-----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, L+dooIS+yJoVqOmtIWfPpAC2m/cRtLPLhdO023hhL4r9uqwYFOX6BOY+4vc3Af3V WQ59aWuxFxP6rPbtBi4fNg== 0000930661-00-000925.txt : 20000413 0000930661-00-000925.hdr.sgml : 20000413 ACCESSION NUMBER: 0000930661-00-000925 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000412 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TITAN EXPLORATION INC CENTRAL INDEX KEY: 0001024645 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 752671582 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-21843 FILM NUMBER: 599143 BUSINESS ADDRESS: STREET 1: 500 W TEXAS AVE STREET 2: STE 200 CITY: MIDLAND STATE: TX ZIP: 79701 BUSINESS PHONE: 9154988600 MAIL ADDRESS: STREET 1: 500 W TEXAS AVE STREET 2: SUITE 200 CITY: MIDLAND STATE: TX ZIP: 79701 10-K/A 1 FORM 10-K/A ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _________________________ FORM 10-K/A-1 _________________________ (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to _____________ Commission file number: 000-21843 TITAN EXPLORATION, INC. (Exact name of Registrant as Specified in its Charter) Delaware 75-2671582 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 500 West Texas, Suite 200 79701 Midland, Texas (Zip Code) (Address of principal executive offices) (915) 498-8600 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered ----------------------- ---------------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value Participating Preferred Stock Purchase Right (Title of Class) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ - Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] As of March 9, 2000, the Registrant had outstanding 40,189,843 shares of Common Stock. The aggregate market value of the Common Stock held by non- affiliates of the Registrant, based upon the closing sale price of the Common Stock on March 9, 2000, as reported on the Nasdaq National Market, was approximately $153,962,000. ================================================================================ TABLE OF CONTENTS -----------------
Page ---- PART I Item 1. Business.................................................................................. 2 Item 3. Legal Proceedings......................................................................... 9 PART II Item 6. Selected Financial Data.................................................................. 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 12 Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................... 27 Item 8. Financial Statements and Supplementary Data.............................................. 29 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................... 30 Glossary of Oil and Gas Terms............................................................ 34 Signatures............................................................................... 37 Index to Consolidated Financial Statements........................................................... F-1
-1- TITAN EXPLORATION, INC. 1999 ANNUAL REPORT ON FORM 10-K PART I ITEM 1. BUSINESS Titan Exploration, Inc. (the "Company" or "Titan") is an independent energy company engaged in the exploitation, development, exploration and acquisition of oil and gas properties located in the Permian Basin of West Texas and southeastern New Mexico, Brenham Dome area of south central Texas and the Central Gulf Coast region of Texas. Since our inception in March 1995, we have increased our reserves, production and cash flow through (i) the development and exploration of our properties and (ii) the acquisition of producing properties that provide exploitation, development and exploration potential. The Company is incorporated in the State of Delaware. Its principal executive offices are located at 500 West Texas, Suite 200, Midland, Texas 79701, and its telephone number is (915) 498-8600. Recent Developments On December 13, 1999, the Company announced its agreement to merge the Company and the Permian Basin business unit of Unocal Corporation ("Unocal") into a new company named Pure Resources, Inc. ("Pure Resources"). Pure Resources will be a publicly traded company. The Permian Basin business unit of Unocal includes oil and gas exploration and production assets in the Permian Basin of West Texas and the San Juan Basin in New Mexico and Colorado. Pure Resources will have approximately 50 million shares of common stock outstanding upon completion of the merger. Unocal will hold approximately 65% (32.7 million shares) of Pure Resources. The Unocal merger will cause a change of control of the Company. Upon approval by the Company stockholders of the merger, the Company stockholders will receive 0.4302314 shares of Pure Resources common stock for every share held of the Company's common stock and will collectively own approximately 35% of the outstanding common stock of Pure Resources. The Company expects that upon receiving its shareholder approval the merger would close in May 2000. Under a business opportunities agreement entered into in connection with the merger among Titan, Pure Resources and Unocal's subsidiary Union Oil Company of California ("Union Oil"), Pure Resources has agreed to limit the type and geographic scope of its business activities after the merger for as long as Union Oil is a significant stockholder and permits Union Oil to continue to conduct business activities that may compete with Pure Resources' business. The agreement's restrictions may limit Pure Resources' ability to diversify its operating base following the merger. Because of Pure Resources' geographic concentration, any regional events that increase costs, reduce availability of equipment or supplies, reduce demand or limit production may impact Pure Resources more than if its operations were more geographically diversified. For more information about the proposed merger, see definitive proxy materials relating to the merger, which the Company expects to file with the SEC in late April 1999. Management of Pure Resources will include all former officers of the Company plus the addition of (1) Jack Rathbone as Executive Vice President - Operations and (2) Gary Dupriest as Vice President - Production. Jack Rathbone was previously the President of Mobil Producing Texas and New Mexico and has recently become an officer of the Company. Gary Dupriest is currently the Vice President of the Permian Basin business unit for Unocal and will join Pure Resources upon consummation of the merger. The board of directors of Pure Resources will be Jack D. Hightower, George G. Staley and Herbert C. Williamson, III, who are all current directors of the Company, plus Timothy H. Ling, Darrell Chessum, Graydon H. Laughbaum, Jr. and HD Maxwell, who are all designees of Unocal, and one director who satisfies the outside director requirements of the New York Stock Exchange and whom Union Oil and Mr. Hightower agree upon. In November 1999, the Company acquired, for approximately $10 million, proved properties, prospect acreage and approximately 500 square miles of proprietary 3-D geophysical data in the Central Gulf Coast region of Jackson, Victoria, Wharton and Colorado counties in Texas. The properties were acquired to allow the Company exposure to the Expanded Yegua, Frio and Deep Wilcox Trend plays. Through December 31, 1999 the Company participated in the drilling of four exploratory wells on its acreage, of which three were successful. -2- Overview The Company's strategy is to grow reserves, production and net income per share by: . identifying acquisition opportunities that provide significant development and exploratory drilling potential, . exploiting and developing its reserve base, . pursuing exploration opportunities for oil and gas reserves, . capitalizing on advanced technology to identify, explore and exploit projects, and . emphasizing a low overhead and operating cost structure. As of December 31, 1999, the Company estimated net proved reserves of approximately 31.8 MMBbls of oil and 244.7 Bcf of natural gas, or an aggregate of 435.7 Bcfe with a PV-10 of $412.7 million. Approximately 65% of these reserves were classified as proved developed. The Company acquired, explored for and developed its reserves for an average reserve replacement cost of approximately $.74 per Mcfe from inception of the Company through December 31, 1999. The Company prefers to acquire properties over which it can exercise operating control. As of December 31, 1999, the Company operated 819 gross productive wells (718 net productive wells) and these operated properties represented approximately 71% of its proved developed PV-10 and 76% of the Company's PV-10 attributable to total proved reserves as of such date. The Company's emphasis on controlling the operation of its properties enables the Company to better manage expenses, capital allocation and other aspects of development and exploration. The Company's proved oil and gas properties are located in more than 70 fields/areas in the Permian Basin, Brenham Dome area and Central Gulf Coast region. Approximately 74% of the Company's PV-10 of total proved reserves is concentrated in 13 principal fields/areas located in the Permian Basin. The Permian Basin is characterized by complex geology with numerous known producing horizons and provides significant opportunities to increase reserves, production and ultimate recoveries through development, exploratory and horizontal drilling, recompletions, secondary and tertiary recovery methods, and use of 3-D seismic and other advanced technologies. Acquisitions The Company's strategy is to make acquisitions with exploitation potential. The following paragraphs outline the Company's acquisition practices and its significant acquisitions since the inception of the Company. The Company believes the merger with the Permian Basin business unit of Unocal is in keeping with its growth and acquisition strategy. In December 1995, the Company acquired a concentrated group of Permian Basin producing oil and gas properties from a large independent company for a purchase price of approximately $41.0 million (the "1995 Acquisition"). On October 31, 1996, the Company acquired additional Permian Basin producing properties from a major integrated company for a purchase price of approximately $136.0 million (the "1996 Acquisition"). In December 1997, the Company issued 5,486,734 shares of Common Stock in connection with its acquisition of all of the issued and outstanding shares of common stock of Offshore Energy Development Corporation ("OEDC"), an independent energy company that focused on the acquisition, exploration, development and production of natural gas and on natural gas gathering, processing and marketing activities (the "OEDC Acquisition"). OEDC's integrated operations were conducted in the Gulf of Mexico, where OEDC had an interest in 24 lease blocks, all of which were operated by OEDC. In December 1997, the Company issued 899,965 shares of Common Stock in connection with its acquisition of all of the issued and outstanding units of membership interests in Carrollton Resources, L.L.C., a small independent -3- energy company that was engaged in the exploration, development and acquisition of onshore oil and gas properties that were located primarily in the Gulf Coast region (the "Carrollton Acquisition"). In December 1997, the Company completed the acquisition of certain oil and gas producing properties from Pioneer Natural Resources USA, Inc., a wholly-owned subsidiary of Pioneer Natural Resources Company ("Pioneer"), for a purchase price of approximately $55.8 million (the "Pioneer Acquisition"). The Company regularly pursues and evaluates acquisition opportunities (including opportunities to acquire oil and gas properties or related assets or entities owning oil and gas properties or related assets and opportunities to engage in mergers, consolidations or other business combinations with entities owning oil and gas properties or related assets) and at any given time may be in various stages of evaluating these opportunities. These stages may take the form of internal financial and oil and gas property analysis, preliminary due diligence, the submission of an indication of interest, preliminary negotiations, negotiation of a letter of intent, or negotiation of a definitive agreement. While the Company is currently evaluating a number of potential acquisition opportunities (some of which would be material in size to the Company), it has not signed a letter of intent with respect to any material acquisition and currently has no assurance of completing any particular material acquisition or of entering into negotiations with respect to any particular material acquisition. Oil and Gas Marketing and Major Customers The revenues generated by the Company's operations are highly dependent upon the prices of, and demand for, oil and gas. The price received by the Company for its oil and gas production depends on numerous factors beyond the Company's control including seasonality; the condition of the United States and world economies, particularly the manufacturing sector; foreign imports; political and economic conditions in other oil-producing and gas-producing countries; the actions of OPEC and domestic government regulation, legislation and policies. Decreases in the prices of oil and natural gas could have a material adverse effect on the carrying value of the Company's proved reserves and the Company's revenues, profitability and cash flow. Although the Company is not currently experiencing any significant involuntary curtailment of its oil or gas production, market, economic and regulatory factors may in the future materially affect the Company's ability to sell its oil or gas production. During 1999, sales to Enron Corp., and its subsidiaries and affiliates and Dynegy Inc. were approximately 36% and 16% of the Company's oil and gas revenues, respectively. Due to the availability of other markets and pipeline connections, the Company does not believe that the loss of any single crude oil or gas customer would have a material adverse effect on the Company's results of operations. Competition The oil and gas industry is highly competitive. The Company encounters competition from other oil and gas companies in all areas of its operations, including the acquisition of producing properties. The Company's competitors include major integrated oil and gas companies and numerous independent oil and gas companies, individuals and drilling and income programs. Many of its competitors are large, well established companies with substantially larger operating staffs and greater capital resources than the Company and which, in many instances, have been engaged in the energy business for a much longer time than the Company. Such companies may be able to pay more for productive oil and gas properties and exploratory prospects and to define, evaluate, bid for and purchase a greater number of properties and prospects than the Company's financial or human resources permit. The Company's ability to acquire additional properties and to discover reserves in the future will be dependent upon its ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. -4- Operating Hazards and Uninsured Risks Drilling activities are subject to many risks, including the risk that no commercially productive reservoirs will be encountered. There can be no assurance that new wells drilled by the Company will be productive or that the Company will recover all or any portion of its investment. Drilling for oil and gas may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain. The Company's drilling operations may be curtailed, delayed or canceled as a result of numerous factors, many of which are beyond the Company's control, including title problems, weather conditions, mechanical problems, compliance with governmental requirements and shortages or delays in the delivery of equipment and services. The Company's future drilling activities may not be successful and, if unsuccessful, such failure may have a material adverse effect on the Company's future results of operations and financial condition. In addition, the Company's use of 3-D seismic requires greater pre-drilling expenditures than traditional drilling strategies. Although the Company believes that its use of 3-D seismic will increase the probability of success of its exploratory wells and should reduce average finding costs through the elimination of prospects that might otherwise be drilled solely on the basis of 2-D seismic data and other traditional methods, unsuccessful wells are likely to occur. There can be no assurance that the Company's drilling program will be successful or that unsuccessful drilling efforts will not have a material adverse effect on the Company. Although the Company has identified numerous potential drilling locations, there can be no assurance that such locations will ever be drilled upon or that oil or gas will be produced from them. The Company's operations are subject to hazards and risks inherent in drilling for and producing and transporting oil and gas such as fires, natural disasters, explosions, encountering formations with abnormal pressures, blowouts, cratering, pipeline ruptures and spills. Any of the preceding risks can result in the loss of hydrocarbons, environmental pollution, personal injury claims and other damage to properties of the Company and others. The Company's offshore operations are also subject to the additional hazards of marine operations such as severe weather, capsizing and collision. The Company expects to drill a number of deep vertical and horizontal wells in the future. The Company's deep and/or horizontal drilling activities involve greater risk of mechanical problems than other type drilling operations. These wells may be significantly more expensive to drill than those drilled to date. The Company maintains insurance against some, but not all, of the risks described above. The Company may elect to self-insure in circumstances in which management believes that the cost of insurance, although available, is excessive relative to the risks presented. The occurrence of an event that is not covered, or not fully covered, by insurance could have a material adverse effect on the Company's financial condition and results of operations. Employees As of December 31, 1999, the Company had 76 full-time employees, none of whom is represented by a labor union. Included in the total were 29 administrative employees located in the Company's office in Midland, Texas, ten of whom are involved in the management of the Company. The Company considers its relations with its employees to be good. Office Facilities The Company currently leases approximately 50,937 square feet of office space in Midland, Texas, where its principal offices are located. This office lease is on an arms-length basis with an affiliate of Jack Hightower. The Company's principal offices are leased through March 15, 2002. -5- Title to Properties The Company received title opinions relating to properties representing 80% of the PV-10 of the 1995 Acquisition, 90% of the PV-10 of the 1996 Acquisition and 54% of the PV-10 of the Pioneer Acquisition. The Company's land department and contract land professionals have reviewed title records of substantially all its producing properties. The title investigation performed by the Company prior to acquiring undeveloped properties is thorough but less rigorous than that conducted prior to drilling, consistent with industry standards. The Company believes it has satisfactory title to all of its producing properties in accordance with standards generally accepted in the oil and gas industry. The Company's properties are subject to customary royalty interests, liens incident to operating agreements, liens for current taxes and other burdens which the Company believes do not materially interfere with the use of or affect the value of such properties. The Company's Credit Agreement is secured by a first lien on properties that represented at least 80% of the value of the Company's proved oil and gas properties (based on PV-10 as of December 31, 1999). Presently, the Company keeps in force its leaseholds for 18% of its net acreage by virtue of production on that acreage in paying quantities. The remaining acreage is held by lease rentals and similar provisions and requires production in paying quantities prior to expiration of various time periods to avoid lease termination. Governmental Regulation The Company's oil and gas