-----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, SBWBc/GiVED2/CUM6vRmBbsGnrsRubzRxwQ8ZRJIWcT05VoiNHV5hPAkIXrZZ4MZ vCD83hmzXjAOvELnDFIJ9w== 0000912057-99-010753.txt : 19991229 0000912057-99-010753.hdr.sgml : 19991229 ACCESSION NUMBER: 0000912057-99-010753 CONFORMED SUBMISSION TYPE: 10QSB/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991228 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 3TEC ENERGY CORP CENTRAL INDEX KEY: 0000903267 STANDARD INDUSTRIAL CLASSIFICATION: OIL AND GAS FIELD EXPLORATION SERVICES [1382] IRS NUMBER: 631081013 STATE OF INCORPORATION: AL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB/A SEC ACT: SEC FILE NUMBER: 001-14745 FILM NUMBER: 99781844 BUSINESS ADDRESS: STREET 1: TWO SHELL PLZ STREET 2: 777 WALKER STE 2400 CITY: HOUSTON STATE: TX ZIP: 77002 BUSINESS PHONE: 7132226275 MAIL ADDRESS: STREET 1: PO BOX 390 CITY: MOBILE STATE: AL ZIP: 36602 FORMER COMPANY: FORMER CONFORMED NAME: MIDDLE BAY OIL CO INC DATE OF NAME CHANGE: 19930504 10QSB/A 1 10QSB/A - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-QSB/A /X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 OR / / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from ______________ to ______________ COMMISSION FILE NO. 0-21702 3TEC ENERGY CORPORATION (Exact name of small business issuer as specified in its charter) DELAWARE 76-0624573 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.)
------------------------ TWO SHELL PLAZA, 777 WALKER STREET SUITE 2400 HOUSTON, TX 77002 (Address of principal executive offices) ------------------------ (713) 222-6275 (Issuer's telephone number) N/A (Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date: Common stock, $.02 par value 14,439,631 shares as of November 4, 1999 Transitional Small Business Disclosure Format (check one) Yes / / No /X/ - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 3TEC ENERGY CORPORATION AND SUBSIDIARIES INDEX
PAGE NO. ---- PART I. CONSOLIDATED FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets-- September 30, 1999 (Unaudited) and December 31, 1998................................................... 1 Consolidated Statements of Operations (Unaudited)-- Three and nine months ended September 30, 1999 and 1998................................................... 2 Consolidated Statements of Cash Flows (Unaudited)-- Nine months ended September 30, 1999 and 1998......... 3 Notes to Consolidated Financial Statements (Unaudited)............................................ 4 Item 2. Management's Discussion and Analysis Of Financial Condition and Results of Operations..................... 13 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders................................................... 26 Item 6. Exhibits and Reports on Form 8-K................... 26
PART I--FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 3TEC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
SEPTEMBER DECEMBER 31 1999 1998 ----------- ------------ (UNAUDITED) (AUDITED) ASSETS CURRENT ASSETS CASH AND CASH EQUIVALENTS................................. $25,076,465 $ 1,040,096 ACCOUNTS RECEIVABLE....................................... 2,716,165 3,309,043 ACCOUNTS RECEIVABLE-INSURANCE CLAIM....................... -- 448,083 OTHER CURRENT ASSETS...................................... 90,567 141,364 ----------- ----------- TOTAL CURRENT ASSETS.................................... 27,883,197 4,938,586 NON-CURRENT ASSETS NOTES RECEIVABLE--STOCKHOLDER............................. -- 173,115 PROPERTY (AT COST) OIL AND GAS (SUCCESSFUL EFFORTS METHOD)................... 80,659,521 90,849,439 OTHER..................................................... 988,579 795,323 ----------- ----------- 81,648,100 91,644,762 ACCUMULATED DEPLETION, DEPRECIATION AND AMORTIZATION........ (35,425,362) (39,073,584) ----------- ----------- 46,222,738 52,571,178 OTHER ASSETS................................................ 637,875 257,938 ----------- ----------- TOTAL ASSETS................................................ $74,743,810 $57,940,817 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES CURRENT MATURITY OF LONG-TERM DEBT........................ $ 4,314,318 $ -- ACCOUNTS PAYABLE-TRADE.................................... 2,822,415 3,643,241 ACCOUNTS PAYABLE-ENEX LP LIMITED PARTNERS................. -- 538,750 ACCOUNTS PAYABLE-REVENUE.................................. 362,065 342,931 OTHER CURRENT LIABILITIES................................. 200,806 275,010 ----------- ----------- TOTAL CURRENT LIABILITIES................................... 7,699,604 4,799,932 LONG-TERM DEBT.............................................. 24,176,249 27,454,567 CONVERTIBLE SUBORDINATED NOTES.............................. 10,850,000 -- DEFERRED INCOME TAXES....................................... 486,353 1,733,167 OTHER LIABILITIES........................................... 304,404 437,949 MINORITY INTEREST........................................... 1,014,155 957,369 STOCKHOLDERS' EQUITY PREFERRED STOCK, $0.02 PAR, 20,000,000 SHARES AUTHORIZED, 266,667 DESIGNATED SERIES B AND 2,177,481 SHARES DESIGNATED SERIES C, NONE OTHER DESIGNATED................ -- -- CONVERTIBLE PREFERRED STOCK SERIES B, $7.50 STATED VALUE, 266,667 SHARES ISSUED AND OUTSTANDING AT SEPTEMBER 30, 1999 AND DECEMBER 31, 1998. $2,000,000 AGGREGATE LIQUIDATION PREFERENCE.................................... 3,627,000 3,627,000 CONVERTIBLE PREFERRED STOCK SERIES C, $5.00 STATED VALUE, 1,142,996 AND 1,142,663 SHARES ISSUED AND OUTSTANDING AT SEPTEMBER 30, 1999 AND DECEMBER 31, 1998, RESPECTIVELY. $5,714,980 AGGREGATE LIQUIDATION PREFERENCE............... 5,235,083 5,281,937 COMMON STOCK, $.02 PAR VALUE, 40,000,000 SHARES AUTHORIZED, 13,383,005 AND 8,552,365 SHARES ISSUED AND OUTSTANDING AT SEPTEMBER 30, 1999 AND DECEMBER 31, 1998, RESPECTIVELY.... 267,692 171,055 PAID-IN-CAPITAL............................................. 48,137,005 36,947,588 ACCUMULATED DEFICIT......................................... (26,985,695) (23,401,707) LESS COST OF TREASURY STOCK; 21,773 SHARES.................. (68,040) (68,040) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY.................................. 30,213,045 22,557,833 COMMITMENTS AND CONTINGENCIES ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $74,743,810 $57,940,817 =========== ===========
See accompanying notes to consolidated financial statements. 1 3TEC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS UNAUDITED
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ------------------------ ------------------------- 1999 1998 1999 1998 ----------- ---------- ----------- ----------- REVENUE OIL AND GAS SALES AND PLANT INCOME........................ $ 4,656,156 $3,961,442 $11,328,502 $11,078,360 GAIN ON SALE OF PROPERTIES................................ 575,287 1,518,139 882,477 1,527,207 DELAY RENTAL AND LEASE BONUS INCOME....................... 61,911 20,333 64,911 217,404 OTHER..................................................... 469,508 194,846 691,442 436,783 ----------- ---------- ----------- ----------- TOTAL REVENUE............................................... 5,762,862 5,694,760 12,967,332 13,259,754 ----------- ---------- ----------- ----------- COSTS AND EXPENSES LEASE OPERATING, PRODUCTION TAXES AND PLANT COSTS......... 1,434,185 1,934,203 4,450,843 5,539,218 GEOLOGICAL AND GEOPHYSICAL................................ 46,768 139,303 188,484 927,418 DEPRECIATION, DEPLETION AND AMORTIZATION.................. 1,466,006 1,945,110 4,046,546 4,970,052 IMPAIRMENTS............................................... 1,688,443 492,000 1,688,443 492,000 DRYHOLE................................................... 391,477 24,141 455,108 331,405 INTEREST.................................................. 717,917 615,792 1,739,362 1,428,633 STOCK COMPENSATION........................................ 729,938 -- 729,938 67,500 SEVERANCE PAYMENT......................................... 284,060 -- 284,060 -- COMPENSATION PLAN PAYMENT................................. 292,527 -- 292,527 -- GENERAL AND ADMINISTRATIVE................................ 1,112,181 975,435 3,048,430 3,231,349 OTHER..................................................... 272,233 -- 481,622 4,639 ----------- ---------- ----------- ----------- TOTAL COSTS AND EXPENSES.................................... 8,435,735 6,125,984 17,405,363 16,992,214 LOSS BEFORE INCOME TAX BENEFIT AND MINORITY INTEREST........ (2,672,873) (431,224) (4,438,031) (3,732,460) MINORITY INTEREST........................................... 23,545 154,209 (40,228) 5,523 ----------- ---------- ----------- ----------- LOSS BEFORE INCOME TAX BENEFIT.............................. (2,696,418) (585,433) (4,397,803) (3,737,983) INCOME TAX BENEFIT.......................................... (686,314) (199,047) (1,242,324) (1,270,914) ----------- ---------- ----------- ----------- NET LOSS.................................................... (2,010,104) (386,386) (3,155,479) (2,467,069) DIVIDENDS TO PREFERRED STOCKHOLDERS......................... 142,843 -- 428,509 67,945 ----------- ---------- ----------- ----------- NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS................ ($2,152,947) ($ 386,386) ($3,583,988) ($2,535,014) =========== ========== =========== =========== NET LOSS PER SHARE Basic..................................................... ($ 0.21) ($ 0.05) ($ 0.39) ($ 0.32) =========== ========== =========== =========== Diluted................................................... ($ 0.21) ($ 0.05) ($ 0.39) ($ 0.32) =========== ========== =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING Basic..................................................... 10,351,990 8,530,592 9,137,784 7,889,947 =========== ========== =========== =========== Diluted................................................... 10,351,990 8,530,592 9,137,784 7,889,947 =========== ========== =========== ===========
See accompanying notes to consolidated financial statements. 2 3TEC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30 --------------------------- 1999 1998 ------------ ------------ OPERATING ACTIVITIES NET LOSS.................................................... ($ 3,155,479) ($ 2,467,069) ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH PROVIDED BY OPERATING ACTIVITIES DEPLETION, DEPRECIATION AND AMORTIZATION.................. 4,046,546 4,970,052 IMPAIRMENTS............................................... 1,688,443 492,000 DRYHOLE COSTS............................................. 455,108 331,405 STOCK COMPENSATION EXPENSE................................ 729,938 67,500 GAIN ON SALE OF PROPERTIES................................ (882,477) (1,527,207) DEFERRED INCOME TAX BENEFIT............................... (1,242,324) (1,270,914) MINORITY INTEREST......................................... (40,228) 5,523 OTHER CHARGES............................................. 345,533 (34,680) ------------ ------------ CASH FLOW FROM OPERATIONS BEFORE CHANGES IN CURRENT ASSETS AND LIABILITIES........................................... 1,945,060 566,610 CHANGES IN CURRENT ASSETS AND LIABILITIES, NET OF ACQUISITION EFFECTS: ACCOUNTS RECEIVABLE AND OTHER CURRENT ASSETS.............. 827,906 (588,159) ACCOUNTS PAYABLE, REVENUE PAYABLE, AND OTHER CURRENT LIABILITIES............................................. (1,330,626) 2,080,921 ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES................... 1,442,340 2,059,372 INVESTING ACTIVITIES PROCEEDS FROM SALES OF PROPERTIES........................... 3,614,453 4,707,497 ADDITIONS TO OIL AND GAS PROPERTIES......................... (1,827,614) (3,305,635) ACQUISITION OF ENEX RESOURCES CORPORATION, NET OF CASH ACQUIRED OF $4,698,211................................. -- (11,329,203) ACQUISITION OF ASSETS OF SERVICE DRILLING CO................ -- (6,337,689) OTHER ASSETS................................................ (251,680) (492,129) PAYMENTS FROM (ADVANCES TO) STOCKHOLDER..................... 173,115 (5,211) ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES......... 1,708,274 (16,762,370) FINANCING ACTIVITIES PROCEEDS FROM DEBT ISSUED................................. 1,036,000 32,469,604 PROCEEDS FROM SUBORDINATED NOTES ISSUED................... 10,850,000 -- PROCEEDS FROM COMMON STOCK ISSUED......................... 9,975,000 -- PRINCIPAL PAYMENTS ON DEBT................................ -- (15,976,432) PREFERRED STOCK DIVIDENDS PAID............................ (242,293) (67,945) REGISTRATION COSTS ON SERIES C PREFERRED STOCK............ (48,518) (778,501) OTHER..................................................... (684,434) (242,375) ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES................... 20,885,755 15,404,351 NET INCREASE IN CASH AND CASH EQUIVALENTS................... 24,036,369 701,353 CASH AND CASH EQUIVALENTS- BEGINNING........................ 1,040,096 1,587,184 ------------ ------------ CASH AND CASH EQUIVALENTS- ENDING........................... $ 25,076,465 $ 2,288,537 ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION: INTEREST PAID IN CASH..................................... $ 1,446,736 $ 1,322,038 ============ ============ PREFERRED DIVIDENDS INCURRED BUT NOT PAID................. $ 186,216 -- ============ ============ ACQUISITION OF OIL AND GAS PROPERTIES FROM 3TEC........... $ 875,000 -- ============ ============ DRYHOLE COST ACCRUED BUT NOT PAID......................... $ 345,841 -- ============ ============ CONVERSION OF SERIES A PREFERRED STOCK.................... -- $ 10,000,000 ============ ============ COMMON STOCK ISSUED AS FINDERS' FEE IN ENEX RESOURCES CORP. TENDER OFFER.................... -- $ 245,231 ============ ============ COMMON STOCK ISSUED IN ACQUISITION OF ASSETS FROM SERVICE DRILLING CO., LLC....................................... -- $ 5,078,250 ============ ============
