prices (expressed as percentages of principal amount) set forth below, together with accrued and unpaid interest and Liquidating Damages, if any, to the applicable redemption date. Year Percentage ------------------------------------------------------------------- From April 29, 2007 to April 28, 2008 104.00% From April 29, 2008 to April 28, 2009 102.00% After April 28, 2009 100.00% Prior to April 28, 2007, we may redeem up to 35% of the aggregate original principal amount of the notes using the net proceeds of one or more equity offerings, in each case at the redemption price equal to the product of (i) the principal amount of the notes being so redeemed and (ii) a redemption price factor of 1.00 plus the per annum interest rate on the notes (expressed as a decimal) on the applicable redemption date plus accrued and unpaid interest to the applicable redemption date, provided certain conditions are also met. If we experience specific kinds of change of control events, each holder of notes may require us to repurchase all or any portion of such holder's notes at a purchase price equal to 101% of the principal amount of the notes, plus accrued and unpaid interest to the date of repurchase. The indenture governing the notes contains covenants that, among other things, limit our ability to: 20 o incur or guarantee additional indebtedness and issue certain types of preferred stock or redeemable stock; o transfer or sell assets; o create liens on assets; o pay dividends or make other distributions on capital stock or make other restricted payments, including repurchasing, redeeming or retiring capital stock or subordinated debt or making certain investments or acquisitions; o engage in transactions with affiliates; o guarantee other indebtedness; o permit restrictions on the ability of our subsidiaries to distribute or lend money to us; o cause a restricted subsidiary to issue or sell its capital stock; and o consolidate, merge or transfer all or substantially all of the consolidated assets of our and our restricted subsidiaries. The indenture also contains customary events of default, including nonpayment of principal or interest, violations of covenants, cross default and cross acceleration to certain other indebtedness, including our credit facility, bankruptcy, and material judgments and liabilities. Senior Secured Revolving Credit Facility. On October 28, 2004, we entered into an agreement for a revolving credit facility having a maximum commitment of $15 million, which includes a $2.5 million subfacility for letters of credit. Availability under the revolving credit facility is subject to a borrowing base consistent with normal and customary natural gas and crude oil lending transactions. Outstanding amounts under the revolving credit facility bear interest at the prime rate announced by Wells Fargo Bank, National Association plus 1.00%. The current interest rate is 8.75% per annum. Subject to earlier termination rights and events of default, the stated maturity date under the revolving credit facility is October 28, 2008. We are permitted to terminate the revolving credit facility, and under certain circumstances, may be required, from time to time, to permanently reduce the lenders' aggregate commitment under the revolving credit facility. Such termination and each such reduction is subject to a premium equal to the percentage listed below multiplied by the lenders' aggregate commitment under the revolving credit facility, or, in the case of partial reduction, the amount of such reduction. Year % Premium -------------- -------------------- 1 1.5 2 1.0 3 0.5 4 0.0 Each of our current subsidiaries has guaranteed, and each of our future restricted subsidiaries will guarantee, our obligations under the revolving credit facility on a senior secured basis. In addition, any other subsidiary or affiliate of ours, that in the future guarantees any of our other indebtedness or of our restricted subsidiaries will be required to guarantee our obligations under the revolving credit facility. Obligations under the revolving credit facility are secured, together with the notes, by a shared first priority perfected security interest, subject to certain permitted encumbrances, in all of our and each of our restricted subsidiaries' material property and assets, including substantially all of our and their natural gas and crude oil properties and all of the capital stock (or in the case of an unrestricted subsidiary that is a controlled foreign corporation, up to 65% of the outstanding capital stock) in any entity, owned by us and our restricted subsidiaries. 21 Under the revolving credit facility, we are subject to customary covenants, including certain financial covenants and reporting requirements. The revolving credit facility requires us to maintain a minimum net cash interest coverage and also requires us to enter into hedging agreements on not less than 25% or more than 75% of our projected natural gas and crude oil production. In addition to the foregoing and other customary covenants, the revolving credit facility contains a number of covenants that, among other things, restrict Abraxas' ability to: o incur or guarantee additional indebtedness and issue certain types of preferred stock or redeemable stock; o transfer or sell assets; o create liens on assets; o pay dividends or make other distributions on capital stock or make other restricted payments, including repurchasing, redeeming or retiring capital stock or subordinated debt or making certain investments or acquisitions; o engage in transactions with affiliates; o guarantee other indebtedness; o make any change in the principal nature of our business; o prepay, redeem, purchase or otherwise acquire any of our or our restricted subsidiaries' indebtedness; o permit a change of control; o directly or indirectly make or acquire any investment; o cause a restricted subsidiary to issue or sell our capital stock; and o consolidate, merge or transfer all or substantially all of the consolidated assets of Abraxas and our restricted subsidiaries. The revolving credit facility also contains customary events of default, including nonpayment of principal or interest, violations of covenants, cross default and cross acceleration to