exploration, production and related operations are subject to extensive rules and regulations promulgated by federal and state agencies. Failure to comply with such rules and regulations can result in substantial penalties. The regulatory burden on the oil and gas industry increases the Company's cost of doing business and affects its profitability. Although the Company believes it is in substantial compliance with all applicable laws and regulations, because such rules and regulations are frequently amended or reinterpreted, the Company is unable to predict the future cost or impact of complying with such laws. Significant expenditures may be required to comply with governmental laws and regulations and may have a material adverse effect on the Company's financial condition and results of operations. Such regulation requires permits for drilling operations, drilling bonds and reports concerning operations and imposes other requirements relating to the exploration and production of oil and gas. Such state and federal agencies have statutes or regulations addressing conservation matters, including provisions for the unitization or pooling of oil and gas properties, the establishment of maximum rates of production from wells, and the regulation of spacing, plugging and abandonment of such wells. The Federal Energy Regulatory Commission ("FERC") regulates interstate natural gas transportation rates and service conditions, which affect the marketing of gas produced by the Company, as well as the revenues received by the Company for sales of such production. Since the mid-1980s, FERC has issued a series of orders, culminating in Order Nos. 636, 636-A and 636-B ("Order 636"), that have significantly altered the marketing and transportation of gas. Order 636 mandated a fundamental restructuring of interstate pipeline sales and transportation service, including the unbundling by interstate pipelines of the sale, transportation, storage and other components of the city-gate sales services such pipelines previously performed. One of FERC's purposes in issuing the orders is to increase competition within all phases of the gas industry. The United States Court of Appeals for the District of Columbia Circuit largely upheld Order 636, and the Supreme Court has declined to hear the appeal. Generally, Order 636 has eliminated or substantially reduced the interstate pipelines' traditional role as wholesalers of natural gas, and has substantially increased competition and volatility in natural gas markets. The price the Company receives from the sale of oil and natural gas liquids is affected by, among other things, the cost of transporting products to market. Effective January 1, 1995, FERC implemented regulations establishing an indexing system for transportation rates for oil pipelines, which, generally, would index such rates to inflation, subject to certain conditions and limitations. The Company is not able to predict with certainty the effect, if any, of these regulations on its operations. However, the regulations may increase transportation costs or reduce wellhead prices for oil and natural gas liquids. -6- Environmental Matters The Company's operations and properties are subject to extensive and changing federal, state and local laws and regulations relating to environmental protection including the generation, storage, handling, emission, transportation and discharge of materials into the environment, and their relation to safety and health. The recent trend in environmental legislation and regulation generally is moving toward stricter standards, and this trend will likely continue. These laws and regulations may require the acquisition of a permit or other authorization before construction or drilling commences and for certain other activities; limit or prohibit construction, drilling and other activities on certain lands lying within wilderness and other protected areas; and impose substantial liabilities for pollution resulting from the Company's operations. The permits required for various operations of the Company are subject to revocation, modification and renewal by issuing authorities. Governmental authorities have the power to enforce compliance with their regulations, and violators are subject to fines or injunction, or both. In the opinion of management, the Company is in substantial compliance with current applicable environmental laws and regulations, and the Company has no material commitments for capital expenditures to comply with existing environmental requirements. Nevertheless, changes in existing environmental laws and regulations or in interpretations thereof could have a significant material impact on the Company, as well as the oil and gas industry in general. The Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and comparable state statutes impose strict, joint and several liability on owners and operators of sites and on persons who disposed of or arranged for the disposal of "hazardous substances" found at such sites. It is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. Resource Conservation and Recovery Act ("RCRA") and comparable state statutes govern the disposal of "solid waste" and "hazardous waste" and authorize the imposition of substantial fines and penalties for noncompliance. Although CERCLA currently excludes petroleum from its definition of "hazardous substance," state laws affecting the Company's operations impose clean-up liability relating to petroleum and petroleum related products. In addition, although RCRA classifies certain oil field wastes as "nonhazardous," such exploration and production wastes could be reclassified as hazardous wastes thereby making such wastes subject to more stringent handling and disposal requirements. Federal regulations require certain owners or operators of facilities that store or otherwise handle oil, such as the Company, to prepare and implement spill prevention, control countermeasure and response plans relating to the possible discharge of oil into surface waters. The Oil Pollution Act of 1990, as amended ("OPA"), contains numerous requirements relating to the prevention of and response to oil spills into waters of the United States. For onshore facilities that may affect waters of the United States, the OPA requires an operator to demonstrate $10 million in financial responsibility. In addition, the OPA currently requires persons responsible for "offshore facilities" to establish $150 million in financial responsibility to cover environmental cleanup and restoration costs likely to be incurred in connection with an oil spill in the waters of the United States. On September 10, 1996, Congress passed legislation that would lower the financial responsibility requirement under OPA to $35 million, subject to an increase of $150 million if a formal risk assessment indicates the increase is warranted. The impact of any legislation is not expected to be any more burdensome to the Company than it will be to other similarly situated companies involved in oil and gas exploration and production. OPA imposes a variety of additional requirements on "responsible parties" for vessels or oil and gas facilities related to the prevention of oil spills and liability for damages resulting from such spills in waters of the United States. The responsible parties include the owner or operator of an onshore facility, pipeline, or vessel or the lessee or permittee of the area in which an offshore facility is located. OPA assigns liability to each responsible party for oil spill removal costs and a variety of public and private damages from oil spills. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill is caused by gross negligence or willful misconduct or resulted from violation of a federal safety, construction or operating regulation. If a party fails to report a spill or to cooperate fully in the cleanup, liability limits likewise do not apply. OPA establishes a liability limit for offshore facilities (including pipelines) of all removal costs plus $75 million. Few defenses exist to the liability for oil spills imposed by OPA. OPA also imposes other requirements on facility operators, such as the preparation of an oil spill contingency plan. Failure to comply with ongoing requirements or inadequate cooperation in a spill event may subject a responsible party to civil or criminal enforcement actions. In addition, the Outer Continental Shelf Lands Act ("OCSLA") authorizes regulations relating to safety and environmental protection applicable to lessees and permittees operating in the Outer Continental Shelf ("OCS"). -7- Specific design and operational standards may apply to OCS vessels, rigs, platforms, pipelines, vehicles and structures. Violations of lease conditions or regulations issued pursuant to OCSLA can result in substantial civil and criminal penalties, as well as potential court injunctions curtailing operations and the cancellation of leases. Such enforcement liabilities can result from either governmental or private prosecution. The Federal Water Pollution Control Act ("FWPCA") imposes restrictions and strict controls regarding the discharge of produced waters and other oil and gas wastes into navigable waters. Permits must be obtained to discharge pollutants into state and federal waters. The FWPCA and analogous state laws provide for civil, criminal and administrative penalties for any unauthorized discharges of oil and other hazardous substances in reportable quantities and, along with the OPA, may impose substantial potential liability for the costs of removal, remediation and damages. State water discharge regulations and the federal National Pollutant Discharge Elimination System ("NPDES") permits prohibit, or are expected to prohibit within the next year, the discharge of produced water and sand, and some other substances related to the oil and gas industry, into coastal waters. Although the costs to comply with zero discharge mandates under federal or state law may be significant, the entire industry will experience similar costs and the Company believes that these costs will not have a material adverse impact on the Company's financial conditions and operations. Some oil and gas exploration and production facilities are required to obtain permits for their storm water discharges. Costs may be incurred in connection with treatment of wastewater or developing storm water pollution prevention plans. Regulations are currently being developed under federal and state laws concerning oil pollution prevention and other matters that may impose additional regulatory burdens on the Company. In addition, the Clean Water Act and analogous state laws require permits to be obtained to authorize discharge into surface waters or to construct facilities in wetland areas. With respect to certain of its operations, the Company is required to maintain such permits or meet general permit requirements. The Environmental Protection Agency ("EPA") recently adopted regulations concerning discharges of storm water runoff. This program requires covered facilities to obtain individual permits, participate in a group or seek coverage under an EPA general permit. The Company believes that it will be able to obtain, or be included under, such permits, where necessary, and to make minor modifications to existing facilities and operations that would not have a material effect on the Company. The implementation of new, or the modification of existing, laws or regulations could have a material adverse effect on the Company. The discharge of oil, gas or other pollutants into the air, soil or water may give rise to significant liabilities on the part of the Company to the government and third parties and may require the Company to incur substantial costs of remediation. Moreover, the Company has agreed to indemnify sellers of producing properties purchased in each of its substantial acquisitions against environmental claims associated with such properties. No assurance can be given that existing environmental laws or regulations, as currently interpreted or reinterpreted in the future, or future laws or regulations will not materially adversely affect the Company's results of operations and financial condition or that material indemnity claims will not arise against the Company with respect to properties acquired by the Company. The Company has acquired leasehold interests in numerous properties that for many years have produced oil and gas. Although the previous owners of these interests may have used operating and disposal practices that were standard in the industry at the time, hydrocarbons or other wastes may have been disposed of or released on or under the properties. In addition, some of the Company's properties are operated by third parties over whom the Company has no control. Notwithstanding the Company's lack of control over properties operated by others, the failure of the operator to comply with applicable environmental regulations may, in certain circumstances, materially adversely impact the Company. Abandonment Costs The Company is responsible for payment of plugging and abandonment costs on the oil and gas properties pro rata to its working interest. Based on its experience, with the exception of offshore oil and gas properties, the Company anticipates that the ultimate aggregate salvage value of lease and well equipment located on its properties will exceed the costs of abandoning such properties. There can be no assurance, however, that the Company will be successful in avoiding additional expenses in connection with the abandonment of any of its properties. In addition, abandonment costs and their timing may change due to many factors including actual production results, inflation rates and changes in environmental laws and regulations. -8- ITEM 3. LEGAL PROCEEDINGS OEDC and certain of its officers and directors, as well as Natural Gas Partners, L.P. ("NGP"), the managing underwriters of OEDC's initial public offering and an analyst from each of the managing underwriters, were named as defendants in a suit styled Eric Baron and Edward C. Allen, On behalf of Themselves and all Others Similarly Situated, v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P., David Garcia, John J. Myers, Offshore Energy Development Corporation, Morgan Keegan & Company, Inc. and Principal Securities Inc., which was filed October 20, 1997, in the Texas State District Court of Harris County, Texas, 270/th/ Judicial District and subsequently removed to federal court in the United States Southern District of Texas. OEDC and certain of its officers and directors, as well as NGP, were also named defendants in a suit styled John W. Robertson, et al. v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P. and Offshore Energy Development Corporation, which was filed February 6, 1998, in the United States Southern District of Texas, Houston Division. The officer and director defendants in the suits were Messrs. Strassner and Kiesewetter, who were officers and directors of OEDC and who are no longer employed by Titan, and Mr. Albin, who was a director of OEDC and Titan. Mr. Albin, a manager of NGP's investment funds, resigned as a director of Titan in 1999. These matters were settled in the fourth quarter of 1999 at an expense to the Company of approximately $200,000. The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity. -9- ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and related notes included in "Item 8. Consolidated Financial Statements and Supplementary Data."
Period March 31, 1995 (date of inception) Year Ended December 31, through --------------------------------------------------------- December 31, 1999(a) 1998(b) 1997(b) 1996 (b) 1995(b) ------------- -------------- -------------- ---------- --------------------- (in thousands, except per share amounts and operating data) Consolidated Statement of Operations Data: Revenues- Operating revenues........................... $ 75,717 $ 72,876 $ 73,827 $ 23,824 $ 743 Expenses: Oil and gas production....................... 18,643 27,078 16,298 7,312 265 Production and other taxes................... 6,116 5,725 5,548 1,887 39 General and administrative................... 7,771 9,163 5,372 2,270 1,546 Amortization of stock option awards.......... 5,049 5,055 5,053 1,839 576 Exploration and abandonment.................. 11,049 17,596 3,055 184 490 Depletion, depreciation and amortization..... 19,222 27,090 19,972 5,789 299 Impairment of long-lived assets.............. 31,783 25,666 68,997 -- -- Restructuring costs.......................... -- 625 -- -- -- Interest..................................... 7,320 8,648 1,524 2,965 97 Other........................................ (2,893) (1,172) (258) (503) (1,038) -------- -------- --------- --------- -------- Total expenses.......................... 104,060 125,474 125,561 21,743 2,274 -------- -------- --------- --------- -------- Income (loss) before income taxes............ (28,343) (52,598) (51,734) 2,081 (1,531) Income tax (expense) benefit................. 20,069 5,381 18,267 (3,484) -- -------- -------- --------- --------- -------- Net loss..................................... $ (8,274) $(47,217) $ (33,467) $ (1,403) $ (1,531) ======== ======== ========= ========= ======== Net loss per common share.................... $ (.22) $ (1.22) $ (.99) $ (.07) $ (.11) Net loss per common share - assuming dilution............................ $ (.22) $ (1.22) $ (.99) $ (.07) $ (.11) Weighted average common shares outstanding............................... 38,038 38,808 33,942 19,605 14,066 Consolidated Statement of Cash Flows Data: Net cash provided by (used in): Operating activities......................... $ 33,426 $ 18,448 $ 46,563 $ 7,710 $ (1,805) Investing activities......................... 28,858 (58,413) (114,302) (144,998) (47,522) Financing activities......................... (61,584) 38,972 63,052 137,365 55,540 Other Consolidated Financial Data: Capital expenditures............................ $ 45,212 $ 63,235 $ 114,377 $ 150,119 $ 43,770 Consolidated Operating Data: Production: Oil and condensate (MBbls)...................... 2,272 2,492 1,880 714 30 Natural gas (MMcf).............................. 23,190 26,731 22,104 5,787 245 Total (MMcfe)................................... 36,822 41,683 33,385 10,071 425 Average Sales Prices Per Unit(c): Oil and condensate (per Bbl).................... $ 16.22 $ 12.05 $ 18.67 $ 19.16 $ 16.80 Natural gas (per Mcf)........................... 1.68 1.60 1.75 1.75 .97 Total (per Mcfe)................................ 2.06 1.75 2.21 2.37 1.75 Expenses per Mcfe Production costs, excluding production and other taxes.................................. $ .51 $ .65 $ .48 $ .72 $ .63 Production and other taxes...................... .17 .14 .17 .19 .09 General and administrative...................... .21 .22 .16 .23 3.64 Depletion, depreciation and amortization........ .52 .65 .60 .57 .70
-10-
December 31, -------------------------------------------------------------- 1999(a) 1998(b) 1997(b) 1996(b) 1995(b) ----------- ----------- ----------- ----------- ---------- (in thousands) Consolidated Balance Sheet Data: Cash and cash equivalents..................... $ 1,310 $ 610 $ 1,603 $ 6,290 $ 6,213 Working capital (deficit) (d)................. (3,912) 105,697 28 8,124 11,946 Oil and gas assets, net....................... 230,101 209,177 271,920 190,062 42,861 Total assets.................................. 268,798 341,022 352,583 207,179 57,487 Total debt.................................... 90,000 144,200 85,450 6,500 20,000 Stockholders' equity and predecessor capital...................................... 160,851 171,354 232,421 187,186 34,585