See accompanying notes to consolidated financial statements. 3 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 (UNAUDITED) (1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION 3TEC Energy Corporation (the Company)(Formerly Middle Bay Oil Company, Inc.), was incorporated under the laws of the State of Alabama on November 30, 1992. The Company was reincorporated in Delaware on December 7, 1999 and changed its name to 3TEC Energy Corporation. Effective March 27, 1998, the Company acquired 79.2% of Enex Resources Corporation ("Enex") and over a three-week period ending December 23, 1998, the Company acquired an additional 0.80% of Enex for a total of 80% of Enex. Effective April 16, 1998, the Company acquired the assets of Service Drilling Co., LLC ("Service Drilling"). Effective October 1, 1998, the Company acquired 100% of Enex Consolidated Partners, L.P. ("Enex Partnership"), a limited partnership of which Enex owned greater than a 50% interest. The Company and its subsidiaries are engaged in the acquisition, development and production of oil and gas in the contiguous United States. BASIS OF PRESENTATION In management's opinion, the accompanying consolidated financial statements contain all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company as of September 30, 1999 and December 31, 1998 and the consolidated results of operations and consolidated cash flows for the periods ended September 30, 1999 and 1998. The consolidated financial statements were prepared pursuant to the rules and regulations of the Securities and Exchange Commission. An independent accountant has not audited the accompanying consolidated financial statements. Certain information and disclosures normally included in annual audited financial statements prepared in accordance with generally accepted accounting principles have been omitted, although the Company believes that the disclosures made are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the Company's financial statements and notes thereto included in the Company's Annual Report on Form 10-KSB for the year ended December 31, 1998. RESTATEMENT OF CURRENT PERIOD FINANCIAL INFORMATION The Company has amended the financial information included in its Form 10-QSB filed November 14, 1999, for its financial results as of, and for the periods ended September 30, 1999. On December 16, 1999 the Company obtained from Ryder Scott Company, an independent reserve engineer, a reserve valuation of its oil and gas properties as of October 1, 1999. Based upon the reserve valuation the Company has recorded an additional impairment of its oil and gas properties of $939,000 ($620,000, net of tax). The effect of the additional impairment increased the net loss per share attributable to common stockholders by $0.07 to $0.39 for the nine month period ended September 30, 1999 and by $0.06 to $0.21 for the three month period ended September 30, 1999. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary and Enex, an 80% owned subsidiary. The equity of the minority interest in Enex is shown in the consolidated statements as "minority interest". Significant intercompany accounts and transactions are eliminated in consolidation. EARNINGS PER SHARE Basic earnings per share is based on the weighted average shares outstanding without any dilutive effects considered. Diluted earnings per share reflects dilution from all potential common shares, including options, warrants and convertible preferred stock. A weighted average of 2,041,751 and 3,285,751 common stock equivalents in 1999 and 330,297 and 288,535 common stock equivalents in 1998, are not considered in the calculation of diluted earnings per share for the nine and three month periods ending September 30, respectively, due to the net loss recorded during these periods. 4 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECLASSIFICATIONS Certain reclassifications of prior period amounts have been made to conform to the current presentation. (2) ACQUISITIONS On March 27, 1998, the Company acquired 1,064,432 common shares, approximately 79.2%, of Enex for $15,966,480. The Company purchased the common shares of Enex through a cash tender offer that commenced February 19, 1998 (the "Enex Acquisition"). The Company also incurred approximately $60,934 in legal, accounting and printing expenses and issued 33,825 shares of Company common stock for finders fees to unrelated third parties. At the time, Enex was general partner of Enex Consolidated Partners, L.P., (the "Enex Partnership"), a New Jersey limited partnership whose principal business was oil and gas exploration and production. Enex's general partner interest was 4.1%. Enex also owned an approximate 56.2% limited partner interest in Enex Partnership. The cost of acquiring 79.2% of Enex was allocated using the purchase method of accounting to the consolidated assets and liabilities of Enex based on estimates of the fair values with the remaining purchase price allocated to proved oil and gas properties. The allocation of the purchase price is summarized as follows: (in thousands) Working capital............................................. $ 5,640 Oil and gas properties (proved and unproved)................ 19,090 Minority interest........................................... (7,669) ------- Total....................................................... $17,061 =======
Over a three-week period ending December 23, 1998, the Company acquired an additional 0.80% (9,747 common shares) of Enex common stock for approximately $68,000. On April 16, 1998, the Company acquired substantially all of the oil and gas assets of Service Drilling Co., LLC and certain affiliates ("Service Drilling"), in exchange for 666,000 shares of Company common stock and $6,500,000 in cash for a total acquisition cost of $10,054,774, before post-closing adjustments (the "Service Acquisition"). The fair value of the securities issued in connection with the Service Acquisition was calculated using the price of the Company's common stock at the time the Service Acquisition was announced to the public and further adjusted for tradability restrictions. An independent valuation firm determined the tradability discount for the Company's common stock. The effective date of the acquisition was March 1, 1998 and the cost was allocated using the purchase method of accounting. On December 30, 1998, the Company completed the acquisition of the Enex Partnership (the "Enex Partnership Acquisition"). The transaction consisted of an exchange offer whereby the Company offered to exchange 2.086 shares of Series C Preferred stock ("Series C") for each Enex Partnership unit (the "Exchange Offer"). In connection with the Exchange Offer, the Company submitted a proposal to investors in the Enex Partnership to amend the partnership agreement to provide for the transfer of all of the assets and liabilities of the Enex Partnership to the Company as of October 1, 1998 and dissolve the 5 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (2) ACQUISITIONS (CONTINUED) Enex Partnership. The Exchange Offer was approved on December 30, 1998 and the Company issued 2,177,481 Series C shares for 100% of the outstanding limited partner units. At the close of the Exchange Offer, the Enex Partnership had 1,102,631 units outstanding. Enex was issued 1,293,521 Series C shares for its 56.2% ownership of the Enex Partnership. The remaining 883,959 Series C shares were issued to the limited partners that elected to take Series C shares in lieu of cash. In January 1999, certain dissenting limited partners were paid $516,000 and other unitholders were paid $23,000 in lieu of fractional shares. Because of the dissenting limited partners, Enex owns 59.4% of the Series C shares, of which 20% (258,704 shares) are considered outstanding and held by third parties. The Series C accrues dividends at an annual rate of $0.50 per share which are paid on March 31 and September 30 and has a $5.00 per share liquidation value. The cost of acquiring 100% of the outstanding limited partner units was approximately $11.9 million, consisting of the following (in thousands): Estimated fair value of 2,177,481 shares of Company Series C preferred stock........................................... $10,887 Cash consideration.......................................... 539 Legal, accounting and other expenses........................ 431 ------- Total....................................................... $11,857 =======
As Enex is consolidated into the Company's financial statements, the number of shares outstanding and the value of the shares outstanding attributable to the 43.8% of the Enex Partnership not owned by Enex and the minority interest owners of Enex (20%) is 1,142,663 and $5,713,317, respectively. The cost of acquiring the outstanding limited partner units that were not owned by Enex was approximately $6.7 million, consisting of the following (in thousands): Estimated fair value of 1,142,663 shares of Company Series C preferred stock........................................... $5,713 Cash consideration.......................................... 539 Legal, accounting and other expenses........................ 431 ------ Total....................................................... $6,683 ======
The Company's purchase price was allocated to the assets and liabilities of the Enex Partnership based on estimates of the fair values with the remaining purchase price allocated to proved oil and gas properties. The registration costs of approximately $431,000 reduced the value of the Series C shares issued. Because the Enex Partnership was consolidated in the financial statements of the Company as of the effective date 6 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (2) ACQUISITIONS (CONTINUED) of October 1, 1998, the purchase price allocation below shows the effect of the acquisition on the consolidated financial statements (in thousands): Working capital............................................. $ (539) Oil and gas properties...................................... (23) Minority interest........................................... 5,844 ------ Series C Preferred Stock.................................... $5,282 ======
The following pro forma data presents the results of the Company for the nine months ended September 30, 1998, as if the acquisitions of Service, Enex and the Enex Partnership had occurred on January 1, 1998. The pro forma results are presented for comparative purposes only and are not necessarily indicative of the results which would have been obtained had the acquisitions been consummated as presented. The following data reflect pro forma adjustments for oil and gas revenues, production costs, depreciation and depletion related to the properties and businesses acquired, preferred stock dividends on preferred stock issued, and the related income tax effects (in thousands, except per share amounts):
PROFORMA NINE MONTHS ENDED SEPTEMBER 30, 1998 ------------------ (UNAUDITED) Total revenues.............................................. $20,765 Net loss available to stockholders.......................... (3,346) Net loss per share available to stockholders................ (0.41)