certain other indebtedness, bankruptcy and material judgments and liabilities, and is subject to an Intercreditor, Security and Collateral Agency Agreement, which specifies the rights of the parties thereto to the proceeds from the Collateral. Intercreditor Agreement. The holders of the notes, together with the lenders under our credit facility, are subject to an Intercreditor, Security and Collateral Agency Agreement, which specifies the rights of the parties thereto to the proceeds from the Collateral. The Intercreditor Agreement, among other things, (i) creates security interests in the Collateral in favor of a collateral agent for the benefit of the holders of the notes and the credit facility lenders and (ii) governs the priority of payments among such parties upon notice of an event of default under the Indenture or the credit facility. So long as no such event of default exists, the collateral agent will not collect payments under the new credit facility documents or the indenture governing the notes and other note documents (collectively, the "Secured Documents"), and all payments will be made directly to the respective creditor under the applicable Secured Document. Upon notice of an event of default and for so long as an event of default exists, payments to each credit facility lender and holder of the notes from us and our current subsidiaries and proceeds from any disposition of any collateral, will, subject to limited exceptions, be collected by the collateral agent for deposit into a collateral account and then distributed as provided in the following paragraph. Upon notice of any such event of default and so long as an event of default exists, funds in the collateral account will be distributed by the collateral agent generally in the following order of priority: first, to reimburse the collateral agent for expenses incurred in protecting and realizing upon the value of the Collateral; 22 second, to reimburse the credit facility administrative agent and the trustee, on a pro rata basis, for expenses incurred in protecting and realizing upon the value of the Collateral while any of these parties was acting on behalf of the Control Party (as defined below); third, to reimburse the credit facility administrative agent and the trustee, on a pro rata basis, for expenses incurred in protecting and realizing upon the value of the Collateral while any of these parties was not acting on behalf of the Control Party; fourth, to pay all accrued and unpaid interest (and then any unpaid commitment fees) under the credit facility; fifth, if, the collateral coverage value of three times the outstanding obligations under the credit facility would be met after giving effect to any payment under this clause "fifth," to pay all accrued and unpaid interest on the notes; sixth, to pay all outstanding principal of (and then any other unpaid amounts, including, without limitation, any fees, expenses, premiums and reimbursement obligations) the credit facility; seventh, to pay all accrued and unpaid interest on the notes (if not paid under clause "fifth"); eighth, to pay all outstanding principal of (and then any other unpaid amounts, including, without limitation, any premium with respect to) the notes; and ninth, to pay each credit facility lender, holder of the notes, and other secured party, on a pro rata basis, all other amounts outstanding under the credit facility and the notes. To the extent there exists any excess monies or property in the collateral account after all of ours and our subsidiaries' obligations under the credit facility, the indenture and the notes are paid in full, the collateral agent will be required to return such excess to us. The collateral agent will act in accordance with the Intercreditor Agreement and as directed by the "Control Party" which for purposes of the Intercreditor Agreement is the holders of the notes and the credit facility lenders, acting as a single class, by vote of the holders of a majority of the aggregate principal amount of outstanding obligations under the notes and the credit facility. The Intercreditor Agreement provides that the lien on the assets constituting part of the Collateral that is sold or otherwise disposed of in accordance with the terms of each Secured Document may be released if (i) no default or event of default exists under any of the Secured Documents, (ii) we have delivered an officers' certificate to each of the collateral agent, the trustee, the credit facility administrative agent certifying that the proposed sale or other disposition of assets is either permitted or required by, and is in accordance with the provisions of, the applicable Secured Documents and (iii) the collateral agent has acknowledged such certificate. The Intercreditor Agreement provides for the termination of security interests on the date that all obligations under the Secured Documents are paid in full. HEDGING ACTIVITIES. Our results of operations are significantly affected by fluctuations in commodity prices and we seek to reduce our exposure to price volatility by hedging our production through commodity derivative instruments. Under the senior credit agreement, we are required to maintain hedge positions on not less than 25% or more than 75% of our projected oil and gas production for a six month rolling period. NET OPERATING LOSS CARRYFORWARDS. At December 31, 2005, we had $190.0 million of net operating loss carryforwards for U.S. tax purposes. These loss carryforwards will expire through 2025 if not utilized. 23 Uncertainties exist as to the future utilization of the operating loss carryforwards under the criteria set forth under FASB Statement No. 109. Therefore, we have established a valuation allowance of $67.0 million for deferred tax assets at March 31, 2006. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK COMMODITY PRICE RISK As an independent crude oil and natural gas producer, our revenue, cash flow from operations, other income and profitability, reserve values, access to capital and future rate of growth are substantially dependent upon the prevailing prices of crude oil and natural gas. Declines in commodity prices will materially adversely affect our financial condition, liquidity, ability to obtain financing and operating results. Lower commodity prices may reduce the amount of crude oil and natural gas that we can produce economically. Prevailing prices for such commodities are subject to wide fluctuation in response to relatively minor changes in supply and demand and a variety of additional factors beyond our control, such as global political and economic conditions. Historically, prices received for crude oil and natural gas production have been volatile and unpredictable, and such volatility is expected to continue. Most of our production is sold at market prices. Generally, if the commodity indexes fall, the price that we receive for our production will also decline. Therefore, the amount of revenue that we realize is partially determined by factors beyond our control. Assuming the production levels we attained during the quarter ended March 31, 2006, a 10% decline in crude oil and natural gas prices would have reduced our operating revenue, cash flow and net income by approximately $1.3 million for the quarter. HEDGING SENSITIVITY On January 1, 2001, we adopted SFAS 133 as amended by SFAS 137 and SFAS 138. Under SFAS 133, all derivative instruments are recorded on the balance sheet at fair value. In 2003 we elected not to designate derivative instruments as hedges. Accordingly the instruments are recorded on the balance sheet at fair value with changes in the market value of the derivatives being recorded in current oil and gas revenue. Under the terms of our revolving credit facility, we are required to maintain hedging positions with respect to not less than 25% nor more than 75% of our natural gas and crude oil production for a rolling six month period. INTEREST RATE RISK At March 31, 2006 we had $125.0 million in outstanding indebtedness under the floating rate senior secured notes due 2009. The notes bear interest at a per annum rate of six-month LIBOR plus 7.5%. The rate is redetermined on June 1 and December 1 of each year, beginning June 1, 2005. The current rate on the notes is 12.08%. For every percentage point that the LIBOR rate rises, our interest expense would increase by approximately $1.3 million on an annual basis. At March 31, 2006, we had $4.8 million of outstanding indebtedness under our revolving credit facility. Interest on this facility accrues at the prime rate announced by Wells Fargo Bank plus 1.00%. For every percentage point increase in the announced prime rate, our interest expense would increase by approximately $48,000 on an annual basis. ITEM 4. CONTROLS AND PROCEDURES. As of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of Abraxas' "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)and 15d-15(e)) and concluded that the disclosure controls and procedures were effective and designed to ensure that material information relating to Abraxas and our consolidated subsidiaries which is required to be included in our periodic Securities and Exchange Commission filings would be made known to them by others within those entities. There were no changes in our internal controls that could materially affect, or are reasonably likely to materially affect our financial reporting. 24 ABRAXAS PETROLEUM CORPORATION PART II OTHER INFORMATION Item 1. Legal Proceedings. There have been no changes in legal proceedings from that described in the Company's Annual Report of Form 10-K for the year ended December 31, 2005, and in Note 7 in the Notes to Condensed Consolidated Financial Statements contained in Part I of this report on Form 10-Q. Item 1A. Risk Factors. In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing Abraxas. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None Item 3. Defaults Upon Senior Securities. None Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits (a) Exhibits Exhibit 31.1 Certification - Robert L.G. Watson, CEO Exhibit 31.2 Certification - Chris E. Williford, CFO Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 - Robert L.G. Watson, CEO Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 - Chris E. Williford, CFO 25 ABRAXAS PETROLEUM CORPORATION SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: May 10, 2006 By: /s/Robert L.G. Watson -------------- ------------------------- ROBERT L.G. WATSON, President and Chief Executive Officer Date: May 10, 2006 By: /s/Chris E. Williford -------------- ------------------------- CHRIS E. WILLIFORD, Executive Vice President and Principal Accounting Officer 26 EX-31 2 exhibit31rlgw.txt Exhibit 31.1 CERTIFICATIONS I, Robert L. G. Watson, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Abraxas Petroleum Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 10, 2006 /s/Robert L.G. Watson - ---------------------- Robert L.G. Watson Chairman of the Board, President and Principal Executive Officer EX-31 3 exhibit31cew.txt Exhibit 31.2 CERTIFICATIONS I, Chris Williford, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Abraxas Petroleum Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 10, 2006 /s/Chris E. Williford - ------------------- Chris E. Williford Executive Vice President and Principal Accounting Officer EX-32 4 exhibit32rlgw.txt Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Abraxas Petroleum Corporation (the "Company") on Form 10-Q for the quarter ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the Report"), I, Robert L.G. Watson, Chairman of the Board, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Robert L.G. Watson ------------------------------ Robert L.G. Watson Chairman of the Board, President and Chief Executive Officer May 10, 2006 This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss.18 of the Securities Exchange Act of 1964, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 5 exhibit32cew.txt Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Abraxas Petroleum Corporation (the "Company") on Form 10-Q for the quarter ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Chris E, Williford, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Chris E. Williford ----------------------- Chris E. Williford Executive Vice President and Chief Financial Officer May 10, 2006 This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss.18 of the Securities Exchange Act of 1964, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----