____________ (a) In May 1999, the Company sold its assets in the Gulf of Mexico for $71.3 million in cash. (b) Certain reclassifications have been made to the 1998, 1997, 1996 and 1995 amounts to conform to the 1999 presentation. (c) Reflects results of hedging activities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." (d) The 1998 amount includes $109.5 million of assets held for sale. -11- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unocal Merger On December 13, 1999, the Company announced its agreement to merge the Company and the Permian Basin business unit of Unocal Corporation ("Unocal") into a new company named Pure Resources, Inc. ("Pure Resources"). Pure Resources will be a publicly traded company. The Permian Basin business unit of Unocal includes oil and gas exploration and production assets in the Permian Basin of West Texas and the San Juan Basin in New Mexico and Colorado. Pure Resources will have approximately 50 million shares of common stock outstanding upon completion of the merger. Unocal will hold approximately 65% (32.7 million shares) of Pure Resources. The Unocal merger will cause a change of control of the Company. Upon approval by the Company stockholders of the merger, the Company stockholders will receive 0.4302314 shares of Pure Resources common stock for every share held of the Company's common stock and will collectively own approximately 35% of the outstanding common stock of Pure Resources. The Company expects that upon receiving its shareholder approval the merger would close in May 2000. For more information about the proposed merger, see definitive proxy materials relating to the merger, which the Company expects to file with the SEC in late April 1999. Management of Pure Resources will include all former officers of the Company plus the addition of (1) Jack Rathbone as Executive Vice President - Operations and (2) Gary Dupriest as Vice President - Production. Jack Rathbone was previously the President of Mobil Producing Texas and New Mexico and has recently become an officer of the Company. Gary Dupriest is currently the Vice President of the Permian Basin business unit for Unocal and will join Pure Resources upon consummation of the merger. The board of directors of Pure Resources will be Jack D. Hightower, George G. Staley and Herbert C. Williamson, III, who are all current directors of the Company, plus Timothy H. Ling, Darrell Chessum, Graydon H. Laughbaum, Jr. and HD Maxwell, who are all designees of Unocal, and one director who satisfies the outside director requirements of the New York Stock Exchange and whom Union Oil and Mr. Hightower agree upon. Impact on Pure Resources of Ancillary Agreements and Severance Arrangements Under a business opportunities agreement entered into in connection with the merger among Titan, Pure Resources and Union Oil, Pure Resources has agreed to limit its business activities. The agreement's restrictions may limit Pure Resources' ability to diversify its operating base following the merger. Because of Pure Resources' geographic concentration, any regional events that increase costs, reduce availability of equipment or supplies, reduce demand or limit production may impact Pure Resources more than if its operations were more geographically diversified. The aggregate amount to be paid in connection with the merger to all the covered Titan officers under existing severance and retention bonus agreements of Titan will be approximately $7.8 million. Titan does not believe that these payments will materially impact the liquidity of the combined company. Mr. Hightower's employment agreement with Pure Resources and new Pure Resources officer severance agreements to be entered into in connection with the merger will entitle each of the initial Pure Resources officers to require Pure Resources to purchase his or her Pure Resources common stock at a price that may be in excess of market value in the event of a change of control of Pure Resources or Unocal and in some circumstances following termination of employment. On December 31, 1999, when the trading price of Titan common stock was $5.44 per share, the pro forma "per share net asset value" of Pure Resources, calculated in accordance with the agreements, adjusted to a Titan equivalent price, was estimated at approximately $6.18. On a pro forma basis using a market price of $5.44 per share, Pure Resources would incur a non-cash expense of approximately $6.8 million per year for three years to amortize the deferred compensation recorded as a result of these arrangements. The amortization amounts will change quarterly based on relative changes in the net asset value and market value of the Pure Resources shares. General The Company is an independent energy company engaged in the exploitation, development, exploration and acquisition of oil and gas properties. The Company's strategy is to grow reserves, production and net income per share by: . identifying acquisition opportunities that provide significant development and exploratory drilling potential, . exploiting and developing its reserve base, . pursuing exploration opportunities for oil and gas reserves, . capitalizing on advanced technology to identify, explore and exploit projects, and . emphasizing a low overhead and operating cost structure. The Company has grown rapidly through the acquisition and exploitation of oil and gas properties, consummating the 1995 Acquisition for a purchase price of approximately $41.0 million, the 1996 Acquisition for approximately $136.0 million and the Pioneer Acquisition, in 1997, for approximately $55.8 million. In addition, the Company issued, in 1997, 5,486,734 shares and 899,965 shares of the Company's common stock in connection with the OEDC Acquisition and the Carrollton Acquisition, respectively. The Company's growth from acquisitions has impacted its financial results in a number of ways. Acquired properties may not have received focused attention prior to sale. After acquisition, certain of these properties required -12- extensive maintenance, workovers, recompletions and other remedial activity that while not constituting capital expenditures may initially increase lease operating expenses. The Company may dispose of certain of the properties it determines are outside the Company's strategic focus. The increased production and revenue resulting from the rapid growth of the Company has required it to recruit and develop operating, accounting and administrative personnel compatible with its increased size. As a result, the Company has incurred increases in its general and administrative expense levels. The Company uses the successful efforts method of accounting for its oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that result in proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not result in proved reserves and geological and geophysical costs are expensed. Costs of significant nonproducing properties, wells in the process of being drilled and significant development projects are excluded from depletion until such time as the related project is developed and proved reserves are established or impairment is determined. Impact of Commodity Oil Prices During 1998 and through the first quarter of 1999, the posted price of West Texas intermediate crude oil (the "West Texas Crude Oil Price") ranged from $15.75 to $8.00 per barrel. These low prices were thought to be caused primarily by an oversupply of crude oil inventory created, in part, by an unusually warm winter in the United States and Europe, the apparent unwillingness of Organization of Petroleum Exporting Countries ("OPEC") to abide by crude oil production quotas and a decline in demand in Asian markets. The prices for crude oil during the second through fourth quarters of 1999 have shown significant improvement over those of the previous fifteen months. A return of low prices for crude oil, natural gas or other commodities sold by the Company could have a material adverse effect on the Company's results of operations, on the quantities of crude oil and natural gas that can be economically produced from its fields, and on the quantities and economic values of its proved reserves and potential resources. Such adverse pricing scenarios could result in write-downs of the carrying values of the Company's properties and materially adversely affect the Company's financial condition, as well as its results of operations. Year 2000 Issues The Company has initially incurred no significant problems related to the Year 2000 issue. However, the Company has not yet fully utilized all functions and processes of its systems and accordingly cannot be sure that all its systems will be free of Year 2000 issues. Also, the Company has no assurance that its "critical business partners," or governmental agencies or other key third parties, have not incurred Year 2000 issues that may affect the Company. -13- Operating Data The following sets forth the Company's historical operating data:
Year ended December 31, ------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- Production: Oil and condensate (MBbls)............................... 2,272 2,492 1,880 Natural gas (MMcf)....................................... 23,190 26,731 22,104 Total (Mmcfe)............................................ 36,822 41,683 33,385 Average sales price per unit (excluding the effects of hedging): Oil and condensate (per Bbl)............................. $ 16.83 $ 11.97 $ 18.38 Natural gas (per Mcf).................................... $ 1.68 $ 1.51 $ 1.75 Total (per Mcfe)......................................... $ 2.10 $ 1.68 $ 2.19 Average sales price per unit (including the effects of hedging): Oil and condensate (per Bbl)............................. $ 16.22 $ 12.05 $ 18.67 Natural gas (per Mcf).................................... $ 1.68 $ 1.60 $ 1.75 Total (per Mcfe)......................................... $ 2.06 $ 1.75 $ 2.21 Expenses per Mcfe: Production costs, excluding production and other taxes... $ .51 $ .65 $ .48 Production and other taxes............................... $ .17 $ .14 $ .17 General and administrative............................... $ .21 $ .22 $ .16 Depletion, depreciation and amortization................. $ .52 $ .65 $ .60
Results of Operations The Company began operations on March 31, 1995. As a result of the Company's limited operating history and rapid growth, its financial statements are not readily comparable and may not be indicative of future results. The OEDC Acquisition, the Carrollton Acquisition and the Pioneer Acquisition, did not close until the end of December 1997 and, consequently, did not contribute to 1997 operating results. In May 1999, the Company sold its offshore assets acquired in the OEDC Acquisition and accordingly only 5 months of those assets' operations are reflected in the 1999 operating results. Year ended 1999 as compared to 1998 The Company's revenues from the sale of oil and gas (excluding the effects of hedging activities) were $38.2 million and $38.9 million in 1999 and $29.8 million and $40.3 million in 1998, respectively. Realized oil and gas prices increased $4.86 per Bbl and $.17 per Mcf, respectively. Excluding the production from the two significant dispositions, oil production was 2,448,000 barrels and 2,216,000 barrels and gas production was 22,935 MMcf and 21,961 MMcf in 1999 and 1998, respectively. Oil and gas production decreased 220,000 barrels and 3,541 MMcf, respectively, between years. Excluding the production from the two significant dispositions in 1999, oil and gas production decreased 232,000 barrels and 974 MMcf, respectively, between years. The decrease in the oil production is principally due to normal production declines and the Company deferring some of its 1998 projects and not budgeting significant 1999 projects due to the uncertainties over crude oil price levels earlier in the year. The decrease in gas production is partially due to normal production declines and loss and/or curtailment of production on wells due to mechanical and/or reservoir problems, offset by increased gas production from the -14- Company's recent drilling activities. The Company's hedging activities in 1999 decreased oil and gas revenues $1.4 million ($.61 per Bbl) and $72,000 ($.003 per Mcf), respectively, as compared to 1998, when hedging activities increased oil and reduced gas revenues $206,000 ($.08 per Bbl) and $2.6 million ($.09 per Mcf), respectively. At December 31, 1999, the Company had oil and gas hedges in place for approximately 1.9 million barrels and 5,475 Mcf of the Company's production through 2000 and early 2001. The hedges will allow the Company to realize, at a minimum, a price of $16.93 per barrel of oil and $2.37 per Mcf on the volumes hedged. The outstanding hedges had an estimated cost to settle of approximately $1.6 million at December 31, 1999. The Company's oil and gas production costs were $18.6 million ($.51 per Mcfe) and $27.1 million ($.65 per Mcfe) in 1999 and 1998, respectively. Excluding the production costs from the two significant dispositions in 1999, the Company's production costs would have been $17.3 million ($.49 per Mcfe) and $22.4 million ($.59 per Mcfe) in 1999 and 1998, respectively. A portion of the decrease is due to the first half of 1998 rework expenses ($.06 per Mcfe) associated with the 1997 acquisitions properties. Initially, acquired properties generally incur significant rework expenses, which are costs incurred to perform required maintenance, workovers and other remedial activities. Also, the decrease is due to the sale of properties and the Company performing only routine and necessary expenditures in certain fields early in 1999 due to depressed commodity prices. Depletion, depreciation and amortization expense (DD&A) was $19.2 million ($.52 per Mcfe) and $27.1 million ($.65 per Mcfe) in 1999 and 1998, respectively. The decrease in the absolute and per unit amounts is attributable to (a) the first three quarters of 1999 not including DD&A for the assets then classified as assets held for sale, (b) increased proved reserves, in high net book value fields, resulting from increased commodity prices and recent drilling activities and (c) the effects from the 1998 impairment. The Company recognized an impairment of $31.8 million and $25.7 million in 1999 and 1998, respectively. The 1999 impairment was comprised of (a) $25.9 million related to assets held for sale and (b) $5.9 million related to oil and gas properties. The 1999 impairment on assets held for sale was due to the write-down of the net cost of the assets held for sale based on the expected net proceeds from the sale of these assets. The 1999 impairment of oil and gas properties relates directly to one field in which proved undeveloped reserve volumes were revised downward based on new information. The 1998 impairment was comprised of (a) $22.2 million related to oil and gas properties, (b) $2.2 million related to impairment of an investment in a partnership and (c) $1.3 million related to assets held for sale. The 1998 impairment related to the oil and gas properties was primarily attributable to loss of proved reserves associated with below expectation developmental drilling results and downhole mechanical problems primarily in the Company's Gulf Coast and Gulf of Mexico regions. Estimated future cash flows for purposes of determining impairment of oil and gas properties are determined using the following assumptions: . Reserve economics are adjusted for known changes such as extensions and discoveries, acquisitions and dispositions of proved properties and changes in production rates and projected decline characteristics. . Only cash flows from proved oil and gas properties, such as disclosed in Note 22 of the consolidated financial statements are considered in the analysis. . The prices used for determining cash flows are determined based on the near-term (a period of one to three years, depending on management's current views of future market conditions) NYMEX futures index adjusted for property specific qualitative and location differentials. The latest futures price in the near-term price outlook is then held constant for the remaining life of the properties. Prices estimated for future periods may be above or below current pricing levels. For example, futures prices for periods following December 31, 1998 were significantly higher than the actual prices for oil and gas as of that date, and futures prices for the periods following December 31, 1999 were significantly below the actual prices for oil and gas as of that date. Consequently, the prices used in the Company's impairment analysis were adjusted accordingly. . If production is subject to hedges, future product prices are further adjusted to reflect the prices to be realized under these arrangements. The Company's exploration and abandonment expense was $11.0 million and $17.6 million in 1999 and 1998, respectively. The decrease is due primarily to lower impairment of unproved properties. In 1998, the Company impaired its Webb County prospect by over $9 million. Offsetting the 1998 impairment are increases in the Company's dry hole costs due to increased exploratory well activity in 1999 and increases in seismic costs primarily due to the Company's 3-D seismic shoot in the Paragon venture. -15- The Company's general and administrative expense (G&A) was $7.8 million ($.21 per Mcfe) and $9.2 million ($.22 per Mcfe) in 1999 and 1998, respectively. Excluding G&A from the two significant dispositions in 1999, the Company's G&A would have been $7.2 million ($.20 per Mcfe) and $6.9 million ($.18 per Mcfe) in 1999 and 1998, respectively. In the fourth quarter of 1998, the Company recognized a restructuring charge of $625,000. This charge related to the severance and related benefits that were provided to individuals whose positions were eliminated as a result of the planned disposition of assets in 1999. The 1999 and 1998 equity in net loss of affiliates is primarily attributable to the Company's ownership in two partnerships acquired in the OEDC Acquisition both which were included in the Gulf of Mexico disposition. Included in the equity loss is approximately $211,000 and $632,000 of amortization of the Company's cost basis in excess of the underlying historical net assets of one of the partnerships in 1999 and 1998, respectively. The Company's interest expense was $7.3 million and $8.6 million in 1999 and 1998, respectively. The decrease is due to the decrease in average debt level between years, resulting from the sale of the Gulf of Mexico properties in the second quarter of 1999. The Company's effective income tax rates were 71% and 10% for 1999 and 1998, respectively. In 1998 the Company provided a valuation allowance of $14.0 million against its deferred tax asset which was reversed in 1999. During the year ended December 31, 1999, commodity prices for the Company's products improved significantly. As a result, based on the Company's analysis of the expected future results of operations based on current prices, the associated reserve volumes and the availability of tax planning strategies (such as elective capitalization of intangible drilling costs) it does not appear more likely than not that the Company will be unable to generate the $51.6 million in taxable income necessary to utilize net operating loss carryforwards over the carryforward period. The change in the outlook for commodity prices is the major factor that changed management's view with respect to the reversal of the deferred tax asset valuation as of December 31, 1998. In addition, for the year ended December 31, 1999, the Company would have generated significant operating income if impairments were not considered. This was not the case for the year ended December 31, 1998. Future estimated revenues, net of operating expenses from proved properties as disclosed in unaudited reserve disclosures in Note 22 of the consolidated financial statements, amount to over $775 million based on current prices and costs. This net revenue, when considered together with estimated future general and administrative expenses and existing tax basis expected to be deductible in future years is not more likely than not to yield insufficient taxable income to utilize the current tax net operating loss carryforwards during the carryforward period. A similar analysis of expected future results as of December 31, 1998 did not yield a similar result. Changes in future economic conditions, future business combinations or other factors may significantly alter this assessment. Year ended 1998 as compared to 1997 The Company's revenues from the sale of oil and gas (excluding the effects of hedging activities) were $29.8 million and $40.3 million in 1998 and $34.6 million and $38.7 million in 1997, respectively. Realized oil and gas prices decreased $6.41 per Bbl and $.24 per Mcf, respectively. In 1998, the 1997 acquisitions contributed oil sales of $8.0 million and gas sales of $9.7 million with associated production of approximately 649 Mbls of oil and 5,038 Mmcf of gas, respectively. The decrease in oil revenues due to price was offset by an increase in production primarily attributable to the 1997 acquisitions. Gas revenues increased as a result of increased production, primarily the result of the 1997 acquisitions, despite a decrease in gas