(3) COMMON STOCK, WARRANT AND SENIOR SUBORDINATED NOTE SALE TO 3TEC ENERGY COMPANY, L.L.C. ("3TEC") On August 27, 1999, the Company closed a Securities Purchase Agreement(the "Agreement') for a total of $21,400,000 with 3TEC Energy Corporation, a privately-held company ("Old 3TEC"). Contemporaneously with the closing of the transactions contemplated by the Securities Purchase Agreement, Old 3TEC was merged with and into 3TEC with 3TEC as the surviving entity. As a result of the merger, all of the properties, rights, privileges, powers and franchises of Old 3TEC, including without limitation, the rights, obligations and duties of Old 3TEC under the Securities Purchase Agreement became vested in 3TEC as the surviving entity. The Securities Purchase Agreement and contemplated transactions were approved by the stockholders at the Company's annual meeting on August 10, 1999. The controlling person of 3TEC is EnCap Investments L.L.C., a Delaware limited liability company ("EnCap Investments"). The sole member of EnCap Investments is El Paso Field Services Company, a Delaware corporation ("El Paso Field Services"). The controlling person of El Paso Field Services is El Paso Energy Corporation, a Delaware corporation. The Company received $9,825,000 in cash and oil and gas properties valued at $875,000 for 4,755,556 shares of common stock and 3,600,000 warrants (the 7 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (3) COMMON STOCK, WARRANT AND SENIOR SUBORDINATED NOTE SALE TO 3TEC ENERGY COMPANY, L.L.C. ("3TEC") (CONTINUED) "Warrants")(See Note 7) and $10,700,000 for a 5-year senior subordinated convertible note with a face value of $10,700,000 (the "Note"). At closing, 3TEC became the Company's largest shareholder with ownership of approximately 36% of the outstanding common stock. If 3TEC chooses to fully exercise the Warrants and fully convert the Note to common shares, 3TEC would control approximately 58% of the then issued and outstanding shares of common stock of the Company. As part of the Agreement, at closing, five of the seven directors resigned and all of the executive officers, except Stephen W. Herod and Robert W. Hammons, resigned from their executive positions. A new five-member board was formed. John J. Bassett, former president, chief executive officer and chairman of the Company and Gary C. Christopher, continued as directors and 3TEC appointed three new board members, Floyd C. Wilson, David B. Miller and D. Martin Phillips. Floyd C. Wilson is Managing Director and a member of 3TEC. David B. Miller and D. Martin Phillips are Managing Directors of EnCap Investments. The Company appointed Mr. Wilson Chairman of the Board, President, Chief Executive Officer, Secretary and Treasurer, Mr. Bassett Executive Vice-President and Frank C. Turner II acting Chief Financial Officer. Subsequently, Mr. Bassett resigned and Mr. Herod was named to the Board effective September 30, 1999. (4) ACCOUNTS RECEIVABLE-INSURANCE CLAIM The Company owns a 100% working interest in the Louis Mayard #1 well (the "Well") located in the Esther Field in Vermillion Parish, Louisiana. Due to a failed recompletion attempt and the inability of the Company to shut in the Well using normal operating methods, the Company incurred approximately $1,856,000 during 1998 to gain control of the Well using special crews. On November 4, 1998, the insurance company made a partial payment to the Company under its well control insurance policy of approximately $1,408,000. In April, 1999 the Company was paid $383,000 in final settlement of all claims related to the Well. The Company had recorded the estimated remaining amount due from the insurance company in current assets as Accounts Receivable-Insurance Claim. (5) LONG-TERM DEBT
SEPTEMBER 30 DECEMBER 31 1999 1998 ------------ ----------- Reducing revolving line of credit of up to $100,000,000 due April 1, 2001, secured by oil and gas properties, monthly borrowing base reductions of $250,000 effective May 1, 1999 and monthly payments of interest at Libor plus 2.00% and prime. At September 30, 1999 the Libor and prime rates were 5.30% and 8.25%, respectively........................ 28,490,567 27,454,567 Less current maturities..................................... (4,314,318) -- ----------- ----------- Long-term debt excluding current maturities................. $24,176,249 $27,454,567 =========== ===========
8 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (5) LONG-TERM DEBT (CONTINUED) In connection with the Enex Acquisition the Company entered into a new reducing revolving line of credit agreement (the "$100 million Revolver"). The $100 million Revolver is subject to semi-annual borrowing base redeterminations which are affected by acquisitions and dispositions of assets. The borrowing base at September 30, 1999 was $27,600,000 and monthly borrowing base reduction requirements are $250,000. The principal is due at maturity, April 1, 2001. Monthly principal payments are made as required in order that the outstanding principal balance plus outstanding letters of credit does not exceed the borrowing base. Interest is payable monthly and is calculated at the prime rate. The Company may also elect to calculate interest under the Libor rate, as defined in the agreement. The Libor rate increases by (a) 2.00% if the outstanding loan balance and letters of credit are equal to or greater than 75% of the borrowing base, (b) 1.75% if the outstanding loan balance and letters of credit are less than 75% or greater than 50% of the borrowing base or (c) 1.50% if the outstanding loan balance and letters of credit are equal to or less than 50% of the borrowing base. Libor interest is payable at maturity of the Libor loan which cannot be less than thirty days. At September 30, 1999, the Company had borrowed $28,490,567 and had $373,750 of outstanding letters of credit. As of September 30, 1999, the Company is paying Libor plus 2.00% on a ninety day Libor loan for $26,505,605 and prime on $1,984,962. Effective May 1, 1999, the borrowing base was redetermined to be $31,000,000 with monthly borrowing base reductions of $250,000. Effective September 1, 1999, the Company sold mortgaged properties for $2,741,000 with a borrowing base of $2,200,000. Considering the monthly reductions and the September property sale, the outstanding principal balance and letters of credit exceed the borrowing base by $1,314,000 as of September 30. The property sale closed on September 30 and the Company made a $1,900,000 principal payment on October 1. The terms of the October 1, 1999 redetermination for the Company's $100 million Revolver have been deferred pending execution of a definitive agreement with Bank One (See Note 10). Pursuant to the terms of the $100 million Revolver, if the borrowing base is less than the outstanding principal balance plus outstanding letters of credit the Company has sixty days, after receipt of notice from the Banks, to cure the excess by prepayment, providing additional collateral or a combination of both. Amounts spent on debt retirement due to reductions in the borrowing base reduce the cash available to spend on acquisition, development and exploration activities, and accordingly, oil and natural gas revenues and operating results may be adversely affected. The Company paid a facility fee equal to 3/8% of the initial borrowing base and is required to pay 3/8% on any future increase in the borrowing base within five days of written notice. The Company is required to pay a quarterly commitment fee on the unused portion of the borrowing base of 1/2% if the outstanding loan balance plus letters of credit are greater than 50% of the borrowing base or 3/8% if the outstanding loan balance plus letters of credit are less than or equal to 50% of the borrowing base. The Company is required to pay a letter of credit fee on the date of issuance or renewal of each letter of credit equal to the greater of $500 or 1 1/2% of the face amount of the letter of credit. 9 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (5) LONG-TERM DEBT (CONTINUED) The Company has granted to the Banks liens on substantially all of the Company's oil and natural gas properties, whether currently owned or hereafter acquired, and a negative pledge on all other oil and gas properties. The $100 million Revolver requires, among other things, a cash flow coverage ratio of 1.25 to 1.00 and a current ratio, excluding current maturities of the $100 million Revolver, of 0.9 to 1.00, determined on a quarterly basis. (6) SENIOR SUBORDINATED NOTES On August 27, 1999, senior subordinated promissory notes (the "Senior Notes") were sold to 3TEC and affiliates of Alvin V. Shoemaker ("Shoemaker"), a former director and significant shareholder, for $10,700,000 and $150,000, respectively. The Senior Notes bear interest at an annual rate of 9%. Interest is payable on December 31, 1999 and on every March 31, June 30, September 30 and December 31, thereafter until maturity. The Company may defer payment of fifty percent (50%) of the first eight quarterly interest payments. The Senior Notes may be prepaid, without premium or penalty, in whole or in part, at any time after August 27, 2001. 3TEC and Shoemaker may convert all or any portion of outstanding principal and accrued interest at any time into shares of Company common stock at a conversion price of $3.00 per common share, a total of 3,616,667 common shares. The conversion price may be adjusted from time to time based on the occurrence of certain events. In the event of a change in control (as defined in the Agreement), the entire outstanding principal balance and all accrued but unpaid interest shall be immediately due and payable. The Senior Notes rank senior in right of payment to all Company notes and indebtedness other than the $100 Million Revolver. (7) COMMON STOCK, OPTIONS AND WARRANTS On August 27, 1999, the Company sold 3TEC 4,755,556 shares of common stock and five-year warrants to purchase 3,600,000 shares of common stock for $9,825,000 in cash and oil and gas properties valued at $875,000. On the same date, the Company sold 66,666 shares of common stock and five-year warrants to purchase 50,466 shares of common stock to Shoemaker for $150,000. The warrants issued to 3TEC and Shoemaker are exercisable for $1.00 per share and expire five years from the issue date. Sixty percent of the warrants are immediately exercisable, in whole or in part at any time until the expiration date. An additional 10% of the warrants may be exercised at each anniversary of the grant date until expiration. On the occurrence of either a change of control, payment in full of the Senior Notes or conversion of the entire principal balance of the Senior Notes, all of the warrants become immediately exercisable. If less than the entire principal balance of the Senior Notes are converted, a pro-rata portion of the warrants will be convertible based on the portion of the Senior Notes that are converted. On August 24, 1999, the Company amended the 1995 Stock Option and Stock Appreciation Rights Plan due to the change in control that resulted from the sale of securities to 3TEC. The Plan was amended to extend the exercise date for all options issued prior to July 1, 1999 to one year from the following dates: (1) the termination date of employees if the termination date is without cause and occurred during the 10 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (7) COMMON STOCK, OPTIONS AND WARRANTS (CONTINUED) six-month period commencing with the closing of the Purchase Agreement; (2) the date of termination for employees terminated for "Good Reason" as defined in such employee's employment agreement; and (3) the date of resignation of a holder who is also a director who resigns at closing of the Purchase Agreement. According to APB Opinion 25, the extension of the exercise period results in a new measurement date and compensation expense, equal to the intrinsic value of all of the Plan's outstanding options, is recognized. A one-time charge of $730,000 due to the Plan amendment was recorded as Compensation Expense during the three-month period ending September 30, 1999. On February 9, 1999 and January 13, 1998, the Board of Directors granted to certain employees and directors, options with exercise prices of $1.50 and $5.75 per share, respectively, to acquire 200,000 and 232,000 shares of Company common stock, respectively. All of the options were granted under the 1995 Stock Option and Stock Appreciation Rights Plan at fair market value on date of grant and will expire five years from date of grant if not exercised. On September 15, 1998, warrants to acquire 75,000 shares of Company common stock at an exercise price of $5.00 were granted to a consultant as compensation. The warrants vested over the period September 15, 1998 to January 1, 1999. The estimated fair value of the warrants of $198,946 was determined at the date of grant and charged to stock compensation expense over the vesting period. The agreement was amended on August 9, 1999 to include issuing the consultant 10,000 shares of Series C Preferred Stock as additional compensation for services performed to date. General and administrative expense was charged $50,000 during the three-month period ending September 30, 1999 for the issuance of the 10,000 Series C shares. (8) COMMITMENTS AND CONTINGENCIES Effective September 30, 1999, John J. Bassett, resigned as executive vice-president and board member and ceased employment with the Company. Under the terms of Mr. Bassett's employment agreement, the Company is obligated to make a lump-sum payment of $280,000 to Mr. Bassett within ten days of his resignation. The severance payment, and associated taxes of $4,060, was recognized as severance payment expense during the quarter ending September 30. Mr. Bassett was paid on October 10. Stephen W. Herod, Vice-President Corporate Development, was appointed to the Board to replace Mr. Bassett. In March 1995, the Board of Directors adopted an employee incentive compensation plan (the "Plan") for the benefit of Company employees. The Plan benefits are equal to one percent (1%) of the annual net profit from oil and gas properties acquired or discovered on or after January 1, 1994 and one percent (1%) of the annual sales proceeds from any oil and gas properties sold on or after January 1, 1994. The Compensation Committee of the Board of Directors has sole authority regarding the amount and timing of payment of any Plan benefits to eligible employees. On August 27, 1999, the Compensation Committee authorized the payment of $274,625 to the eligible participants in the Plan. The authorized amount, equal to 100% of the Plan benefits through August 27, 1999, was paid to the Plan participants and the Plan was terminated pursuant to the terms of the 3TEC Agreement. The entire amount of the payment, including associated taxes of $17,902, was recognized as compensation expense during the quarter ending September 30, 1999. Prior to the Compensation Committee's authorization, the Plan benefits were not accrued as an expense in the financial statements because 11 3TEC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1999 (UNAUDITED) (8) COMMITMENTS AND CONTINGENCIES (CONTINUED) the likelihood that the Compensation Committee would determine that the benefits would be payable to eligible employees was less than probable. The Company is a defendant in various legal proceedings which are considered routine litigation incidental to the Company's business, the disposition of which management believes will not have a material effect on the financial position or results of operations of the Company. (9) HEDGING ACTIVITIES In April, the Company entered into costless collar hedges for approximately 3,650 Mcf per day with a weighted average floor and ceiling of $2.06 and $2.20, for the months of May through October of 1999. During the three month and nine month periods ending September 30, 1999, the Company incurred hedging losses of approximately $118,000 and $131,000, respectively. (10) SUBSEQUENT EVENTS On October 1, 1999 the Company executed, and subsequently amended on October 22, a commitment letter with Bank One Texas, N.A. and Banc One Capital Markets, Inc. ("Bank One") for a $250 million credit facility (the "Facility") to finance the potential Floyd Oil Acquisition, subject to an initial borrowing base of $95 million. Unless a definitive agreement is executed on or before November 30, 1999 the $95 million commitment with Bank One will terminate. The terms of the October 1, 1999 redetermination for the Company's $100 million Revolver have been deferred pending execution of a definitive agreement with Bank One. On October 7, 1999, the Company announced that it had entered into an agreement for the acquisition of properties and interests owned by a group of private sellers and managed by Floyd Oil Company. There is no relationship between Floyd C. Wilson, President of the Company, and Floyd Oil Company. The transaction has an adjusted purchase price of approximately $96 million with an effective date of January 1, 1999. The majority of the properties are located in Texas and Louisiana. The properties being acquired have estimated proved reserves at August 1, 1999 of 186,000 Mmcfe with 73% of the reserves classified as proved developed producing. The reserves being acquired are 76% natural gas. The Company will operate the majority of the properties. Closing is expected to be on or before November 30, 1999 and is subject to execution of definitive agreements and completion of due diligence. The transaction is expected to be financed through the Bank One Facility and from working capital. On October 19, 1999, the Company closed a private placement of securities to The Prudential Insurance Company of America ("Prudential"). The economic terms and conditions of the private placement are similar to those of the Agreement with 3TEC entered into on July 1, 1999. The private placement consisted of the sale of 1,055,042 shares of common stock and five-year warrants to purchase 798,677 shares at $1.00 per share of common stock for $2,373,844 and a five-year senior subordinated convertible note for $2,373,844. The subordinated note will bear interest at a rate of 9% per annum and is convertible into 791,281 shares of common stock. On November 2, 1999, the operator authorized the plugging and abandonment of the Cornelius #1 well on the Hawkins Ranch Prospect which was spudded on September 3, 1999. The Company incurred approximately $363,000 in costs, which were charged to dryhole expense in the current period. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table reflects certain summary operating data for the periods presented:
THREE MONTHS NINE MONTHS SEPTEMBER 30 SEPTEMBER 30 ------------------- ------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Net Production Data: Oil and Liquids (MBbls)................................. 116 163 367 427 Natural Gas (MMcf)...................................... 982 1,031 2,778 2,713 Equivalent Production (Mcfe)............................ 1,680 2,009 4,980 5,277 Average Sales Price (1) Oil and Liquids (per Bbl)............................... $19.10 11.35 14.66 11.91 Natural Gas (per Mcf)................................... 2.35 1.90 2.01 2.04 Average equivalent price (per Mcfe)......................... 2.69 1.90 2.20 2.02 Expenses ($ per Mcfe) Oil and gas operating (2)............................... 0.78 0.92 0.82 0.99 General and administrative.............................. 0.66 0.49 0.61 0.61 Depreciation and depletion (3).......................... 0.85 0.95 0.79 0.93 Cash Margin ($ per Mcfe) (4)................................ 1.25 0.49 0.77 0.42
- ------------------------ (1) Excludes revenue from Spivey Field gas plant. (2) Includes lease operating costs, production and ad valorem taxes and excludes Spivey Field plant costs. (3) Represents depreciation and depletion, excluding impairments, of oil and gas properties only. (4) Represents average equivalent price per Mcfe less oil and gas operating expenses per Mcfe and general and administrative expenses per Mcfe. THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 For the three months ended September 30, 1998, the revenues and expenses include the Enex Acquisition and the Service Acquisition but do not include the Enex Partnership Acquisition. REVENUES-- Total revenues for the current period of $5,763,000 were $68,000 higher than the comparable period. The increase in total revenues was due principally to increases in oil and gas revenues of $695,000 and other income of $275,000, offset partially by a $943,000 decrease in gains on sales of properties. Oil and gas revenues increased $695,000. The increase in oil and gas revenues consisted of a $371,000 increase in oil revenues, a $348,000 increase in gas revenues and a $24,000 decrease in other revenues. The increase in gas revenues included a loss on hedging of $118,000. The increase in oil and gas revenues was the result of higher oil and gas prices. Production of oil and gas decreased 29% and 5%, respectively while oil and gas prices increased 68% and 24%, respectively. Normal production decline and property sales contributed to the declines in oil and gas production. In April, the Company entered into costless collar hedges for approximately 3,650 Mcf per day with a weighted average floor and ceiling of $2.06 and $2.20, for the months of May through October. During the current period, the Company incurred a hedging loss of $118,000. In the current period, the realized gas price would have been $2.47, if the hedging loss was excluded versus a realized price of $2.35. The Company recorded gains on the sale of properties in the current and comparable periods of $575,000 and $1,518,000, respectively. The sale of approximately 157 wells in 19 fields for approximately $2,741,000 to a private company accounted for the primary portion of the gain in the current period. The 13 effective date of the private sale was September 1. In the prior period, the Company also sold several hundred properties at auction and in private sales for approximately $4,140,000. In the current and comparable periods a significant portion of the proceeds was credited against the original acquisition cost. Other income in the current period of $469,000 includes $256,000 from a lawsuit settlement. Other income in the comparable period includes a lawsuit settlement of $123,000. COSTS AND EXPENSES-- Total expenses increased $2,310,000 over the comparable period. The primary reasons for the total expense increase were non-recurring charges of $1,307,000 associated with the sale of securities to 3TEC and the resulting change in management control, increased impairments of $1,196,000 and increased dryhole costs of $367,000. The non-recurring charges were stock compensation expense of $730,000, severance payment of $284,000 and employee incentive compensation plan payment of $293,000. The stock compensation charge resulted from an amendment to the Company's stock option plan, prior to the sale of securities to 3TEC, which increased the length of time employees and directors could exercise their options if they were terminated or resigned, in the case of directors, for a certain period of time after the sale of securities to 3TEC. The severance payment was the amount payable to John J. Bassett upon his resignation on September 30, 1999, according to the terms of his employment agreement. The employee incentive compensation plan payment was the result of an agreement between 3TEC and the Company to pay the benefits due under the plan as a condition precedent to the closing of the securities sale to 3TEC. Lease operating expense decreased $500,000. Property sales that have closed throughout the twelve month period ending September 30, 1999 contributed to the lower lease operating expenses. Geological and geophysical expenses ("G&G expenses") decreased $92,000. In the current and comparable periods, the Company incurred approximately $47,000 and $139,000, respectively, of G&G expenses. The principal G&G expenses in the current and comparable periods were attributable to the Cedartown Prospect and the Sherburne Prospect, respectively. Depletion, depreciation and amortization expenses decreased $479,000. Reserve write-downs, property sales and lower production contributed to the lower depletion, depreciation and amortization expenses. Impairment expense in the current period of $1,688,000 consists of a $472,000 impairment on the fee mineral acreage situated in Louisiana, a $27,000 impairment of various non-producing leases and a $1,189,000 impairment on various oil and gas properties. The fee mineral impairment was the result of 6,227 unleased acres in Terrebonne Parish that are expected to revert to the surface owners by December 1, 1999. Impairments on oil and gas properties were incurred primarily as a result of reserve reclassifications and estimations by new reserve engineers engaged by the Company to evaluate the Company's reserves as of October 1, 1999. Impairment expense in the comparable period was due to the writedown of reserves resulting from an unsuccessful recompletion attempt. During the current period, dryhole expense increased by $367,000. In the current and comparable periods, the Company incurred approximately $391,000 and $24,000, respectively, of dryhole expenses. Dryhole expense attributable to the Cornelius #1 of $363,000 was the primary dryhole expense in the current period. The Cornelius #1 was declared a dryhole subsequent to September 30 and the estimated costs to complete the drilling and plug and abandon the well were accrued at September 30. Interest expense increased $102,000. Accrued interest on the subordinated notes since August 27, 1999 resulted in slightly higher interest expense. Interest rates and the loan balance did not vary significantly between the current and comparable periods. General and administrative expenses ("G&A") increased $137,000. Increases in salary, legal and consulting expenses in the current period offset decreases in salary, office and rent expenses in the comparable period. The increase in salary expense was due to employees hired subsequent to the sale of securities to 3TEC. Legal and consulting expenses increased for various reasons. The decrease in salary, 14 office and rent expenses in the comparable period was due to the staff reductions at Enex and the