prices. Excluding the 1997 acquisitions, 1998 oil and gas production was relatively flat compared to 1997. The increase in production, assuming 1997 prices, would have resulted in additional revenues to the Company of $18.2 million while the decrease in prices reduced revenues by $21.4 million. The Company's hedging activities in 1998 increased both oil and gas revenues $206,000 ($.08 per Bbl) and $2.6 million ($.09 per Mcf), respectively, as compared to 1997, when hedging activities increased oil and reduced gas revenues $551,000 ($.29 per Bbl) and $62,000 ($.003 per Mcf), respectively. At December 31, 1998 the Company had no oil hedges in place; however, gas hedges for 12,499 Mmcf of the Company's production through early 2000 were outstanding. The Company's oil and gas production costs were $27.1 million ($.65 per Mcfe) and $16.3 million ($.48 per Mcfe) in 1998 and 1997, respectively. In 1998, production costs attributable to the 1997 acquisitions were $11.9 million ($1.32 per Mcfe). Thus, the increase in production costs was primarily related to the 1997 acquisitions. Excluding the 1997 acquisitions, the Company's production costs would have decreased slightly on an absolute and Mcfe basis. Initially, acquired properties generally incur significant rework expenses, which are costs incurred to perform required maintenance, workovers and other remedial activities. The properties acquired in the Pioneer Acquisition were primarily oil in nature and generally have a higher per unit production cost as compared to gas properties. Depletion, depreciation and amortization expense (DD&A) was $27.1 million ($.65 Mcfe) and $20.0 million ($.60 per Mcfe) in 1998 and 1997, respectively. In 1998 and 1997, DD&A included $.03 per Mcfe and $.01 per Mcfe, respectively, of depreciation and amortization of other property and equipment and other assets. In the fourth -16- quarter of 1997 the Company recorded an impairment of $69.0 million which acted to reduce the DD&A rate going forward. This effect was offset by the higher finding costs for the properties acquired in the acquisitions in 1997 as compared to previous acquisitions. Through the first three quarters of 1998, the Company's DD&A rate was slightly below the rates for the prior comparable quarters. In the fourth quarter of 1998, the Company lost proved reserves due to the decrease primarily in oil prices, which had an adverse effect on the fourth quarter DD&A rate. The fourth quarter DD&A rate caused the annual DD&A rate for 1998 to slightly exceed that of 1997. The Company recognized an impairment of $25.7 million and $69.0 million in 1998 and 1997, respectively. The 1997 impairment was primarily related to significantly depressed commodity prices as compared to the commodity price expectations on which most of the property acquisitions were based. The 1998 impairment was comprised of (a) $22.2 million related to oil and gas properties, (b) $2.2 million related to impairment of an investment in a partnership and (c) $1.3 million related to assets held for sale. The 1998 impairment related to the oil and gas properties was primarily attributable to loss of proved reserves associated with below expectation developmental drilling results and downhole mechanical problems primarily in the Company's Gulf Coast and Gulf of Mexico regions. The Company's exploration and abandonment expense was $17.6 million and $3.1 million in 1998 and 1997, respectively. The increase was due primarily to (a) increased geological and geophysical staff, (b) impairment of unproved properties, (c) uneconomical exploratory wells and (d) delay rentals. Increase in the geological and geophysical staff was due to the Company's exploratory efforts primarily associated with the OEDC and Carrollton Acquisitions in the Gulf Coast and Gulf of Mexico regions. The Company's Webb County prospect was the significant contributing factor to the increase due to (a) $1.1 million uneconomical exploratory well, (b) $9.1 million impairment of the unproved acreage and (c) approximately $1.3 million in delay rentals paid in 1998 to hold leases. The Company's general and administrative expense (G&A) was $9.2 million ($.22 per Mcfe) and $5.4 million ($.16 per Mcfe) in 1998 and 1997, respectively. G&A attributable to the OEDC and Carrollton Acquisitions was over $2.2 million (over $.54 per Mcfe) in 1998. Excluding the OEDC and Carrollton Acquisitions, G&A would have been approximately $.19 per Mcfe. After excluding the OEDC and Carrollton Acquisitions, the remainder of the increase in G&A from 1997 to 1998 was primarily the result of a full year's effect of the increase in staff in 1997 necessitated by the Company's growth. In the fourth quarter of 1998, the Company recognized a restructuring charge of $625,000. This charge related to the severance and related benefits that were provided to individuals whose positions were eliminated as a result of the planned disposition of assets in 1999. The 1998 equity in net loss of affiliates is attributable to the Company's ownership in two partnerships acquired in the OEDC Acquisition. Included in the equity loss is approximately $632,000 of amortization of the Company's cost basis in excess of the underlying historical net assets of one of the partnerships. The Company's interest expense was $8.6 million and $1.5 million in 1998 and 1997, respectively. The increase was primarily due to the increase in debt levels between years. In 1997, the average debt outstanding was lower as a result of the December 1996 initial public common stock offering. In 1998, the average outstanding debt obligation increased primarily due to (a) the Pioneer Acquisition in December 1997, (b) the purchase of treasury stock, (c) the assumption of $15.8 million in debt from the OEDC and Carrollton Acquisitions, (d) the Company's capital expenditure program and (e) the reduction in operating cash flow due to significantly depressed commodity prices. The Company's effective income tax rates were 10% and 35% for 1998 and 1997, respectively. The decrease in rate was due to the Company's inability in 1998 to recognize the income tax benefit associated with a loss before income taxes because it was more likely than not that the Company would not be able to utilize all its available loss carryforwards prior to their ultimate expiration. Due to the Company's inability to potentially use its loss carryforwards, the Company provided a valuation allowance of approximately $14.0 million against its deferred tax assets. -17- Liquidity and Capital Resources The Company's primary sources of capital have been its initial capitalization, private equity sales, bank financing, cash flow from operations and the Company's initial public offering. The 1996 Acquisition was principally funded with bank financing, which was repaid with the proceeds from the Company's initial public offering. The OEDC Acquisition and the Carrollton Acquisition were completed by issuing common stock in exchange for the equity interest in each entity. The Pioneer Acquisition was funded with bank financing. Net Cash Provided by Operating Activities. Net cash provided by operating activities was $33.4 million for 1999 and $18.4 million for 1998 and net cash provided by operating activities, before changes in operating assets and liabilities, was $35.9 million for 1999, compared to $20.2 million for 1998. The increase was primarily attributable to a decrease in operating costs with a slight increase in revenues. The increase in revenues is due to an increase in commodity prices offset by decrease in production due primarily to the sale of properties. Captial Expenditures. For 1999, the Company's adjusted budget was 46.2 million for capital expenditures, and the Company incurred actual cash expenditures of $44.2 million. The Company acquired proved and unproved properties in the Central Gulf Coast region for approximately $10 million, which was not budgeted. The Company requires capital primarily for the exploration, development and acquisition of oil and gas properties, the repayment of indebtedness and general working capital needs. The following table sets forth costs incurred by the Company in its exploration, development and acquisition activities.
Year Ended December 31, ------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- Development costs............................. $12,176 $30,663 $ 44,896 Exploration costs............................. 17,087 21,316 2,856 Acquisition costs: Unproved properties......................... 8,211 4,994 24,532 Proved properties........................... 7,892 404 100,871 ------- ------- -------- Total.................................... $45,366 $57,377 $173,155 ======= ======= ========
Excluding the effects of the Unocal merger, for 2000 the Company, currently, expects to spend approximately $50 million in capital projects, of which approximately $25 million would be for development projects. The Company regularly engages in discussions relating to potential acquisitions of oil and gas properties. The Company, other than the Unocal merger, has no present agreement, commitment or understanding with respect to any such acquisition, other than the acquisition of oil and gas properties and interests in its normal course business. Any future acquisitions may require additional financing and may be dependent upon financing which may be required in the future to fund the Company's acquisition and drilling programs. Capital Resources. The Company's primary capital resources are net cash provided by operating activities and the availability under the Credit Agreement, of which approximately $86 million was available at December 31, 1999. Credit Agreement. In June 1999, the Company entered into an amended and restated credit agreement (the "Credit Agreement") with Chase Bank of Texas, N.A. (the "Bank"), which established a revolving credit facility of $250 million subject to a borrowing base. The borrowing base, which is $175 million at December 31, 1999, is subject to redetermination annually each April by the lenders based on certain proved oil and gas reserves and other assets of the Company. To the extent the borrowing base is less than the aggregate principal amount of all outstanding loans and letters of credit under the Credit Agreement, such deficiency must be cured by the Company ratably within 180 days, by either prepaying a portion of the outstanding amounts under the Credit Agreement or pledging additional collateral to the lenders. A portion of the Credit Agreement is available for the issuance of up to $15.0 million of -18- letters of credit, of which $144,000 was outstanding at December 31, 1999. All amounts outstanding are due and payable in full on April 1, 2001. At December 31, 1999, the outstanding principal was $89 million and the available capacity was approximately $86 million. At the Company's option, borrowings under the Credit Agreement bear interest at either the "Base Rate" (i.e., the higher of the applicable prime commercial lending rate, or the federal funds rate plus .5% per annum) or the Eurodollar rate, plus 1% to 1.50% per annum, depending on the level of the Company's aggregate outstanding borrowings. In addition, the Company is committed to pay quarterly in arrears a fee of .300% to .375% of the unused borrowing base. The Credit Agreement contains certain covenants and restrictions that are customary in the oil and gas industry. In addition, the line of credit is secured by substantially all of the Company's oil and gas properties. The Company obtained a consent and waiver of certain provisions of the Credit Agreement as it related to the Company entering into the Merger Agreement with Unocal. The Company also obtained an extension of the maturity date of the Credit Agreement from January 1, 2001 to April 1, 2001. Liquidity and Working Capital. At December 31, 1999, the Company had $1.3 million of cash and cash equivalents as compared to $610,000 at December 31, 1998. The Company's ratio of current assets to current liabilities was .77 at December 31, 1999, compared to 6.23 at December 31, 1998. The Company's working capital ratio decreased due to $109.5 million of assets held for sale at December 31, 1998. Excluding the assets held for sale, the Company would have a working capital deficit of $3.8 million, as compared to a working capital deficit of $3.9 million at December 31, 1999. The working capital deficits are due partially to the Company maintaining low cash levels for cash management purposes. The Company, at December 31, 1999, has availability under its Credit Agreement to fund any working capital deficit. Unsecured Credit Agreement. In April 1997, the Company entered into a credit agreement, as amended (the "Unsecured Credit Agreement"), with the Bank which establishes a revolving credit facility, up to the maximum of $5 million. Individual borrowings may be made for up to a three week period. The Unsecured Credit Agreement has no maturity date and is cancellable at any time by the Bank. Proceeds of the Unsecured Credit Agreement are utilized to fund short-term needs (less than thirty days). The Company had $1 million in outstanding principal under the Unsecured Credit Agreement at December 31, 1999. The interest rate of amounts outstanding under the Unsecured Credit Agreement is at a rate determined by agreement between the Company and the Bank. The rate shall not exceed the maximum interest rate permitted under applicable law. Interest rates generally are the Bank's cost of funds plus 1% per annum. Other Matters Stock Options and Compensation Expense In 1996, the Company issued options to purchase 3,631,350 shares of Common Stock, at an exercise price of $2.08 per share, to certain of its officers and employees in substitution of previous options held by the officers and employees. As a result, at the time the Company recorded deferred compensation related to these options which it amortized over a 39-month period beginning in October 1996. Noncash compensation expense recorded for the years ended December 31, 1999, 1998 and 1997 was $5,049,000, $5,055,000 and $5,053,000, respectively. During the years ended December 31, 1999, 1998 and 1997, the Company issued additional options to purchase aggregates of 486,309, 389,499, and 259,000 shares, respectively, for which no deferred compensation was recorded as these options had no implicit value when issued. Hedging Activities The Company uses swap agreements and other financial instruments in an attempt to reduce the risk of fluctuating oil and gas prices and interest rates. There are various counterparties to these agreements, including Enron Capital & Trade Resources Corp., an affiliate of a significant stockholder of the Company. Settlement of gains or losses on the hedging transactions are generally based on the difference between the contract price and a -19- formula using New York Mercantile Exchange ("NYMEX") or other major indices related prices and is reported as a component of oil and gas revenues as the associated production occurs. At December 31, 1999, the Company had entered into hedging transactions with respect to approximately 5,475,000 MMBtu of its future 2000 estimated natural gas production and 1,463,000 and 452,500 barrels of its future 2000 and 2001, respectively, estimated crude oil production. For additional information, see note 18 of Notes to Consolidated Financial Statements. Crude Oil The Company reports average oil prices per Bbl including the net effect of oil hedges. In 1999, 1998 and 1997, the Company received (paid) related to its oil hedges ($1.4million), $206,000 and $551,000, respectively. Natural Gas The Company reports average gas prices per Mcf including the net effect of gas hedges. In 1999, 1998 and 1997, the Company received (paid) related to its gas hedges ($72,000), $2.6 million and ($62,000), respectively. Natural Gas Balancing In the natural gas industry, various working interest partners produce more or less than their entitled share of natural gas from time to time. The Company's net underproduced position at December 31, 1999 was approximately 112,000 Mcf. Under terms of typical natural gas balancing agreements, the underproduced party can take a certain percentage, typically 25% to 50% of the overproduced party's entitled share of gas sales in future months, to eliminate such imbalances. During the make-up period, the overproduced party's cash flow will be adversely affected. The Company recognizes revenue and imbalance obligations under the entitlements method of accounting, which means that the Company recognizes the revenue to which it is entitled and records an asset/liability with respect to the value of the underproduced/overproduced gas. Environmental and Other Laws and Regulations The Company's business is subject to certain federal, state and local laws and regulations relating to the exploration for and the development, production and transportation of oil and gas, as well as environmental and safety matters. Many of these laws and regulations have become more stringent in recent years, often imposing greater liability on a larger number of potentially responsible parties. Although the Company believes it is in substantial compliance with all applicable laws and regulations, the requirements imposed by such laws and regulations are frequently changed and subject to interpretation, and the Company is unable to predict the ultimate cost of compliance with these requirements or their effect on its operations. The Company has no material commitments for capital expenditures to comply with existing environmental requirements. Nevertheless, changes in existing environmental laws or in interpretations thereof could have a significant adverse impact on the operating costs of the Company, as well as the oil and gas industry in general. See "Risk Factors- Compliance with Environmental Regulations," "Business and Environmental Matters" and "Business and Abandonment Costs." Recently Issued Accounting Standards In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," which establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. It establishes conditions under which a derivative may be designated as a hedge, and establishes standards for reporting changes in the fair value of a derivative. SFAS No. 133 is required to be implemented for the first quarter of the fiscal year ended 2001. Early adoption is permitted. The Company has not evaluated the effects of implementing SFAS No. 133. -20- Risk Factors Our rapid growth placed significant demands upon our resources Our brief operating history has been characterized by rapid growth which places significant demands on our financial, operational and administrative resources. Any future growth of our oil and gas reserves, production and operations would place significant further demands on our financial, operational and administrative resources. Our future performance and profitability will depend in part on our ability to successfully integrate the administrative and financial functions of acquired properties and companies into our operations, to hire additional personnel and to implement necessary enhancements to our management systems. You should not place undue reliance on our reserve data because numerous uncertainties are inherent in the estimation of the reserve data There are numerous uncertainties inherent in estimating quantities of oil and gas reserves and their values, including many factors beyond our control. The reserve information contained in this filing represents estimates only. Approximately 35% of our total proved reserves on December 31, 1999 were undeveloped, which are by their nature less certain. Recovery of these reserves will require significant capital expenditures and successful drilling operations. The reserve data set forth in the estimates assumes that we will expend substantial capital to develop these reserves. The estimates of oil and gas reserves in this filing are based on several factors, including the evaluation of available geological, geophysical, economic and engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that are difficult to measure. The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment. The estimates of economically recoverable oil and gas reserves and of future net cash flows rely on various assumptions, including, for example, historical production from the area compared with production from other producing areas, constant oil and gas prices, future operating costs, capital expenditures and the availability