closing of the Enex offices in Kingwood, Texas. Other expenses increased $272,000. Bad debt expense of $70,000 and various other charges accounted for the increase. OPERATING LOSS AND NET LOSS-- The Company reported an operating loss before minority interest of $2,673,000 for current period versus an operating loss of $431,000 for the comparable period. Due to the Enex Acquisition, the Company records a minority interest on its income statement to remove the net income or loss attributable to the minority interest holders of Enex (20%). In the current and comparable periods, the minority interest increased the operating loss by $23,000 and $154,000, respectively. The minority interest in the current period accounted only for the Enex operations while the minority interest in the comparable period accounted for the operations of Enex and the Enex Partnership. The Enex Partnership was acquired by the Company effective October 1, 1998. The Company reported an income tax benefit of $686,000 in the current period versus a $199,000 benefit in the comparable period. The Company reported a net loss of $2,010,000 for the current period versus a net loss of $386,000 for the comparable period. After considering the preferred stock dividend requirement of $143,000 in the current period versus none in the comparable period, the Company reported a net loss attributable to common stockholders in the current and comparable periods of $2,153,000 and $386,000, respectively. The preferred dividends in the current period represent three months of accrued dividends on the Series C preferred stock. If the non-recurring charges of $1,307,000 associated with the sale of securities to 3TEC and the resulting change in management control in the current period were excluded, the Company would have reported net loss attributable to common stockholders of $1,060,000 versus the actual net loss attributable to common stockholders of $2,153,000. NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 For the nine months ended September 30, 1998, the revenues and expenses include the Enex Acquisition for the period April through September and do not include the Enex Partnership Acquisition. The Service Acquisition is included in the revenues and expenses for the months of May through September. REVENUES-- Total revenues for the current period of $12,967,000 were $292,000 lower than the comparable period. The decrease in total revenues was due principally to a decrease in gain on sale of properties of $645,000 offset partially by increases in other income and oil and gas revenues. Oil and gas revenues increased $250,000. The increase in oil and gas revenues consisted of a $292,000 increase in oil revenues, a $35,000 increase in gas revenues and a $77,000 decrease in other revenues. The increase in gas revenues included a loss on hedging of $131,000. The increase in oil and gas revenues was primarily the result of higher oil prices. Oil production decreased 14% while oil prices increased 23%. The 2% increase in gas production was almost entirely offset by the 2% lower gas prices caused by the hedging loss. Normal production decline and property sales contributed to the reduced oil production over the comparable period. The Enex, Service and Enex Partnership Acquisitions, which closed subsequent to March 26, 1998, increased oil and gas production over the comparable period. 15 In April, the Company entered into costless collar hedges for approximately 3,650 Mcf per day with a weighted average floor and ceiling of $2.06 and $2.20, for the months of May through October. During the current period, the Company incurred a hedging loss of $131,000. In the current period, the realized gas price would have been $2.06, if the hedging loss was excluded versus a realized price of $2.01. The Company recorded gains on the sale of properties in the current and comparable periods of $882,000 and $1,527,000, respectively. The sale of approximately 157 wells in 19 fields for approximately $2,741,000 to a private company accounted for the primary portion of the gain in the current period. The effective date of the private sale was September 1. In the comparable period, the Company also sold several hundred properties at auction and in private sales for approximately $4,495,000. In the current and comparable periods a significant portion of the proceeds was credited against the original acquisition cost. Other income in the current period of $691,000 includes $256,000 from a lawsuit settlement and $135,000 in interest income. Other income in the comparable period includes a lawsuit settlement of $123,000. COSTS AND EXPENSES-- Total expenses increased $413,000 over the comparable period. The primary reason for the total expense increase was an increase in impairments, offset by lower lease operating expenses, production taxes and plant costs ("lease operating expenses"), geological and geophysical expenses and depletion. Certain non-recurring charges associated with the sale of securities to 3TEC and the resulting change in management control increased total expenses by $1,307,000. The non-recurring charges were stock compensation expense of $730,000, severance payment of $284,000 and employee incentive compensation plan payment of $293,000. The stock compensation charge resulted from an amendment to the Company's stock option plan, prior to the sale of securities to 3TEC, which increased the length of time employees and directors could exercise their options if they were terminated or resigned, in the case of directors, for a certain period of time after the sale of securities to 3TEC. The severance payment was the amount payable to John J. Bassett upon his resignation on September 30, 1999, according to the terms of his employment agreement. The employee incentive compensation plan payment was the result of an agreement between 3TEC and the Company to pay the benefits under the plan as a condition precedent to the closing of the securities sale to 3TEC. Lease operating expense decreased $1,088,000. Property sales that have closed throughout the twelve month period ending September 30, 1999 contributed to the lower lease operating expenses. Geological and geophysical expenses ("G&G expenses") decreased $739,000. In the current and comparable periods, the Company incurred approximately $188,000 and $927,000, respectively, of G&G expenses. The principal G&G expenses in the current and comparable periods were attributable to the Cedartown Prospect and Hawkins Ranch Prospect, respectively. Depletion, depreciation and amortization expenses decreased $923,000. Reserve write-downs, property sales and lower production contributed to the lower depletion, depreciation and amortization expenses. Impairment expense in the current period of $1,688,000 consists of a $472,000 impairment on the fee mineral acreage situated in Louisiana, a $27,000 impairment of various non-producing leases and a $1,189,000 impairment on various oil and gas properties. The fee mineral impairment was the result of 6,227 unleased acres in Terrebonne Parish that are expected to revert to the surface owners by December 1, 1999. Impairments on oil and gas properties were incurred primarily as a result of reserve reclassifications and estimations by new reserve engineers engaged by the Company to evaluate the Company's reserves as of October 1, 1999. Impairment expense in the comparable period was due to the writedown of reserves resulting from an unsuccessful recompletion attempt. During the current period, dryhole expense increased by $124,000. The dryhole expense in the current period of $455,000 was due primarily to expenses on the Hawkins 60 #1 of $39,000 and Cornelius #1 of $363,000. Both wells are part of the Hawkins Ranch Prospect. The dryhole expense in the prior period of 16 $331,000 consisted principally of a $199,000 dryhole on the S. Highbaugh Prospect and additional dryhole expense of $102,000 on two dryholes in the Reflection Ridge Prospect. Interest expense increased $311,000 due to a lower average loan balance in the first quarter of the comparable period and higher interest expense in the current period due to the interest on the subordinated notes issued on August 27, 1999. The loan balance was lower in the first quarter of the comparable period compared to the second quarter of the comparable period because the Enex Acquisition closed on March 27, 1998 and the Service Acquisition closed on April 16, 1998. In addition, advances on the $100 Million Revolver occurred in February and April of the current period. General and administrative expenses ("G&A") decreased $183,000. Decreases in several expense categories contributed to the decrease. The primary expense decrease was due to decreases in salary, contract labor, office and rent expenses. The staff reductions at Enex and the closing of the Enex offices in Kingwood, Texas contributed largely to these expense reductions. Increases in salary, legal, accounting and consulting expenses in the current period partially offset the expense reductions. An increase in salary expense was due to employees hired subsequent to the sale of securities to 3TEC. Legal, accounting and consulting expenses increased for various reasons. Other expenses increased $477,000. Bad debt expense of $170,000 and other miscellaneous adjustments resulted in the expense increase. OPERATING LOSS AND NET LOSS-- The Company reported an operating loss before minority interest of $4,438,000 for current period versus an operating loss of $3,732,000 for the comparable period. Due to the Enex Acquisition, the Company records a minority interest on its income statement to remove the net income or loss attributable to the minority interest holders of Enex (20%). In the current and comparable periods, the minority interest decreased the operating loss by $40,000 and increased the operating loss by $6,000, respectively. The minority interest in the current period accounted only for the Enex operations while the minority interest in the comparable period accounted for the operations of Enex and the Enex Partnership. The Enex Partnership was acquired by the Company effective October 1, 1998. The Company reported an income tax benefit of $1,242,000 in the current period versus a $1,271,000 benefit in the comparable period. The Company reported a net loss of $3,155,000 for the current period versus a net loss of $2,467,000 for the comparable period. After considering the preferred stock dividend requirement of $428,000 in the current period versus $68,000 in the comparable period, the Company reported a net loss attributable to common stockholders in the current and comparable periods of $3,584,000 and $2,535,000, respectively. The preferred dividends in the current period represent nine months of accrued dividends on the Series C preferred stock. The preferred dividend in the comparable period represents accrued dividends on the Series A preferred stock. If the non-recurring charges of $1,307,000 associated with the sale of securities to 3TEC and the resulting change in management control in the current period were excluded, the Company would have reported net loss attributable to common stockholders of $2,469,000 versus the actual net loss attributable to common stockholders of $3,584,000. LIQUIDITY AND CAPITAL RESOURCES NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 Cash flow from operating activities for the current period of $1,442,000 decreased $617,000 from the comparable period. The decrease in cash flow was due primarily to working capital changes offset partially by lower lease operating and geological and geophysical expenses. Cash flow from oil and gas properties 17 (oil and gas revenues and plant income less lease operating expenses, production taxes and plant costs) increased $1,338,000 over the comparable period. Lower lease operating expense was the primary reason for the increased cash flow from oil and gas properties. Increases in oil prices and gas production resulted in higher oil and gas revenues. Oil prices increased 23%, while oil production decreased 14%. Gas prices decreased 1%, while gas production increased 2%. The change in working capital was caused principally by timing differences in the payment of expenses and receipt of revenues. Cash additions to oil and gas properties were lower than the comparable period due primarily to less exploratory and developmental drilling in the current period. The amount spent on acquisitions was lower due to no acquisitions in the current period versus the Enex and Service Acquisitions that closed in the comparable period. The Company acquired approximately 79% of Enex common stock for cash in a tender offer that closed March 27, 1998 and acquired the oil and gas assets of Service Drilling Co., LLC and certain affiliates for cash and stock in a transaction that closed April 16, 