of funds. Therefore, estimates of reserves are inherently imprecise indications of future net cash flows. Actual future production, cash flows, taxes, operating expenses, development expenditures and quantities of recoverable oil and gas reserves may vary substantially from those assumed in the estimates. Any significant variance in the assumptions could materially affect the estimated quantity and value of the reserves. Additionally, we may have to revise our reserve data based upon actual production performance, results of future development and exploration, prevailing oil and gas prices and other factors, many of which are beyond our control. You should not construe the present value of our proved reserves as the current market value of the estimated proved reserves of oil and gas attributable to our properties. In accordance with SEC requirements, the estimated discounted future net cash flows from proved reserves have been based on prices and costs as of the date of the estimate, whereas actual future prices and costs may vary significantly. The amount and timing of actual production and related expenses, supply and demand for oil and gas, changes in consumption levels, changes in governmental regulations or taxation and other factors will also affect actual future net cash flows. In addition, the calculation of the present value of the future net cash flows using a 10% discount factor, which the SEC requires for reporting purposes, is not necessarily the most appropriate discount factor based on interest rates in effect from time to time and risks associated with us or the oil and gas industry in general. -21- Maintaining reserves and revenues in the future depends on successful exploration and development Our future success will depend upon our ability to find or acquire additional oil and gas reserves that are economically recoverable. Unless we successfully explore or develop properties containing proved reserves, our proved reserves will generally decline as a result of continued production. The decline rate varies depending upon reservoir characteristics and other factors. Our oil and gas reserves and production, and, therefore, cash flow and income, will depend greatly upon our success in exploiting out current reserves and acquiring or finding additional reserves. Our exploration and development activities will be subject to significant risks Our drilling activities will involve a variety of operating risks, including well blow outs, cratering, uncontrollable flows of oil, natural gas or well fluids into the environment, fires, formations with abnormal pressures, pollution, releases of toxic gases and other environmental hazards and risks, any of which could result in substantial losses to us. We cannot assure you that the new wells we drill will be productive or that we will recover all or any portion of our investment in wells drilled. Drilling for oil and gas may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce net reserves to return a profit after drilling, operating and other costs. The cost of drilling, completing and operating wells is often uncertain. Numerous factors, many of which are beyond our control, including economic conditions, mechanical problems, title problems, weather conditions, compliance with governmental requirements and shortages and delays in the delivery of equipment and services may curtail, delay or cancel our drilling operations. In accordance with industry practices, we maintain insurance against some, but not all, of these risks. We cannot assure you that any of our insurance will be adequate to cover losses or liabilities. Our use of enhanced oil recovery techniques will involve certain risks, especially the use of water flooding techniques. Part of our inventory of development prospects will include waterflood projects. Water flooding involves significant capital expenditures and uncertainty as to the total amount of recoverable secondary reserves. In waterflood operations, there is generally a delay between the initiation of water injection into a formation containing hydrocarbons and any resulting increase in production. The operating cost per unit of production of waterflood projects is generally higher during the initial phases of such projects due to the purchase of injection water and related costs, as well as during the later stages of the life of the project as production declines. The degree of success, if any, of any enhanced recovery program depends on a large number of factors, including the porosity of the formation, the technique used and the location of injector wells. We cannot assure you that our planned development and exploration projects and acquisition activities will result in significant additional reserves or that we will have success drilling productive wells at low finding and development costs. Furthermore, while our revenues may increase if prevailing oil and gas prices increase significantly, our finding costs for additional reserves could also increase. We face the risk of volatility of oil and gas prices Our revenues, operating results and future rate of growth will depend upon the price we receive for our oil and gas. Historically, the markets for oil and gas have been volatile and may continue to be volatile in the future. Various factors that are beyond our control will affect prices of oil and gas, such as: . the worldwide and domestic supplies of oil and gas, . the ability of the members of the Organization of Petroleum Exporting Countries ("OPEC") to agree to and maintain oil price and production controls, . political instability or armed conflict in oil-producing regions, . the price and level of foreign imports, -22- . the level of consumer demand, . the price and availability of alternative fuels, . the availability of pipeline capacity, . weather conditions, . domestic and foreign governmental regulations and taxes, and . the overall economic environment. We are unable to predict the long-term effects of these and other conditions on the prices of oil and gas. Lower oil and gas prices may reduce the amount of oil and gas we produce economically, which may adversely affect our revenues and operating income. Lower oil and gas prices may also require a reduction in the carrying value of our oil and gas properties. We will make substantially all of our sales of oil and gas in the spot market or pursuant to contracts based on spot market prices and not pursuant to long-term fixed price contracts. Our hedging activities may not adequately offset risks we face Our use of hedging contracts to reduce our sensitivity to oil and gas price volatility will be subject to a number of risks. If we do not produce reserves at the rates we estimate due to inaccuracies in the reserve estimation process, operational difficulties or regulatory limitations, we would be required to satisfy obligations we may have under fixed price sales and hedging contracts on potentially unfavorable terms without the ability to hedge that risk through sales of comparable quantities of our own production. The terms under which we will enter into fixed price sales and hedging contracts will be based on assumptions and estimates of numerous factors, including transportation costs to delivery points. Substantial variations between the assumptions and estimates we will use and actual results we will experience could adversely affect our anticipated profit margins and our ability to manage the risks associated with fluctuations in oil and gas prices. Additionally, fixed price sales and hedging contracts limit the benefits we will realize if actual prices rise above the contract prices. Hedging contracts are also subject to the risk that the counter-party may not be able or willing to perform its obligations. Our acquisitions will involve a high degree of risk We will evaluate and pursue acquisition opportunities available on terms that our management considers favorable. Although our management will review and analyze the properties that we will acquire, such reviews are subject to uncertainties. The acquisition of producing properties will involve an assessment of several factors, including recoverable reserves, future oil and gas prices, operating costs, potential environmental and other liabilities and other factors beyond our control. These assessments are necessarily inexact, and it is generally not possible to review in detail every individual property involved in an acquisition. However, even a detailed review of all properties may not reveal all existing structural and environmental problems. We will generally assume preclosing liabilities, including environmental liabilities, and will generally acquire interests in oil and gas properties on an "as is" basis. In addition, volatile oil and gas prices will make it difficult for us to accurately estimate the value of producing properties for acquisition and may cause disruption in the market for oil and gas producing properties. Price volatility also makes it difficult to budget for and project the return on acquisitions and development and exploration projects. We will not be able to assure you that our acquisitions will achieve desired profitability objectives. Our business will require substantial capital expenditures We will make substantial capital expenditures for the exploration, development, acquisition and production of oil and gas reserves. We intend to finance these capital expenditures primarily with funds provided by operations, the incurrence of debt, the issuance of equity and the sale of non-core assets. If revenues decrease as a result of lower oil or gas prices or for other reasons, we may not be able to expend the capital necessary to replace our -23- reserves or to maintain production levels, resulting in a decrease in production over time. If our cash flow from operations and availability under our credit facilities are not sufficient to satisfy our capital expenditure requirements, we may not be able to obtain additional debt or equity financing to meet these requirements. Our use of leverage may limit our operational flexibility We will have certain debt obligations that may affect our operations, including: . our need to dedicate a substantial portion of our cash flow from operations to the payment of interest on our indebtedness which prevents us from using these funds for other purposes; . the covenants contained in our credit facility limit our ability to borrow additional funds or to dispose of assets and may affect our flexibility in planning for, and reacting to, changes in business conditions; and . our potential inability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes. Moreover, future acquisition or development activities may require us to alter our capitalization significantly. These changes in capitalization may significantly alter our leverage structure. Our ability to meet our debt service obligations and to reduce our total indebtedness will depend on future performance, which will be subject to general economic conditions and to financial, business and other factors affecting our operations, many of which are beyond our control. We may not be able to market our production The marketability of our production will depend, in part, upon the availability and capacity of natural gas gathering systems, pipelines and processing facilities. Most of our natural gas will be delivered through gas gathering systems and gas pipelines that we do not own. Our ability to produce and market our oil and gas will be subject to several factors, including Federal and state regulation of oil and gas production and transportation, tax and energy policies, changes in supply and demand and general economic conditions. We will be subject to extensive government regulations Our business will be subject to federal, state and local laws and regulations relating to the oil and gas industry as well as regulations relating to safety matters. Although we believe we will be in substantial compliance with all applicable laws and regulations, the requirements imposed by such laws and regulations change frequently, and these laws and regulations are subject to interpretation. Consequently, we cannot predict the ultimate cost of compliance with these requirements or their effect on our operations. We may have to expend a significant amount of resources to comply with government laws and regulations. We will be subject to substantial environmental regulation Our operations will be subject to complex and constantly changing environmental laws and regulations adopted by federal, state and local governmental authorities. The implementation of new or modified laws or regulations could have a material adverse effect on our business. The discharge of oil, gas or other pollutants into the air, soil or water may lead to significant liability to the government and third parties and may require us to incur substantial costs. Moreover, we have agreed to indemnify sellers of producing properties purchased in each of our substantial acquisitions against environmental claims associated with these properties. Current environmental laws or regulations or future laws or regulations may adversely affect our operations or our financial condition. Furthermore, material indemnity claims may arise against us. The competition in our industry is intense, some of our competitors have significantly greater resources than we, and this competition may adversely affect our operations We will operate in the highly competitive areas of oil and gas exploration, development, acquisition and production with other companies, many of which have substantially larger financial resources, staffs and facilities. -24- In seeking to acquire desirable producing properties or new leases for future exploration and in marketing our oil and gas production, we will face intense competition from both major and independent oil and gas companies. Many of these competitors have financial and other resources substantially in excess of those that will be available to us. This highly competitive environment could have a material adverse effect on us. We depend heavily on certain key personnel, and our failure to retain these individuals could adversely affect the management of Titan Our success will be highly dependent on Jack Hightower, our Chief Executive Officer, and a limited number of other senior management personnel. Loss of the services of Mr. Hightower or any of those other individuals could have a material adverse effect on our operations. We will maintain a $3.0 million key man life insurance policy on the life of Mr. Hightower, with one-half of the benefits payable to Titan, but no other senior management personnel. We cannot assure you that we will be successful in retaining key personnel. Our failure to hire additional personnel, if necessary, or retain our key personnel could have a material adverse effect on our business, financial condition and results of operations. The Delaware General Corporation Law may inhibit a takeover, which may limit the price that certain investors might be willing to pay for our common stock. Delaware law includes a number of provisions that may have the effect of delaying or deterring a change in the control of our management and encouraging persons considering unsolicited tender offers or other unilateral takeover proposals to negotiate with our board of directors rather than pursue non- negotiated takeover attempts. These provisions may make it more difficult for our stockholders to benefit from certain transactions which are opposed by the incumbent board of directors. -25- FORWARD-LOOKING STATEMENTS Certain statements contained in or incorporated by reference into this document, including, but not limited to, those regarding our financial position, business strategy and other plans and objectives for future operations and any other statements which are not historical facts constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that the actual results or developments we anticipate will be realized or, even if substantially realized, that they will have the expected effects on our business or operations. Among the factors that could cause actual results to differ materially from our expectations are inherent uncertainties in interpreting engineering and reserve data, operating hazards, delays or cancellations of drilling operations for a variety of reasons, competition, fluctuations and volatility in oil and gas prices, our ability to successfully integrate the business and operations of acquired companies, compliance with government and environmental regulations, increases in our cost of borrowing or inability or unavailability of capital resources to fund capital expenditures, dependence on key personnel, changes in general economic conditions and/or in the markets in which we compete or may, from time to time, compete and other factors including but not limited to those set forth in "Risk Factors" or in "Item 1" in this report. These factors expressly qualify all subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf. We assume no obligation to update any of these statements. -26- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following quantitative and qualitative information is provided about financial instruments to which the Company is a party as of December 31, 1999, and from which the Company may incur future earnings gains or losses from changes in market interest rates and commodity prices. The Company does not enter into derivative or other financial instruments for trading purposes. Quantitative Disclosures Commodity Price Sensitivity: The following table provides information about the Company's derivative financial instruments that are sensitive to changes in natural gas and crude oil commodity prices. See note 18 of Notes to Consolidated Financial Statements included in "Item 8. Financial Statements" for specific information regarding the terms of the Company's commodity derivative financial instruments that are sensitive to natural gas and crude oil commodity prices.
Fair 2000 2001 Total Value ---- ---- ----- ----- (dollars in thousands, except volumes and prices) Natural Gas Hedge Derivatives (a): Collar option contracts (b): Notional volumes (MMBtu) 5,475,000 -- 5,475,000 $ 1,342,473 Weighted average short call MMBtu strike price (c) $ 2.500 $ -- $ 2.500 Weighted average long put MMBtu strike price (c) $ 2.948 $ -- $ 2.948 Basis differential contracts (d): Notional volumes (MMBtu) 8,215,000 -- 8,215,000 $ (212,180) Weighted average MMBtu strike price $ .132 $ -- $ .132 Crude Oil Hedge Derivatives (a): Collar option contracts (e): Notional volume (Bbls) 1,463,000 452,500 1,915,500 $(2,755,669) Weighted average short call strike price per Bbl (c) $ 17.06 $ 16.50 $ 16.93 Weighted average long put strike price per Bbl (c) $ 21.47 $ 20.48 $ 21.24
___________________________________ (a) See note 18 of Notes to Consolidated Financial Statements included in "Item 8. Financial Statements" for additional information related to hedging activities. (b) A counterparty has the option to extend a collar option from October 1, 2000 to June 30, 2001 on volumes of 15,000 MMBtu per day at a floor and ceiling price of $2.60 and $3.08 per MMBtu, respectively. The table does not include amounts or volumes related to the extension as it is not probable the counterparty would exercise. (c) The strike prices are based on the prices traded on the New York Mercantile ("NYMEX"). (d) The basis differential relates to the spread between the NYMEX price and an El Paso/Permian price or Waha West Texas price. (e) A counterparty has the option to extend a collar option from July 1, 2000 to June 30, 2001 on volumes of 2,500 barrels per day at a floor and ceiling price of $16.50 and $20.48 per barrel, respectively. The fair value assumes the extension is exercised by the counterparty. -27- Interest Rate Sensitivity: The following table provides information about the Company's financial instruments that are sensitive to interest rates. The debt obligations are presented in the table at their contractual maturity dates together with the weighted average interest rates expected to be paid on the debt. The weighted average interest rates for the variable debt represents the weighted average interest paid and/or accrued in December 1999. See note 5 of Notes to Consolidated Financial Statements included in "Item 8. Financial Statements" for specific information regarding the terms of the Company's debt obligations that are sensitive to interest rates.