1998. During the current period, the Company was advanced $516,000 on the $100 million Revolver to pay the dissenting limited partners in the Enex Partnership Acquisition and $520,000 to pay for developmental drilling projects on several of its major properties. In the comparable period, the Company refinanced its existing debt and financed the Enex and Service Acquisitions with proceeds from the $100 million Revolver. The Company made no principal payments on the $100 million Revolver during the current period. In the comparable period, the Company made principal payments, excluding refinancings, of $5,015,000. During the current period, the Company sold $10,850,000 of common stock, receiving $9,975,000 in cash and $875,000 in oil and gas properties, and $10,850,000 of subordinated notes to 3TEC and Shoemaker. No common stock or note sales were made in the comparable period. Cash costs of $684,000 were incurred in the sale of the securities to 3TEC and classified as Other Financing Activities. In the current period, the Company paid approximately $242,000 in dividends on the Series C preferred stock issued in the Enex Partnership Acquisition. The amount paid represents a portion of the $428,000 of dividends accrued for the nine months ended September 30, 1999. Of the $428,000, $97,000 is attributable to the 20% minority interest ownership in Enex. The remaining dividends were not immediately paid in cash because of unknown addresses and non-receipt of preferred stock issuance forms. Net cash from operations, property sales, $100 million Revolver advances and cash on hand were used during the period ending September 30, 1999 principally for proved property and leasehold acquisitions, exploratory and developmental drilling and geological and geophysical expenses. Approximately $134,000 and $198,000 was spent on leasehold and legal costs on the Cedartown and Hawkins Ranch Prospects, respectively. Approximately $1,329,000 was spent on exploratory and developmental drilling and recompletions. Approximately $167,000 was spent on abandonment costs on a field in Florida. The principal exploratory well drilled in the current period was the Hawkins 60 #1 on the Hawkins Ranch Prospect which was unsuccessful. The principal developmental expenditure in the current period was a recompletion in the Murphy Lake Field for approximately $351,000. The remaining exploratory and developmental work was throughout several fields. The Company had current assets of $27,883,000 and current liabilities of $7,700,000, which resulted in working capital of $20,183,000 as of September 30, 1999. Current period working capital increased $20,044,000 from working capital of $139,000 as of December 31, 1998. Cash received from the sale of securities to 3TEC and Shoemaker of $20,825,000 caused the increase in working capital. The current maturity of long-term debt increased from December 31, 1998 because the amount of debt outstanding increased and the borrowing base decreased since December 31, 1998. The Company's current ratio of 8.24, calculated under the terms of the $100 million Revolver agreement, which excludes current maturities of debt due under the $100 million Revolver, was in excess of the 0.90 to 1.00 required. 18 COMMON STOCK, WARRANT AND SENIOR SUBORDINATED NOTE SALE TO 3TEC ENERGY COMPANY, L.L.C. ("3TEC") On August 27, 1999, the Company closed a Securities Purchase Agreement(the "Agreement') for a total of $21,400,000 with 3TEC Energy Corporation, a privately-held company ("Old 3TEC"). Contemporaneously with the closing of the transactions contemplated by the Securities Purchase Agreement, Old 3TEC was merged with and into 3TEC with 3TEC as the surviving entity. As a result of the merger, all of the properties, rights, privileges, powers and franchises of Old 3TEC, including without limitation, the rights, obligations and duties of Old 3TEC under the Securities Purchase Agreement became vested in 3TEC as the surviving entity. The Securities Purchase Agreement and contemplated transactions were approved by the stockholders at the Company's annual meeting on August 10, 1999. The controlling person of 3TEC is EnCap Investments L.L.C., a Delaware limited liability company ("EnCap Investments"). The sole member of EnCap Investments is El Paso Field Services Company, a Delaware corporation ("El Paso Field Services"). The controlling person of El Paso Field Services is El Paso Energy Corporation, a Delaware corporation. The Company received $9,825,000 in cash and oil and gas properties valued at $875,000 for 4,755,556 shares of common stock and 3,600,000 warrants (the "Warrants") and $10,700,000 for a 5-year senior subordinated convertible note with a face value of $10,700,000 (the "Note"). The Warrants may be exercised for up to 3,600,000 shares of common stock at an exercise price of $1 per share. Sixty percent of the Warrants may be exercised immediately. The remaining 40% will be exercisable over a 4-year period commencing 12 months from the closing date of the Agreement. The Note will bear interest at a rate of 9% per annum and is convertible into 3,566,667 shares of common stock. Simultaneous with the close of the Agreement with 3TEC, the Company sold 66,666 shares of Company common stock for $150,000 and $150,000 of 5-year senior subordinated convertible notes to affiliates of Alvin V. Shoemaker, a former director and significant shareholder of the Company ("Shoemaker"). At closing, 3TEC became the Company's largest shareholder with ownership of approximately 36% of the outstanding common stock. If 3TEC chooses to fully exercise the Warrants and fully convert the Note to common shares, 3TEC would control approximately 58% of the then issued and outstanding shares of common stock of the Company. As part of the Agreement, at closing, five of the seven directors resigned and a new five-member board was formed. John J. Bassett, former president, chief executive officer and chairman of the Company and Gary C. Christopher, continued as directors and 3TEC appointed three new board members, Floyd C. Wilson, David B. Miller and D. Martin Phillips. Floyd C. Wilson is Managing Director and a member of 3TEC. David B. Miller and D. Martin Phillips are Directors of EnCap Investments. Subsequently, Mr. Bassett resigned and Mr. Herod was named to the Board effective September 30, 1999. As part of the Agreement, at closing, all of the officers of the Company, except Stephen W. Herod and Robert W. Hammons, resigned from their executive positions. The Company appointed Mr. Wilson Chairman of the Board, President, Chief Executive Officer, Secretary and Treasurer, Mr. Bassett Executive Vice-President and Frank C. Turner II acting Chief Financial Officer. COMMITMENT FOR A $250 MILLION CREDIT FACILITY On October 1, 1999 the Company executed, and subsequently amended on October 22, a commitment letter with Bank One Texas, N.A. and Banc One Capital Markets, Inc. ("Bank One") for a $250 million credit facility (the "Facility") to finance the potential Floyd Oil Acquisition, subject to an initial borrowing base of $95 million. Unless a definitive agreement is executed on or before November 30, 1999 the $95 million commitment with Bank One will terminate. The terms of the October 1, 1999 redetermination for the Company's $100 million Revolver have been deferred pending execution of a definitive agreement with Bank One. 19 $100 MILLION LINE OF CREDIT In conjunction with the Enex Acquisition on March 27, 1998 the Company entered into a $100 million reducing, revolving line of credit (the "$100 million Revolver") with current borrowings under a term note maturing April 1, 2001. The entire principal balance of the Company's $50 million Convertible Loan was replaced with the $100 million Revolver. The amount the Company can borrow is based upon the borrowing base. The borrowing base and the monthly borrowing base reduction amounts are redetermined semi-annually by unanimous consent of the lenders. The principal is due at maturity, April 1, 2001. Monthly principal payments are made as required in order that the outstanding principal balance plus outstanding letters of credit does not exceed the borrowing base. Interest is payable monthly and is calculated at the prime rate. The Company may elect to calculate interest under the Libor rate, as defined in the agreement. The Libor rate increases by (a) 2.00% if the outstanding loan balance and letters of credit are equal to or greater than 75% of the borrowing base, (b) 1.75% if the outstanding loan balance and letters of credit are less than 75% or greater than 50% of the borrowing base or (c) 1.50% if the outstanding loan balance and letters of credit are equal to or less than 50% of the borrowing base. The borrowing base at September 30, 1999 was $27,600,000. Effective May 1, the borrowing base was redetermined to be $31,000,000 with monthly borrowing base reductions of $250,000. The borrowing base was reduced by $2,200,000 due to the sale of mortgaged properties for $2,741,000 effective September 1, 1999. At September 30, 1999 the Company had borrowed $28,491,000 and had $374,000 of outstanding letters of credit. During the current period, the Company did not make any principal payments and was advanced $1,036,000 under the $100 million Revolver. The Company is currently paying Libor plus 2.00% on a ninety day Libor loan for $26,506,000 and prime on $1,985,000. At September 30, 1999, the outstanding principal balance and letters of credit exceed the borrowing base by $1,314,000. The property sale closed on September 30 and the Company made a $1,900,000 principal payment on October 1. Pursuant to the terms of the $100 million Revolver, if the borrowing base is less than the outstanding principal balance plus outstanding letters of credit the Company has sixty days, after receipt of notice from the Banks, to cure the excess by prepayment, providing additional collateral or a combination of both. The terms of the October 1, 1999 redetermination have been deferred pending execution of a definitive agreement on the $250 million credit facility with Bank One. The Company paid a facility fee equal to 3/8% of the initial borrowing base and is required to pay 3/8% on any future increase in the borrowing base within five days of written notice. The Company is required to pay a quarterly commitment fee on the unused portion of the borrowing base of 1/2% if the outstanding loan balance plus letters of credit are greater than 50% of the borrowing base or 3/8% if the outstanding loan balance plus letters of credit are less than or equal to 50% of the borrowing base. The Company is required to pay a letter of credit fee on the date of issuance or renewal of each letter of credit equal to the greater of $500 or 1 1/2% of the face amount of the letter of credit. The Company has granted to the Banks liens on substantially all of the Company's oil and natural gas properties, whether currently owned or hereafter acquired, and a negative pledge on all other oil and gas properties. The $100 million Revolver requires, among other things, a cash flow coverage ratio of 1.25 to 1.00 and a current ratio, excluding the current maturity of the $100 million Revolver, of 0.9 to 1.00, determined on a quarterly basis. As of September 30, 1999 the Company was in compliance with the cash flow and current ratio covenants. Because the borrowing base was higher than the debt and outstanding letters of credit during the current period, excluding the effects of the property sale that closed on September 30, no debt payments were required. 20 Under the terms of the $100 million Revolver, when mortgaged properties are sold the borrowing base shall be reduced, and if necessary, proceeds from the sales of properties shall be applied to the debt outstanding in an amount equal to the loan value attributable to such properties sold. The $100 million Revolver includes other covenants prohibiting cash dividends, distributions, loans, advances to third parties in excess of $100,000, or sales of assets greater than 10% of the aggregate net present value of the oil and gas properties in the borrowing base. The bank has granted the Company a waiver allowing the Company to pay the dividends to holders of Series C as long as no default or event of default exists or would exist as a result of any Series C dividend payment. SENIOR SUBORDINATED NOTES On August 27, 1999, as part of the Agreement with 3TEC, senior subordinated promissory notes (the "Senior Notes") were sold to 3TEC and Shoemaker for $10,700,000 and $150,000, respectively. The Senior Notes bear interest at an annual rate of 9%. Interest is payable on December 31, 1999 and on every March 31, June 30, September 30 and December 31, thereafter until maturity. The Company may defer payment of fifty percent (50%) of the first eight quarterly interest payments. The Senior Notes may be redeemed, in whole or in part, at any time after August 27, 2001. 