Fair 2000 2001 Total Value ---- ---- ----- ----- (dollars in thousands, except volumes and prices) Debt (a) Variable rate debt: Chase Bank of Texas, N.A. (Secured) $ - $89,000 $89,000 $89,000 Average interest rate -% 6.55% Chase Bank of Texas, N.A. (Unsecured) $ - $ 1,000 $ 1,000 $ 1,000 Average interest rate -% 7.02%
__________________________ (a) See note 5 of Notes to Consolidated Financial Statements included in "Item 8. Financial Statements" for additional information related to debt. Qualitative Disclosures The Company, from time to time, enters into interest rate and commodity price derivative contracts as hedges against interest rate and commodity price risk. See note 18 of Notes to Consolidated Financial Statements included in "Item 8. Financial Statements" for discussions relative to the Company's objectives and general strategies associated with it hedging instruments. The Company is a borrower under variable rate debt instruments that give rise to interest rate risk. See note 5 of Notes to Consolidated Financial Statements included in "Item 8. Financial Statements" for specific information regarding the terms of the Company's debt obligations. The Company's policy and strategy, as of December 31, 1999, is to only enter into interest rate and commodity price derivative instruments that qualify as hedges of its existing interest rate or commodity price risks. As of December 31, 1999, the Company's primary risk exposures associated with financial instruments to which it is a party include natural gas price volatility and interest rate volatility. The Company's primary risk exposures associated with financial instruments have not changed significantly since December 31, 1998. -28- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's Consolidated Financial Statements required by this item are included on the pages immediately following the Index to Consolidated Financial Statements appearing on page F-1. -29- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Consolidated Financial Statements: See Index to Consolidated Financial Statements on page F-1. 2. Financial Statement Schedules: See Index to Consolidated Financial Statements on page F-1. 3. Exhibits: The following documents are filed as exhibits to this report: Exhibit Number Description of Document - ------ 2.1 -- Exchange Agreement and Plan of Reorganization (filed as Exhibit 2.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 2.2 -- Amended and Restated Agreement and Plan of Merger, dated as of November 6, 1997, among Titan Exploration, Inc., Titan Offshore, Inc. and Offshore Energy Development Corporation (included as Appendix I to the Joint Proxy Statement/Prospectus forming a part of the Company's Registration Statement on S-4, Registration No. 333-40215, and incorporated herein by reference). 2.3 -- Agreement and Plan of Merger, dated as of November 4, 1997, among Titan Exploration, Inc., Titan Bayou Bengal Holdings, Inc. and Carrollton Resources, L.L.C. (filed as Exhibit 2.3 to the Company's Registration Statement on S-4 Registration No. 333-40215 incorporated herein by reference). 2.4 -- Agreement and Plan of Merger, dated December 13, 1999, among Union Oil of California, Pure Resources, Inc. (formerly named Titan Resources Holdings, Inc., TRH, Inc. and Titan Exploration, Inc. (filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed December 23, 1999 (date of event December 13, 1999), and incorporated herein by reference.) 3.1 -- Certificate of Incorporation (filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference). 3.1.1 -- Certificate of Amendment of Certificate of Incorporation (filed as Exhibit 3.1.1 to the Company's Registration Statement on Form S- 1, Registration No. 333-14029, and incorporated herein by reference). 3.2 -- Bylaws (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 3.2.1 -- Amendment to the Bylaws (filed as Exhibit 3 to the Company's Current Report on Form 8-K date of report June 10, 1999, and incorporated herein by reference. 4.1 -- Rights Agreement, dated June 10, 1999, between Titan Exploration, Inc. and First Union National Bank - Rights Agent (filed as Exhibit 4 to the Company's Current Report on Form 8-K date of Report June 10, 1999, and incorporated herein by reference). -30- Exhibit Number Description of Document - ------ 10.1 -- Agreement of Limited Partnership of Titan Resources, L.P., dated March 31, 1995, between Titan Resources I, Inc., as general partner, and Natural Gas Partners, L.P., Natural Gas Partners II, L.P. and Jack Hightower, as limited partners (filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.1.1 -- Amendment No. 1 to the Agreement of Limited Partnership of Titan Resources, L.P., dated December 11, 1995, by and among Titan Resources I, Inc., as the general partner, and a Majority Interest of the Limited Partners (filed as Exhibit 10.1.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.1.2 -- Amendment No. 2 to the Agreement of Limited Partnership of Titan Resources, L.P., dated September 27, 1996, by and among Titan Resources I, Inc., as the general partner, and a Majority Interest of the Limited Partners (filed as Exhibit 10.1.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.1.3 -- Amendment No. 3 to the Agreement of Limited Partnership of Titan Resources, L.P., dated September 30, 1996, by and among Titan Resources I, Inc., as the general partner, and a Majority Interest of the Limited Partners (filed as Exhibit 10.1.3 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.2 -- Amended and Restated Registration Rights Agreement, dated September 30, 1996, by and among Titan Exploration, Inc., Jack Hightower, Natural Gas Partners, L.P., Natural Gas Partners II, L.P., Joint Energy Development Investments Limited Partnership, First Union Corporation and Selma International Investment Limited (filed as Exhibit 10.3 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.3 -- Employment Agreement, dated September 30, 1996, by and between Titan Exploration, Inc., Titan Resources I, Inc. and Jack Hightower (filed as Exhibit 10.5 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.3.1 -- Form of Officer Severance and Retention Bonus Agreement (filed as Exhibit 10.1 of the Company's Current Report on Form 8-K date of report June 10, 1999, and incorporated herein by reference). 10.4 -- Form of Confidentiality and Non-compete Agreement among Titan Resources, L.P., Titan Resources I, Inc. and certain of the Registrant's executive officers (filed as Exhibit 10.6.1 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference). 10.4.1 -- Form of Confidentiality and Non-compete Agreement among the Registrant, Titan Resources I, Inc. and certain of the Registrant's executive officers (filed as Exhibit 10.6.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.5 -- Titan Exploration, Inc., Option Plan (filed as Exhibit 10.8 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.5.1 -- Form of Option Agreement (A Option) (filed as Exhibit 10.8.1 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.5.2 -- Form of Option Agreement (B Option) (filed as Exhibit 10.8.2 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.5.3 -- Form of Option Agreement (C Option) (filed as Exhibit 10.8.3 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference) . 10.5.4 -- Form of Option Agreement (D Option) (filed as Exhibit 10.8.4 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). -31- 10.6 -- 1996 Incentive Plan (filed as Exhibit 10.9 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference) . 10.6.1 -- 1999 Stock Option Plan of Titan Exploration, Inc. (filed as Exhibit 10.2 of the Company's Current Report on Form 8-K date of report June 10, 1999, and incorporated herein by reference). 10.7 -- Amended and Restated Credit Agreement, dated June 24, 1999, among Titan Exploration, Inc., Chase Bank of Texas, N.A., as Administrative Agent, and Financial Institutions now or thereafter parties thereto (filed as Exhibit 10.10 to the Company's Form 10-Q for the quarterly period ended June 30, 1999, and incorporated herein by reference). 10.7.1** -- Consent and Waiver Agreement, dated December 20, 1999, among Titan Exploration, Inc., Chase Bank of Texas, N.A., and Financial Institutions now and thereafter parties thereto. 10.8 -- Master Promissory Note, dated July 1, 1999, between Titan Exploration, Inc. and Chase Bank of Texas, N.A. (filed as Exhibit 10.11 to the Company's Form 10-Q for the quarterly period ended June 30, 1999, and incorporated herein by reference). 10.9 -- Purchase and Sale Agreement, dated April 28, 1999 by and among OEDC Exploration & Production, L.P., a Texas limited partnership ("Seller"), and Coastal Oil & Gas USA, L.P., a Delaware limited partnership ("Buyer") (filed as Exhibit 10.10 of the Company's Current Report on Form 8-K date of report May 20, 1999, and incorporated herein by reference). 10.10 -- Administrative Services Contract, dated March 31, 1995, between Staley Operating Co. and Titan Resources, L.P. (filed as Exhibit 10.16 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.11 -- Services Agreement, dated April 1, 1995, between Titan Resources I, Inc. and Titan Resources, L.P. (filed as Exhibit 10.17 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference). 10.12 -- Office Lease, dated April 10, 1997, between Fasken Center, Ltd. and Titan Exploration, Inc. (filed as Exhibit 10.17 to the Company's Registration Statement on Form S-4, Registration No. 333- 40215 incorporated herein by reference). 10.13 -- Lease Amendment to the Lease Agreement dated April 4, 1997 between Fasken Center, LTD. and Titan Exploration, Inc. (filed as Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended September 30, 1998 and incorporated herein by reference). 10.14 -- Form of Indemnity Agreement between the Registrant and each of its executive officers (filed as Exhibit 10.23 to the Company's Registration Statement on Form S-1, Registration No. 333-14029, and incorporated herein by reference). 10.15 -- Advisory Director Agreement, dated September 30, 1996, by and between Titan Exploration, Inc. and Joint Energy Development Investments Limited Partnership (filed as Exhibit 10.24 to the Company's Registration Statement on Form S-1, Registration No. 333- 14029, and incorporated herein by reference). 10.16 -- Letter Agreement, dated November 6, 1997, among Titan Exploration, Inc. and certain stockholders of Titan Exploration, Inc. (filed as Exhibit 10.27 to the Company's Registration Statement on S-4, Registration No. 333-40215, and incorporated herein by reference). 10.17 -- Titan Matching Plan, effective as of September 1, 1998 (filed as Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended September 30, 1998 and incorporated herein by reference) . 10.18 -- Amended and Restated Titan 401(k) Plan, effective as of September 1, 1998. (filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8, Registration No. 333-62115, and incorporated herein by reference). 10.19* -- Employment Agreement, dated December 13, 1999, by and between Pure Resources, Inc. (formerly named Titan Resources Holdings, Inc.) and Jack Hightower. 10.20* -- Amended and Restated Stockholders Voting Agreement dated as of April 10, 2000 among Pure Resources, Inc. (formerly named Titan Resources Holdings, Inc.), Union Oil Company of California, Jack D. Hightower and Titan Exploration, Inc. 10.21* -- Non-Dilution Agreement dated December 13, 1999 between Pure Resources, Inc. (formerly named Titan Resources Holdings, Inc.) and Union Oil Company of California. 10.22*-- Business Opportunities Agreement dated as of December 13, 1999, among Union Oil Company of California, Pure Resources, Inc. (formerly named Titan Resources Holdings, Inc.), TRH, Inc. and Titan Exploration, Inc. The officer and director defendants in the suits were Messrs. Strassner and Kiesewetter, who were officers and directors of OEDC and who are no longer employed by Titan, and Mr. Albin, who was a director of OEDC and Titan. Mr. Albin, a manager of NGP's investment funds, resigned as a director of Titan in 1999. 21** -- Subsidiaries of the Registrant. 23* -- Consent of independent auditors. 27** -- Financial Data Schedule. - --------------- * Filed herewith. ** Previously filed as an exhibit to the Form 10-K on March 14, 2000. -32- (b) During the fourth quarter of 1999 the Company filed a Form 8-K on December 23, 1999 (date of event December 13, 1999), reporting under Item 5. Other Events. The filing reported the merger agreement between the Company and Unocal. -33- GLOSSARY OF OIL AND GAS TERMS The following are abbreviations and definitions of terms commonly used in the oil and gas industry and this report. Unless otherwise indicated in this report, natural gas volumes are stated at the legal pressure base of the state or area in which the reserves are located and at 60 degrees Fahrenheit and in most instances are rounded to the nearest major multiple. BOEs are determined using the ratio of six Mcf of natural gas to one Bbl of oil. "Bbl" means a barrel of 42 U.S. gallons of oil. "Bcf" means billion cubic feet of natural gas. "Bcfe" means billion cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids. "BOE" means barrels of oil equivalent. "Completion" means the installation of permanent equipment for the production of oil or gas. "Development well" means a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. "Exploratory well" means a well drilled to find and produce oil or gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir. "Gross," when used with respect to acres or wells, refers to the total acres or wells in which the Company has a working interest. "Horizontal drilling" means a drilling technique that permits the operator to contact and intersect a larger portion of the producing horizon than conventional vertical drilling techniques and can result in both increased production rates and greater ultimate recoveries of hydrocarbons. "MBbls" means thousands of barrels of oil. "Mcf" means thousand cubic feet of natural gas. "Mcfe" means 1,000 cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids. "MMBbls" means millions of barrels of oil. "MMBOE" means millions of barrels of oil equivalent on a 6:1 basis. "MMcf" means million cubic feet of natural gas. "MMcfe" means million cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids. "Net," when used with respect to acres or wells, refers to gross acres of wells multiplied, in each case, by the percentage working interest owned by the Company. "Net production" means production that is owned by the Company less royalties and production due others. "Oil" means crude oil or condensate. -34- "Operator" means the individual or company responsible for the exploration, development, and production of an oil or gas well or lease. "Present Value of Future Revenues" or "PV-10" means the pretax present value of estimated future revenues to be generated from the production of proved reserves calculated in accordance with SEC guidelines, net of estimated production and future development costs, using prices and costs as of the date of estimation without future escalation, without giving effect to non-property related expenses such as general and administrative expenses, debt service and depreciation, depletion and amortization, and discounted using an annual discount rate of 10%. "Proved developed reserves" means reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery will be included as "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved. "Proved reserves" means the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions. i. Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (A) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any; and (B) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. ii. Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based. iii. Estimates of proved reserves do not include the following: (A) oil that may become available from known reservoirs but is classified separately as "indicated additional reserves"; (B) crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors; (C) crude oil, natural gas, and natural gas liquids that may occur in undrilled prospects; and (D) crude oil, natural gas, and natural gas liquids that may be recovered from oil shales, coal, gilsonite and other such sources. "Proved undeveloped reserves" means reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir. "Recompletion" means the completion for production of an existing well bore in another formation from that in which the well has been previously completed. "Reserves" means proved reserves. -35- "Royalty" means an interest in an oil and gas lease that gives the owner of the interest the right to receive a portion of the production from the leased acreage (or of the proceeds of the sale thereof), but generally does not require the owner to pay any portion of the costs of drilling or operating the wells on the leased acreage. Royalties may be either landowner's royalties, which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalties, which are usually reserved by an owner of the leasehold in connection with a transfer to a subsequent owner. "3-D seismic" means seismic data that are acquired and processed to yield a three-dimensional picture of the subsurface. "Tertiary recovery" means enhanced recovery methods for the production of oil or gas. Enhanced recovery of crude oil requires a means for displacing oil from the reservoir rock, modifying the properties of the fluids in the reservoir and/or the reservoir rock to cause movement of oil in an efficient manner, and providing the energy and drive mechanism to force its flow to a production well. The Company injects chemicals or energy as required for displacement and for the control of flow rate and flow pattern in the reservoir, and a fluid drive is provided to force the oil toward a production well. "Working interest" means an interest in an oil and gas lease that gives the owner of the interest the right to drill for and produce oil and gas on the leased acreage and requires the owner to pay a share of the costs of drilling and production operations. The share of production to which a working interest owner is entitled will always be smaller than the share of costs that the working interest owner is required to bear, with the balance of the production accruing to the owners of royalties. For example, the owner of a 100% working interest in a lease burdened only by a landowner's royalty of 12.5% would be required to pay 100% of the costs of a well but would be entitled to retain 87.5% of the production. "Workover" means operations on a producing well to restore or increase production. -36- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunder duly authorized, as of April 10, 2000. TITAN EXPLORATION, INC. Registrant By: /s/ Jack Hightower ------------------ Jack Hightower President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of April 10, 2000, by the following persons on behalf of the Registrant and in the capacity indicated. /s/ JACK HIGHTOWER - --------------------------------------------- Jack Hightower President of Directors, Chief Executive Officer and Chairman of the Board /s/ GEORGE G. STALEY - --------------------------------------------- George G. Staley Executive Vice President, Exploration and Director /s/ WILLIAM K. WHITE - --------------------------------------------- William K. White Vice President, Finance and Chief Financial Officer /s/ HERBERT C. WILLIAMSON - --------------------------------------------- Herbert C. Williamson, III Director /s/ WILLIAM J. VAUGHN, JR. - --------------------------------------------- William J. Vaughn, Jr. Director -37- Index To Consolidated Financial Statements
Page ---- Consolidated Financial Statements of Titan Exploration, Inc. Independent Auditors' Report F-2 Consolidated Balance Sheets as of December 31, 1999 and 1998 F-3 Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997 F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 F-6 Notes to Consolidated Financial Statements F-7