3TEC and Shoemaker may convert all or any portion of outstanding principal and accrued interest at any time into shares of Company common stock at a conversion price of $3.00 per common share, for a total of 3,616,667 common shares. The conversion price may be adjusted from time to time based on the occurrence of certain events. In the event of a change in control, the entire outstanding principal balance and all accrued but unpaid interest shall be immediately due and payable. The Senior Notes rank senior in right of payment to all Company notes and indebtedness other than the $100 Million Revolver. PRIVATE PLACEMENT OF SECURITIES TO THE PRUDENTIAL INSURANCE COMPANY OF AMERICA On October 19, 1999, the Company closed a private placement of securities to The Prudential Insurance Company of America ("Prudential"). The economic terms and conditions of the private placement are similar to those of the Agreement with 3TEC entered into on July 1, 1999. The private placement consisted of the sale of 1,055,042 shares of common stock and five-year warrants to purchase 798,677 shares of common stock at $1.00 per share for $2,373,844 and a five-year senior subordinated convertible note for $2,373,844. The subordinated note will bear interest at a rate of 9% per annum and is convertible into 791,281 shares of common stock. Prudential owns approximately 7% of the Company's currently outstanding common stock. PROPERTY SALES During the nine-month period ending September 30, 1999, the Company received approximately $3,600,000 in cash from the sales of non-strategic oil and gas properties. The Company recorded a gain of $869,000 on the sales of the oil and gas properties. Subsequent to the May 1 borrowing base redetermination, the borrowing base on the $100 Million Revolver was reduced by $2,200,000 for the loan value of the sold properties. FUTURE CAPITAL REQUIREMENTS AND AVAILABLE FINANCING The Company has made and will continue to make, substantial capital expenditures for acquisition, development and exploration of oil and natural gas reserves. The timing of most of the Company's capital expenditures is discretionary with no material long-term commitments. Consequently, the Company has a significant degree of flexibility to adjust the level of such expenditures as conditions warrant. 21 The Company expects to spend approximately $3,400,000 on development and exploration projects over the next twelve months, which excludes any exploration and development projects associated with any future significant acquisitions. The Company intends to use available cash, cash flows from operations and cash proceeds from asset sales of certain non-core properties to fund capital expenditures other than significant acquisitions and expects such funds to be adequate for such purposes. On October 7, 1999, the Company announced that it had entered into an agreement for the acquisition of properties and interests owned by a group of private sellers and managed by Floyd Oil Company. There is no relationship between Floyd C. Wilson, President of the Company, and Floyd Oil Company. The transaction has an adjusted purchase price of approximately $96 million with an effective date of January 1, 1999. The majority of the properties are located in Texas and Louisiana. The properties being acquired have estimated proved reserves at August 1, 1999 of 186,000 Mmcfe with 73% of the reserves classified as proved developed producing. The reserves being acquired are 76% natural gas. The Company will operate the majority of the properties. Closing is expected to be on or before November 30, 1999 and is subject to execution of definitive agreements and completion of due diligence. The transaction is expected to be financed through the Bank One Facility and from working capital. Other than the Floyd Oil Acquisition, the Company does not have a specific acquisition budget as a result of the unpredictability of the timing and size of potential acquisition activities. The Company intends to use borrowings under its bank credit facility, or other debt or equity financings, to the extent available, to finance significant acquisitions. The availability and attractiveness of these sources of financing will depend upon a number of factors, some of which will relate to the financial condition and performance of the Company, and some of which will be beyond the Company's control, such as prevailing interest rates, oil and gas prices and other market conditions. On October 17, 1999 the Company spudded a well in the Cedartown Prospect. The Company's share of the dryhole cost is $187,000. On November 2, 1999, the operator agreed to plug and abandon the second exploratory well drilled on the Hawkins Ranch Prospect, the Cornelius #1, which was spudded on September 3. The first well drilled on the Hawkins Ranch Prospect in the first quarter of 1999 was also unsuccessful. The operator is currently evaluating the future drilling plans on the Hawkins Ranch Prospect in light of the results of the Cornelius #1. Prior to the results of the Cornelius #1, the operator had scheduled the drilling of three additional exploratory wells through February 1, 2000 with total estimated dryhole costs, net to the Company, of approximately $885,000. The Company expects to pay approximately $300,000 in the fourth quarter of 1999 to fund the remaining Cornelius #1 dryhole costs. As of November 12, 1999 the Company had not committed to drill any additional wells on the Hawkins Ranch Prospect. At September 30, 1999, the outstanding principal balance and letters of credit on the $100 million revolver exceeded the borrowing base by $1,314,000. The Company paid $1,900,000 on the outstanding principal balance on October 1, 1999. The terms of the October 1, 1999 redetermination have been deferred pending execution of a definitive agreement on the $250 million credit facility with Bank One. If a definitive agreement on the Bank One credit facility is executed, the outstanding principal balance on the $100 million Revolver will be paid in full. Amounts spent on debt retirement due to reductions in the borrowing base reduce the cash available to spend on acquisition, development and exploration activities and, accordingly, oil and natural gas revenues and operating results may be adversely affected. The Company believes that cash flow from operations, cash on hand and available borrowings will be sufficient to fund its operations and future growth as contemplated under its current business plan. However, if the Company's plans or assumptions change or if its assumptions prove to be inaccurate, the Company may be required to seek additional capital. Management cannot be assured that the Company will be able to obtain such capital or, if such capital is available, that the Company will be able to obtain it on acceptable terms. 22 CURRENT ACTIVITIES As of November 12, 1999, there was one exploratory well drilling on the Cedartown Prospect in Lincoln Parish, Louisiana. YEAR 2000 COMPLIANCE Readers are cautioned that the forward-looking statements contained in the following Year 2000 discussion should be read in conjunction with the Company's disclosures under the heading "Forward-Looking Statements." The disclosures also constitute a "Year 2000 Readiness Disclosure" and "Year 2000 Statement" within the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998. STATEMENT OF READINESS The Company has undertaken various initiatives to ensure that its hardware, software and equipment will function properly with respect to dates before and after January 1, 2000. For this purpose, the phrase "hardware, software and equipment" includes systems that are commonly thought of as Information Technology systems ("IT"), as well as those Non-Information Technology systems ("Non-IT") and equipment which include embedded technology. IT systems include computer hardware and software and other related systems. Non-IT systems include certain oil and gas production and field equipment, gathering systems, office equipment, telephone systems, security systems and other miscellaneous systems. The Non-IT systems present the greatest readiness challenge since identification of embedded technology is difficult and because the Company is, to a great extent, reliant on third parties for Non-IT compliance. The Company has formed a Year 2000 ("Y2K") Project team, which is chaired by its Chief Financial Officer, Frank C. Turner, II. The team includes corporate staff and representatives from the Company's business units. In response to the possible risks posed to the Company, the team has developed a Y2K Plan (the "Plan") which includes guidelines for inventory, assessment, remediation, testing and contingency planning. The following categories represent the mission-critical operational systems of the Company. A "mission-critical system" is a system that is vital to the successful continuation of a core business activity. An application may be mission critical if it interfaces with a designated mission-critical system. Each system has been evaluated by the Company as to (a) the risks to the Company in the event of the most reasonably likely worst case scenario (the "Worst Case Scenario"); (b) the status of the Company's remediation plan, if any ("Status"); and (c) the Company's contingency plans, if any ("Contingency Plans"). ACCOUNTING SOFTWARE SYSTEMS. The Company relies solely on certain software accounting packages ("Accounting Packages") to provide management with various reports that allow managers to determine the cash flow and profitability of individual properties and of the Company as a whole. Management also relies on the Accounting Packages to provide financial information necessary to prepare quarterly and annual financial reports that are sent to the Securities and Exchange Commission, NASDAQ Stock Market, banks and stockholders. In addition, the Company relies on the Accounting Packages to process and print checks to be sent to working and royalty interest owners for their share of the monthly oil and gas sales, to process and print checks for payment to vendors and to process and print monthly joint-interest statements to be sent to working interest owners in Company-operated oil and gas properties. Under a Worst Case Scenario, all accounting functions would have to be completed manually, significantly hindering the Company's ability to complete the above-described mission-critical tasks. Status: The Company has updated its accounting systems. Testing was completed on June 30, 1999 and all primary functions utilizing dates functioned properly. Contingency Plans: Based on the results of the independent testing of the Accounting Software System, the Y2K Team believes the risk of the Accounting Software System being adversely affected by Y2K is remote. If the Accounting Software System is adversely affected by Y2K, the Company 23 has developed various contingency plans which include the utilization of support personnel and the performance of manual tasks. CONTROL SYSTEMS AND IMBEDDED TECHNOLOGY. These systems include the equipment used to produce, monitor, control, sell and record hydrocarbon production, including all artificial lift equipment, storage, measurement and control facilities and third-party systems and technology interrelated to the Company's business. Under a Worst Case Scenario, multiple fields of oil and gas would lose the ability to account for or produce the amount of hydrocarbon production, temporarily shutting down the field(s) until the malfunctioning part(s) could be repaired or replaced. This is not expected to materially adversely affect the Company. Status: The only mission-critical field operated by the Company is the Spivey Field, whose production operations are not affected by Y2K issues. The Spivey Field is affected by a third-party operated gas plant that processes the field's natural gas and may be subject to Y2K issues. Refer to "Third Party Systems-Gas Plant" for a discussion of the gas plant at the Spivey Field. The operations of the remaining fields were not materially affected by Y2K issues. Contingency Plans: The Company will continue to monitor the operations at its field locations and develop contingency planning if an exposure becomes apparent. THIRD-PARTY SYSTEMS--OIL AND GAS PURCHASERS. The Company utilizes third-party purchasers to sell the oil and gas produced from the wells in which it has a working or royalty interest. The Company also depends on third-party purchasers to remit to the Company its share of the proceeds from the sales of oil and gas. The Company does not directly sell any oil and gas produced from the wells in which it has a working or royalty interest and does not take any oil or gas in kind as an alternative to cash payment. Under a Worst Case Scenario, multiple major