All schedules are omitted, as the required information is inapplicable or the information is presented in the financial statements or related notes. F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Titan Exploration, Inc. We have audited the consolidated financial statements of Titan Exploration, Inc. and subsidiaries (the "Company") as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Titan Exploration, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1999, in conformity with generally accepted accounting principles. KPMG LLP Midland, Texas February 1, 2000 F-2 TITAN EXPLORATION, INC. Consolidated Balance Sheets (in thousands, except share data)
December 31, ---------------------- ASSETS 1999 1998 ---- ---- Current assets: Cash and cash equivalents $ 1,310 $ 610 Accounts receivable: Oil and gas 10,365 13,497 Other 252 761 Inventories 732 1,276 Assets held for sale -- 109,452 Prepaid expenses and other current assets 549 316 --------- --------- Total current assets 13,208 125,912 --------- --------- Property, plant and equipment, at cost: Oil and gas properties, using the successful efforts method of accounting 358,787 306,111 Accumulated depletion, depreciation and amortization (128,686) (96,934) --------- --------- 230,101 209,177 --------- --------- Other property and equipment, net 4,188 5,179 Deferred income taxes 20,612 -- Other assets, net of accumulated amortization of $921 in 1999 and $639 in 1998 689 754 --------- --------- $ 268,798 $ 341,022 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities: Trade $ 7,858 $ 14,097 Accrued interest 959 466 Other (Note 20) 8,303 5,652 --------- --------- Total current liabilities 17,120 20,215 --------- --------- Long-term debt 90,000 144,200 Other liabilities (Note 20) 827 5,253 Stockholders' equity: Preferred Stock, $.01 par value, 10,000,000 shares authorized; none issued and outstanding -- -- Common Stock, $.01 par value, 60,000,000 shares authorized; 43,993,843 and 40,534,675 shares issued and outstanding at December 31, 1999 and 1998, respectively 440 405 Additional paid-in capital 285,265 278,109 Notes receivable - officers and employees (8,729) -- Treasury stock, at cost; 3,804,000 and 2,600,000 shares at December 31, 1999 and 1998, respectively (25,764) (20,020) Deferred compensation -- (5,053) Accumulated deficit (90,361) (82,087) --------- --------- Total stockholders' equity 160,851 171,354 --------- --------- Commitments and contingencies (Note 8) $ 268,798 $ 341,022 ========= =========
See accompanying notes to consolidated financial statements. F-3 TITAN EXPLORATION, INC. Consolidated Statements of Operations (in thousands, except per share data)
Year ended December 31, ----------------------------------------- 1999 1998 1997 ---- ---- ---- Revenues: Gas sales $ 38,866 $ 42,844 $ 38,715 Oil sales 36,851 30,032 35,112 -------- --------- --------- Total revenues 75,717 72,876 73,827 -------- --------- --------- Expenses: Oil and gas production 18,643 27,078 16,298 Production and other taxes 6,116 5,725 5,548 General and administrative 7,771 9,163 5,372 Amortization of stock option awards 5,049 5,055 5,053 Exploration and abandonment (Note 21) 11,049 17,596 3,055 Depletion, depreciation and amortization 19,222 27,090 19,972 Impairment of long-lived assets 31,783 25,666 68,997 Restructuring costs -- 625 -- -------- --------- --------- Total expenses 99,633 117,998 124,295 -------- --------- --------- Operating loss (23,916) (45,122) (50,468) -------- --------- --------- Other income (expense): Interest income 102 125 190 Interest expense (7,320) (8,648) (1,524) Gain on sale of assets 1,344 923 58 Management fees - affiliate 3 8 10 Equity in net loss of affiliates (182) (458) -- Other 1,626 574 -- -------- --------- --------- Loss before income taxes (28,343) (52,598) (51,734) -------- --------- --------- Income tax benefit 20,069 5,381 18,267 -------- --------- --------- Net loss $ (8,274) $ (47,217) $ (33,467) ======== ========= ========= Net loss per common share $ (.22) $ (1.22) $ (.99) ======== ========= ========= Net loss per common share - assuming dilution $ (.22) $ (1.22) $ (.99) ======== ========= =========
See accompanying notes to consolidated financial statements. F-4 TITAN EXPLORATION, INC. Consolidated Statements of Stockholders' Equity (in thousands)
Notes Additional Receivable- Total Common Paid-in Officers and Treasury Deferred Accumulated Stockholders' Stock Capital Employees Stock Compensation Deficit Equity ----- ------- --------- ----- ------------ ------- ------ Balance, December 31, 1996 $ 339 $ 203,411 $ -- $ -- $ (15,161) $ (1,403) $ 187,186 Stock options exercised -- 9 -- -- -- -- 9 Tax benefit of stock options exercised -- 6 -- -- -- -- 6 Common stock issued -- (41) -- -- -- -- (41) Acquisitions for common stock 64 74,115 -- -- -- -- 74,179 Purchase of treasury stock -- -- -- (504) -- -- (504) Deferred compensation -- -- -- -- 5,053 -- 5,053 Net loss -- -- -- -- -- (33,467) (33,467) ----- --------- ------- -------- --------- --------- --------- Balance, December 31, 1997 403 277,500 -- (504) (10,108) (34,870) 232,421 Stock options exercised 2 546 -- -- -- -- 548 Tax benefit of stock options exercised -- 63 -- -- -- -- 63 Purchase of treasury stock -- -- (19,516) -- -- (19,516) Deferred compensation -- -- -- -- 5,055 -- 5,055 Net loss -- -- -- -- -- (47,217) (47,217) ----- --------- ------- -------- --------- --------- --------- Balance, December 31, 1998 405 278,109 -- (20,020) (5,053) (82,087) 171,354 Stock options exercised 35 7,160 (8,654) -- -- -- (1,459) Stock options cancelled -- (4) -- -- 4 -- -- Accrued interest on notes receivable -- -- (75) -- -- -- (75) Purchase of treasury stock -- -- -- (5,744) -- -- (5,744) Deferred compensation -- -- -- -- 5,049 -- 5,049 Net loss -- -- -- -- -- (8,274) (8,274) ----- --------- ------- -------- --------- --------- --------- Balance, December 31, 1999 $ 440 $ 285,265 $(8,729) $(25,764) $ -- $ (90,361) $ 160,851 ===== ========= ======= ======== ========= ========= =========
See accompanying notes to consolidated financial statements. F-5 TITAN EXPLORATION, INC. Consolidated Statements of Cash Flows (in thousands)
Year ended December 31, ----------------------------------- 1999 1998 1997 ---- ---- ---- Cash flows from operating activities: Net loss $ (8,274) $ (47,217) $ (33,467) Adjustments to reconcile net loss to net cash provided by operating activities: Depletion, depreciation and amortization 19,222 27,090 19,972 Impairment of long-lived assets 31,783 25,666 68,997 Amortization of stock option awards 5,049 5,055 5,053 Dry holes and abandonments 9,272 14,118 1,053 Gain on sale of assets (1,344) (923) (58) Equity in net loss of affiliates 182 458 -- Deferred income taxes (20,612) (5,381) (18,267) Restructuring costs -- 625 -- Other items 599 672 -- Changes in assets and liabilities, excluding acquisitions: Accounts receivable 2,755 1,279 (1,595) Prepaid expenses and other current assets (97) (445) (463) Other assets (231) 36 (96) Accounts payable and accrued liabilities (4,878) (2,585) 5,434 --------- --------- --------- Total adjustments 41,700 65,665 80,030 --------- --------- --------- Net cash provided by operating activities 33,426 18,448 46,563 --------- --------- --------- Cash flows from investing activities: Redemption of short-term investment -- 2,331 -- Investing in oil and gas properties (44,179) (57,432) (112,301) Payments for acquisitions, net of cash acquired -- -- (715) Additions to other property and equipment (292) (3,919) (1,361) Contributions in equity investments of affiliates (741) (1,884) -- Proceeds from sale of assets 74,070 2,491 75 --------- --------- --------- Net cash provided by (used in) investing activities 28,858 (58,413) (114,302) --------- --------- --------- Cash flows from financing activities: Proceeds (payments) from revolving debt, net (54,200) 60,100 63,588 Payments of debt -- (1,350) -- Exercise of stock options 7,195 548 9 Purchase of treasury stock (5,744) (19,516) (504) Issuance of notes receivable - officers and employees (8,654) -- -- Other financing activities (181) (810) (41) --------- --------- --------- Net cash provided by (used in) financing activites (61,584) 38,972 63,052 --------- --------- --------- Net increase (decrease) in cash and cash equivalents 700 (993) (4,687) Cash and cash equivalents, beginning of year 610 1,603 6,290 --------- --------- --------- Cash and cash equivalents, end of year $ 1,310 $ 610 $ 1,603 ========= ========= =========
See accompanying notes to consolidated financial statements. F-6 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (1) Organization and Nature of Operations Titan Exploration, Inc. (the "Company") a Delaware corporation, was organized on September 27, 1996 and began operations on September 30, 1996 with the combination of two entities under common control with the Company. The Company is an independent energy company engaged primarily in the exploration, development and acquisition of oil and gas properties. Since operations began in March 1995, the Company and its predecessors have experienced significant growth, primarily through the acquisition of companies and oil and gas properties and the exploitation of these properties in the Permian Basin region of west Texas and southeastern New Mexico. (2) Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Investments in corporate joint ventures and partnerships where the Company has ownership interest of 50% or less are accounted for on the equity method. All investments with an ownership interest of less than 20% and no significant influence are accounted for on the cost method. All material intercompany accounts and transactions have been eliminated in the consolidation. Use of Estimates in the Preparation of Financial Statements Preparation of the accompanying consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents For purposes of the statements of cash flows, the Company considers all demand deposits, money market accounts and certificates of deposit purchased with an original maturity of three months or less to be cash equivalents. Inventories Inventories consist of lease and well equipment not currently being used in production and are accounted for at the lower of cost (first-in, first-out) or market. Oil and Gas Properties The Company utilizes the successful efforts method of accounting for its oil and gas properties. Under this method of accounting, all costs associated with productive wells and nonproductive development wells are capitalized. Exploration costs are capitalized pending determination of whether proved reserves have been found. If no proved reserves are found, previously capitalized exploration costs are charged to expense. If, after the passage of one year, the existence of proved reserves cannot be conclusively established, any deferred costs are charged to expense. Costs of significant nonproducing properties, wells in the process of being drilled and development projects are excluded from depletion until such time as the related project is developed and proved reserves are established or (Continued) F-7 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements impairment is determined. The Company capitalizes interest on expenditures for significant development projects until such time as significant operations commence. Capitalized costs of individual properties abandoned or retired are charged to accumulated depletion, depreciation and amortization. Sales proceeds from sales of individual properties are credited to property costs. No gain or loss is recognized until the entire amortization base is sold or abandoned. Other property and equipment are recorded at cost. Major renewals and betterments are capitalized while the costs of repairs and maintenance are charged to operating expenses in the period incurred. With respect to dispositions of assets other than oil and gas properties, the cost of assets retired or otherwise disposed of, and the applicable accumulated depreciation are removed from the accounts, and the resulting gains or losses, if any, are reflected in operations. Depletion, Depreciation and Amortization Provision for depletion of oil and gas properties is calculated using the unit-of-production method on the basis of an aggregation of properties with a common geologic structural feature or stratigraphic condition, typically a field or reservoir. In addition, estimated costs of future dismantlement, restoration and abandonment, if any, are accrued as a part of depletion, depreciation and amortization expense on a unit of production basis; actual costs are charged to the accrual. Other property and equipment is depreciated using the straight- line method over the estimated useful lives of the assets. Loan costs are amortized over the life of the related loan. Impairment of Long-Lived Assets The Company follows the provisions of Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FAS 121"). Consequently, the Company reviews its long-lived assets to be held and used, including oil and gas properties accounted for under the successful efforts method of accounting and other identifiable intangible assets, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. An impairment loss is indicated if the sum of the expected future cash flows, on a depletable unit basis, is less than the carrying amount of such assets. In this circumstance, the Company recognizes an impairment loss for the amount by which the carrying amount of the asset exceeds the fair value of the asset. The Company accounts for long-lived assets to be disposed of at the lower of their carrying amount or fair value less cost to sell once management has committed to a plan to dispose of the assets. Net Income (Loss) per Common Share In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. Income Taxes The Company follows the provisions of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). Under the asset and liability method of FAS 109, deferred tax assets and liabilities are (Continued) F-8 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FAS 109, the effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. Environmental The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and/or remediation is probable, and the costs can be reasonably estimated. Revenue Recognition The Company uses the sales method of accounting for crude oil revenues. Under this method, revenues are recognized based on actual volumes of oil sold to purchasers. The Company uses the entitlements method of accounting for natural gas revenues. Under this method, revenues are recognized based on the Company's proportionate share of actual sales of natural gas. Natural gas revenues would not have been significantly altered in any period had the sales method of recognizing natural gas revenues been utilized. The Company has a net liability of approximately $56,000 and $225,000 at December 31, 1999 and December 31, 1998, respectively, associated with gas balancing recorded. The Company recognizes marketing revenue net of the cost of gas and third- party delivery fees as service is provided. Stock-based Compensation The Company accounts for employee stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, the Company has only adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). See Note 13 for the pro forma disclosures of compensation expense determined under the fair-value provisions of FAS 123. Treasury Stock Treasury stock purchases are recorded at cost. Upon reissuance, the cost of treasury shares held is reduced by the average purchase price per share of the aggregate treasury shares held. Commodity Hedging The financial instruments that the Company accounts for as hedging contracts must meet the following criteria the underlying asset or liability must expose the Company to price or interest rate risk that is not offset in another asset or liability, the hedging contract must reduce that price or interest rate risk at the inception of the contract and (Continued) F-9 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements throughout the contract period, and the instrument must be designated as a hedge. In order to qualify as a hedge, there must be clear correlation between changes in the fair value of the financial instrument and the fair value of the underlying asset or liability such that changes in the market value of the financial instrument will be offset by the effect of price or interest rate changes on the exposed items. The Company periodically enters into commodity derivative contracts in order to hedge the effect of price changes on commodities the Company produces and sells. Gains and losses on contracts that are designed to hedge commodities are included in income recognized from the sale of those commodities. Gains and losses on derivative contracts which do not qualify as hedges are recognized in each period based on the market value of the related instrument. Interest Rate Swap Agreements The Company enters into interest rate swap agreements to effectively convert a portion of its floating-rate borrowings into fixed rate obligations. The interest rate differential to be received or paid is recognized over the lives of the agreements as an adjustment to interest expense. At December 31, 1999, the Company was not subject to any interest rate swap agreements. Reclassifications Certain reclassifications have been made to the 1998 and 