purchasers would be temporarily shut down due to Y2K issues, materially adversely affecting the Company's revenues. Status: Based upon the diversity of purchasers, the Company believes that no single purchaser is a mission-critical purchaser. The Y2K team does not anticipate that a problem with any single purchaser for a reasonable period of time beyond 2000 will force the Company to curtail or shut down its operations. Although no single purchaser is a mission-critical purchaser, the loss of a major purchaser or multiple minor purchasers due to Y2K problems would affect the Company. The Company has obtained information about the top ten purchasers and their Y2K readiness. All but two of the top ten purchasers have formal Y2K Plans and are working to upgrade any mission-critical systems that are affected by Y2K. The other two purchasers acknowledge that certain systems will be affected by Y2K and have been undertaking plans to upgrade these systems. Contingency Plans: The Company continues to monitor the Y2K status of its major purchasers. Should a purchaser not become Y2K compliant, the Company will identify alternative purchasers for its production and, if necessary, temporarily shut-in production. THIRD-PARTY SYSTEMS--GAS PLANT. Over 95% of the gas produced in the Spivey Field, a mission-critical system, is sold to a gas plant under a life of the lease casinghead tailgate gas contract. The Company owns approximately 11.5% of the gas plant and related gathering system. Colt Resources Corporation operates the plant. Under a Worst Case Scenario, the gas plant would be shut down less than one month which would not materially adversely affect the Company. Status: The Company has received a letter from the operator of the Spivey plant stating that the Spivey plant's control systems and embedded technology are not Y2K affected and that its accounting and processing systems are Y2K compliant. Contingency Plans: A short-term interruption of gas sales would not materially affect the Company's operations. If the Spivey plant experiences problems with an expected duration in excess of one month, the Company has identified alternative gas markets it could utilize. 24 THIRD-PARTY SYSTEMS--BANKING. The Company relies on its banks to deposit checks payable to the Company and credit the checks to the appropriate accounts. The Company also relies on its banks to credit third-party accounts for payment. A Worst Case Scenario would occur if the Company's principal bank is unable to provide certain services for an extended period of time due to Y2K, causing the Company to be materially adversely affected. Status: The Company's principal bank has represented that it has a formal Y2K Plan in effect and has substantially remediated and tested all of its non-compliant, in-house and vendor-supported mission-critical systems as of June 30, 1999. Contingency Plans: The Company intends to have cash on hand sufficient to cover short-term emergency payments and payroll. The Company also plans to open accounts with other institutions in the event its principal bank is unable to rectify its problems in a timely manner. The Company has no long-term contingency plans in the event of a system-wide failure of banking institutions. THIRD-PARTY SYSTEMS--SUPPORT FUNCTIONS. The primary material support functions provided by third parties are electrical service, communication service and office space. Under a Worst Case Scenario, all primary support functions would be hindered in the short term. Status: All vendors of these services have reported that formal Y2K remediation plans are in effect and are substantially complete as of September 30, 1999. Contingency Plans: Short-term (less than two weeks) interruptions of services will not materially adversely affect the Company. The Company will be able to conduct business on a reduced scale using alternative business methods. Longer-term interruptions may materially adversely affect the Company. The Company has no plans sufficient to fully offset the effect of long-term interruptions. COMPUTER OPERATING SYSTEMS AND APPLICATION SOFTWARE SYSTEMS. The Company relies solely on its personal computer systems to access the accounting software package through the Company's computer network. In addition, certain schedules and databases that are used for critical functions rely on spreadsheet and word-processing applications that are run on the Company's personal computer systems. Status: All systems appear to be Y2K ready. Contingency Plans: Operations could be performed manually until non-functioning equipment or software is repaired or replaced COSTS OF Y2K COMPLIANCE The costs incurred by the Company to implement the Plan were not material to the Company's financial condition or results of operations. The Company does not expect any future costs related to the Plan to be material to the Company's financial condition or results of operations. THE RISKS OF Y2K ISSUES The Company presently believes that Y2K issues will not pose significant operational problems. However, if all significant Y2K issues are not properly identified or assessed, remediation and testing are not effected timely, the Y2K issues, either individually or in combination, may materially and adversely impact the Company's results of operations, liquidity and financial condition or materially and adversely affect its relationships with its business partners. Additionally, the misrepresentation of compliance by other entities or the persistent, universal failure of financial, transportation or other economic systems will likely have a material and adverse impact on the Company's operations or financial condition for which it cannot adequately prepare. 25 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On July 19, 1999 a proxy was mailed to shareholders of record on July 12, 1999 soliciting their vote at the Annual Meeting of Shareholders of the Company on August 10, 1999. The following matters were submitted to a vote of shareholders (Shares Eligible to Vote on All Matters: 8,534,057): 1. Election of Directors Messrs. Edward P. Turner, Jr., John J. Bassett, Frank E. Bolling, Jr., C.J. Lett, III, Stephen W. Herod, Alvin V. Shoemaker and Gary R. Christopher were elected to serve on the Board of Directors until the next Annual Meeting of Shareholders.
WITHHELD FOR AUTHORITY --------- --------- John J. Bassett......................................... 7,289,621 5,031 C. J. Lett, III......................................... 7,289,521 5,131 Stephen W. Herod........................................ 7,289,621 5,031 Edward P. Turner, Jr.................................... 7,289,521 5,131 Frank E. Bolling, Jr.................................... 7,289,521 5,131 Alvin V. Shoemaker...................................... 7,289,521 5,131 Gary R. Christopher..................................... 7,289,621 5,031
2. Amendment to increase the authorized capital stock of the Company from 20,000,000 to 40,000,000 shares of common stock and from 10,000,000 to 20,000,000 shares preferred stock. The increase in the authorized capital stock of the Company to 40,000,000 common shares and 20,000,000 preferred shares was approved. For Against Abstain 7,094,278 11,123 1,954
3. Ratification of issuance of Series C Preferred Stock in connection with the acquisition by the Company of the oil and gas properties of Enex Consolidated Partners, L.P. The ratification of the issuance of the Series C Preferred Stock was approved. For Against Abstain 7,098,597 5,785 2,973
4. Consideration of and voting upon the approval of a Securities Purchase Agreement with 3TEC Energy Corporation and the issuance of 4,755,556 shares of common stock, 5-year warrants to purchase 3,600,000 shares of common stock and a 5-year $10,700,000 subordinated convertible promissory note. The issuance of the common stock, warrants and convertible note was approved. For Against Abstain 7,101,576 2,826 2,973
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following documents are filed as exhibits to this report: 3.1 Articles of Incorporation (Incorporated by reference to Exhibits to Registration Statement on Form S-4 filed October 4, 1993.)
26 3.2 Articles of Amendment to Articles of Incorporation reflecting reverse split (Incorporated by reference to Exhibits to definitive Proxy Statement filed February 15, 1995.) 3.3 Articles of Amendment to Articles of Incorporation designating preferences and rights of Series A Preferred Stock (Incorporated by reference to Exhibits to Form 8-K filed July 3, 1997.) 3.4 Articles of Amendment to Articles of Incorporation designating preferences and rights of Series B Preferred Stock (Incorporated by reference to Form 8-K filed July 3, 1997.) 3.5 Articles of Amendment to Amended Articles of Incorporation increasing the number of authorized shares (Incorporated by reference to Exhibits to definitive Proxy Statement filed July 19, 1999.) 3.6 Bylaws of the Company (Incorporated by reference to Exhibits to Registration Statement on Form S-4 filed October 4, 1993.) 3.7 Articles of Amendment to Articles of Incorporation designating preferences and rights of Series C Preferred Stock (Incorporated by reference to Exhibits to Amendment No. 1 to Form S-4 filed October 19, 1998.) 10.1 Securities Purchase Agreement, dated July 1, 1999 by and between the Company and 3TEC Energy Corporation (Incorporated by reference to Exhibits to definitive Proxy Statement filed July 19, 1999.) 10.2 Securities Purchase Agreement, dated August 27, 1999 by and between the Company and Shoemaker Family Partners, LP 10.3 Securities Purchase Agreement, dated August 27, 1999 by and between the Company and Shoeinvest II, LP 10.4 Securities Purchase Agreement, dated October 19, 1999 between The Prudential Insurance Company of America and the Company (Incorporated by reference to Exhibits to Form 8-K filed November 2, 1999.) 10.5 Shareholders Agreement, dated August 27, 1999 by and among the Company, 3TEC Energy Corporation and the Major Shareholders 10.6 Registration Rights Agreement, dated August 27, 1999 by and among the Company, 3TEC Energy Corporation, the Major Shareholders, Shoemaker Family Partners, LP and Shoeinvest II, LP 10.7 Amendment to Registration Rights Agreement, dated October 19, 1999 by and among the Company, 3TEC Energy Company L.L.C., f/k/a 3TEC Energy Corporation, Shoemaker Family Partners, LP, Shoeinvest II, LP, and The Prudential Insurance Company of America (Incorporated by reference to Exhibits to Form 8-K filed November 2, 1999.) 10.8 Participation Rights Agreement, dated October 19, 1999 by and among the Company, The Prudential Insurance Company of America and 3TEC Energy Company L.L.C. (Incorporated by reference to Exhibits to Form 8-K filed November 2, 1999.) 10.9 Employment Agreement, dated August 27, 1999 by and between Floyd C. Wilson and the Company 10.10 Employment Agreement, dated August 27, 1999 by and between John J. Bassett and the Company 10.11 Credit Agreement, dated March 27, 1998 by and among the Company, Compass Bank, and Bank of Oklahoma, National Association
27 10.12 First Amendment to Credit Agreement, dated August 27, 1999 by and among the Company, Compass Bank, and Bank of Oklahoma, National Association 10.13 Second Amendment to Credit Agreement, dated October 19, 1999 by and among the Company, Compass Bank, and Bank of Oklahoma, National Association 10.14 Subordination Agreement, dated August 27, 1999 by and between 3TEC Energy Corporation, Compass Bank, and Bank of Oklahoma, National Association 10.15 Subordination Agreement, dated August 27, 1999 by and among Shoemaker Family Partners, LP, Compass Bank, and Bank of Oklahoma, National Association 10.16 Subordination Agreement, dated August 27, 1999 by and among Shoeinvest II, LP, Compass Bank, and Bank of Oklahoma, National Association 27.1* Financial Data Schedule
- ------------------------ * Filed herewith (b) On July 16, 1999, the Company filed a Form 8-K under Item 1 describing the securities purchase agreement between the Company and 3TEC Energy Corporation that was executed on July 1, 1999. On September 8, 1999, the Company filed a Form 8-K under Item 1 describing the final securities purchase agreement and the closing of the transaction on August 27, 1999. 28 SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 3TEC ENERGY CORPORATION (Registrant) By: /s/ FRANK C. TURNER II ----------------------------------------- Frank C. Turner II Date: December 28, 1999 CHIEF FINANCIAL OFFICER
29 EX-27 2 EXHIBIT 27
5 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 25,076,465 0 2,716,165 0 0 27,883,197 81,648,100 (35,425,362) 74,743,810 7,699,604 35,026,249 0 8,862,083 48,404,967 (26,433,735) 74,743,810 11,328,502 12,967,332 4,450,843 17,405,363 0 0 1,739,362 (4,397,803) (1,242,324) (3,583,988) 0 0 0 (3,583,988) (0.39) (0.39)
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