1997 amounts to conform to the 1999 presentation. (3) Unocal Merger Agreement On December 13, 1999, the Company, Union Oil Company of California, a California corporation and wholly-owned subsidiary of Unocal Corporation ("Union Oil"), Pure Resources, Inc., a Delaware corporation and a wholly-owned subsidiary of Union Oil ("Pure"), and TRH, Inc., a Delaware corporation and a wholly-owned subsidiary of Pure ("Merger Sub") entered into an Agreement and Plan of Merger (the "Merger Agreement"). The Merger Agreement provides that, on the Closing Date immediately following the Closing (as such terms are defined in the Merger Agreement), Merger Sub will merge with and into the Company, and the Company will become a wholly-owned subsidiary of Pure (such events constituting the "Merger"). Once the Merger is consummated, Merger Sub will cease to exist as a corporation and all of the business, assets, liabilities and obligations of Merger Sub will be merged into the Company, with the Company remaining as the surviving corporation (the "Surviving Corporation") and a wholly-owned subsidiary of Pure. As a result of the Merger, each outstanding share of the Common Stock, par value $0.01 per share (the "Company Common Stock"), other than shares owned by the Company or any wholly-owned subsidiary of the Company, will be converted into the right to receive .4302314 of a share (the "Exchange Ratio") of Common Stock, par value $0.01 per share, of Pure ("Pure Common Stock"). At the effective time of the Merger, each outstanding option to purchase the Company Common Stock under the Company's stock option plans (each a "Company Common Stock Option") will be assumed by Pure (each an "Assumed Option") and will become an option to purchase that number of shares of Pure Common Stock equal (subject to rounding) to the number of shares of Company Common Stock that was subject to such option immediately prior to the Merger, multiplied by the Exchange Ratio. The exercise price of each Assumed Option will be equal to the quotient determined by dividing the exercise price per share of the Company Common Stock at which the Company Common Stock Option was exercisable immediately prior to the effective time of the Merger by the Exchange Ratio, rounded up to the nearest whole cent. (Continued) F-10 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements On the Closing Date, Union Oil will transfer to Pure substantially all of its oil and gas exploration and production assets in the Permian Basin and San Juan Basin areas of Texas, New Mexico and Colorado in return for Pure Common Stock. Upon consummation of the Merger immediately following the Closing, Union Oil will own approximately 32 million shares of Pure Common Stock, representing approximately 65% of the outstanding Pure Common Stock, and the former stockholders of the Company will own the remaining shares representing approximately 35% of the outstanding Pure Common Stock. (4) Disclosures About Fair Value of Financial Instruments The following table presents the carrying amounts and estimated fair values of the Company's financial instruments (in thousands):
December 31, ----------------------------------------------------------------- 1999 1998 ---------------------------- ---------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ ----- Financial assets: Cash and cash equivalents $ 1,310 $ 1,310 $ 610 $ 610 Notes receivable - officers and employees 8,729 8,729 - - Financial liabilities: Debt: Line of credit 89,000 89,000 140,000 140,000 Unsecured line of credit 1,000 1,000 4,200 4,200 Off-balance sheet financial instruments (see Note 18): Commodity price hedges - (1,625) - 1,673
Cash and cash equivalents, restricted cash, accounts receivable, other current assets, accounts payable and other current liabilities. The carrying amounts approximate fair value due to the short maturity of these instruments. Notes receivable - officers and employees. The carrying amounts approximate fair value due to the comparability of the interest rate to the Company's borrowing rate. Debt. The carrying amount of long-term debt approximates fair value because the Company's current borrowing rate does not materially differ from market rates for similar bank borrowings. Commodity price hedges. The fair market values of commodity derivative instruments are estimated based upon the current market price of the respective commodities at the date of valuation. It represents the amount which the Company would be required to pay or able to receive based upon the differential between a fixed and a variable commodity price as specified in the hedge contracts. (Continued) F-11 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (5) Debt Debt consists of the following (in thousands): December 31, ---------------------- 1999 1998 ---- ---- Line of credit $89,000 $140,000 Unsecured line of credit 1,000 4,200 ------- -------- $90,000 $144,200 ======= ======== Line of Credit In June 1999, the Company entered into an amended and restated credit agreement (the "Credit Agreement") with Chase Bank of Texas, N.A. (the "Bank"), which established a revolving credit facility of $250 million subject to a borrowing base. All amounts outstanding are due and payable in full on April 1, 2001. The borrowing base, which is $175 million at December 31, 1999, is subject to redetermination annually each April by the lenders based on certain proved oil and gas reserves and other assets of the Company. The Credit Agreement, which is secured by a majority of the Company's proved oil and gas reserves, is subject to mandatory prepayments. To the extent that the borrowing base is less than the aggregate principal amount of all outstanding loans and letters of credit under the Credit Agreement, such deficiency must be cured by the Company within 180 days, by either prepaying a portion of the outstanding amounts or pledging additional collateral. Commitment fees are due quarterly and range from .300% to .375% per annum on the difference between the commitment and the average daily amount outstanding. At the Company's option, borrowings under the Credit Agreement bear interest at either (i) the "Base Rate" (i.e. the higher of the agent's prime commercial lending rate, or the federal funds rate plus .50% per annum), or (ii) the Eurodollar rate plus a margin ranging from 1.00% to 1.50% per annum, which margin increases as the level of the Company's aggregate outstanding borrowings under the Credit Agreement increases. The weighted average interest rate at December 31, 1999 was 6.54%. The credit agreement contains various restrictive covenants and compliance requirements, which include (1) limiting the incurrence of additional indebtedness, (2) restrictions as to merger, sale or transfer of assets and transactions with affiliates without the lenders' consent, and (3) prohibition of any return of capital payments or distributions to any of its partners other than for taxes due as a result of their partnership interest. The Company obtained a consent and waiver of certain provisions of the Credit Agreement as it related to the Company entering into the Merger Agreement with Unocal. The Company also obtained an extension of the maturity date of the Credit Agreement from January 1, 2001 to April 1, 2001. The Company is in the process of negotiating a new credit facility, which will replace the Credit Agreement, for Pure Resources, the new parent of the Company after the merger. Unsecured Credit Agreement In April 1997, the Company entered into a credit agreement, as amended (the "Unsecured Credit Agreement"), with the Bank which establishes a revolving credit facility, up to the maximum of $5 million. Individual borrowings (Continued) F-12 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements may be made for up to a three week period. The Unsecured Credit Agreement has no maturity date and is cancellable at anytime by the Bank. The interest of each loan under the Unsecured Credit Agreement is at a rate determined by agreement between the Company and the Bank. The rate shall not exceed the maximum interest rate permitted under applicable law. Interest rates generally are at the Bank's cost of funds plus 1% per annum. At December 31, 1999, there was $1 million of outstanding principal balance under the Unsecured Credit Agreement. Maturities of debt are as follows (in thousands): 2000 $ -- 2001 90,000 Thereafter -- (6) Acquisitions On December 12, 1997, the Company completed the acquisitions of all the outstanding stock of Offshore Energy Development Corporation ("OEDC") and Carrollton Resources, L.L.C. ("Carrollton"). The acquisitions were made by the issuance of 5,486,734 and 899,965 shares of the Company's common stock to the stockholders of OEDC and Carrollton, respectively. The results of operations of OEDC and Carrollton from the closing date are not included in the Company's 1997 results of operations as the acquisitions closed in late December 1997, and the amounts are not material. The acquisitions, accounted for on the purchase method, resulted in the following noncash investing activities: OEDC Carrollton -------- ---------- (in thousands) Recorded amount of assets acquired $104,312 $ 19,820 Liabilities assumed (27,102) (2,243) Deferred income tax liability (13,815) (6,078) Common stock issued (62,849) (11,330) -------- -------- Cash costs, net of cash acquired $ 546 $ 169 ======== ======== The liabilities assumed include amounts recorded for preacquisition contingencies and bank debt of OEDC and Carrollton. (Continued) F-13 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements On December 16, 1997, the Company completed the acquisition of certain oil and gas properties from Pioneer Natural Resources Company (the "Pioneer Acquisition"). The Company funded the acquisition from its debt facilities. The results of operations from the Pioneer Acquisition from the closing date are not included in the Company's 1997 results of operations as the amounts are not material. The acquisition of these oil and gas properties, accounted for using the purchase method, resulted in the following noncash investing activities: Recorded amount of assets acquired, including receivables of $2,589,817 $55,794,243 Liabilities assumed (1,061,330) ----------- Cash paid $54,732,913 =========== Included in assets recorded is a $53,919 long-term receivable recorded as a purchase price adjustment related to the Pioneer Acquisition for a gas imbalance receivable. (7) Rights Agreement On June 10, 1999, the board of directors of the Company authorized and declared a dividend to the holders of record on July 1, 1999 of one Right (a "Right") for each outstanding share of the Company's common stock. When exercisable, each Right will entitle the holder to purchase one one-hundredth of a share of a Series A Junior Participating Preferred Stock, par value $.01 per share, of the Company (the "Preferred Shares") at an exercise price of $30.00 per Right. The rights are not currently exercisable and will become exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's outstanding common stock or announces a tender offer or exchange offer the consummation of which would result in attaining the triggering percentage. The Rights are subject to redemption by the Company for $.01 per Right at any time prior to the tenth day after the first public announcement of a triggering acquisition. If the Company is acquired in a merger or other business combination transaction after a person has acquired beneficial ownership of 15% or more of the Company's common stock, each Right will entitle its holder to purchase, at the Right's then current exercise price, a number of the acquiring company shares of common stock having a market value of two times such price. In addition, if a person or group acquires beneficial ownership of 15% or more of the Company's common stock, each Right will entitle its holder (other than the acquiring person or group) to purchase, at the Right's then current price, a number of the Company's shares of common stock having a market value of two times the exercise price. Subsequent to the acquisition by a person or group of beneficial ownership of 15% or more of the Company's common stock and prior to the acquisition of beneficial ownership of 50% or more of the Company's common stock, the board of directors of the Company may exchange the Rights (other than Rights owned by such acquiring person or group, which will be null and void and nontransferable), in whole or in part, at an exchange ratio of one share of the Company's common stock (or one one-hundredth of a Preferred Share) per Right. The Rights were issued on July 1, 1999, to shareholders of record at the close of business on that date. The Rights will expire on June 9, 2009. The Rights will not be triggered as a result of the Unocal merger disclosed in Note 3. (Continued) F-14 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (8) Commitments and Contingencies Operating Leases The Company has non-cancelable operating leases for office facilities. The Company's non-cancellable operating lease for its Midland, Texas offices is with an entity controlled by an officer of the Company. Future minimum lease commitments under non-cancellable operating leases at December 31, 1999 are as follows (in thousands): Total Affiliate ----- ----------- 2000 $433 $433 2001 433 433 2002 90 90 Thereafter -- -- Lease expense during 1999, 1998 and 1997 was $713,762, $962,986 and $200,474, respectively. In 1999 and 1998, $193,065 and $412,056, respectively, of the lease expense was associated with compressors and recorded as production costs. Lease expense incurred with an affiliate during 1999, 1998 and 1997 was $432,965, $419,704 and $200,474, respectively. Litigation OEDC and certain of its officers and directors, as well as Natural Gas Partners, L.P. ("NGP"), the managing underwriters of OEDC's initial public offering and an analyst from each of the managing underwriters, were named as defendants in a suit styled Eric Baron and Edward C. Allen, On behalf of Themselves and all Others Similarly Situated, v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P., David Garcia, John J. Myers, Offshore Energy Development Corporation, Morgan Keegan & Company, Inc. and Principal Securities Inc., which was filed October 20, 1997, in the Texas State District Court of Harris County, Texas, 270/th/ Judicial District and subsequently removed to federal court in the United States Southern District of Texas. OEDC and certain of its officers and directors, as well as NGP, were also named defendants in a suit styled John W. Robertson, et al. v. David B. Strassner, Douglas H. Kiesewetter, David R. Albin, Natural Gas Partners, L.P. and Offshore Energy Development Corporation, which was filed February 6, 1998, in the United States Southern District of Texas, Houston Division. The officer and director defendants in the suits were Messrs. Strassner and Kiesewetter, who were officers and directors of OEDC and who are no longer employed by Titan, and Mr. Albin, who was a director of OEDC and Titan. Mr. Albin, a manager of NGP's investment funds, resigned as a director of Titan in 1999. These matters were settled in the fourth quarter of 1999 at an expense to the Company of approximately $200,000. The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity. Severance Agreements On June 10, 1999, the board of directors of the Company approved the form of an Officer Severance and Retention Bonus Agreement (the "Severance Agreement") to be entered into with each of the officers of the (Continued) F-15 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements Company. The triggering event of the Severance Agreement would involve "change of control" of the Company as defined in the Severance Agreement. Upon a termination event as defined in the Severance Agreement, each officer will be entitled to receive, among other benefits, (a) three times such officer's base salary plus bonus received in the preceding 12 month period, (b) continuation of life insurance, long-term disability coverage and accidental death and disability coverage for an eighteen month period, (c) payment of all medical and dental insurance premiums until the officer obtains other employment and (d) reimbursement of all reasonable legal fees and other expenses incurred in seeking to obtain or enforce any right or benefit provided by the Severance Agreement. If the payments under the Severance Agreement and other benefit plans from a termination event cause the officer to be subject to federal excise tax, the officer will receive a grossed-up amount to pay the officer's federal excise taxes. At December 31, 1999, the Company's estimated maximum contingent obligation pursuant to the Severance Agreements was $8.3 million. The actual liability might be reduced by amounts potentially payable under (b), (c) and (d) above if the covered officers were not terminated as a result of a triggering event. Letters of Credit At December 31, 1999, the Company had outstanding letters of credit of $144,000, which are issued through the Credit Agreement. (9) Statements of Cash Flows Interest expense of $6,828,000, $8,489,000 and $1,525,000 was paid in 1999, 1998 and 1997, respectively. Income taxes of $561,000 were paid in 1999. No income taxes were paid in 1998 and 1997. In 1998, the Company acquired oil and gas properties by assuming the underlying plugging obligations. The salvage value of the equipment and platforms exceeded the estimated plugging obligations. The Company recorded no basis in the oil and gas properties associated with this transaction. In 1998, the Company executed a like-kind exchange of oil and gas properties of which the Company's net basis in the property exchange was approximately $6,042,000. (10) Common Stock In May 1997, the Company originally announced a plan to repurchase up to $25 million, which in August 1999 the Company's board of directors increased to $35 million, of the Company's common stock. The repurchases will be made periodically, depending on market conditions, and will be funded with cash flow from operations and, as necessary, borrowings under the Credit Agreement. At December 31, 1999 and December 31, 1998, the Company had purchased, pursuant to the repurchase plan, 3,751,000 and 2,547,000 shares of its common stock for approximately $25.3 million and $19.6 million, respectively. (Continued) F-16 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (11) Income Taxes Total income tax expense was allocated as follows:
Year ended December 31, ------------------------------------------------ 1999 1998 1997 ---- ---- ---- Income (loss) from continuing operations $(20,069) $(5,381) $(18,267) Stockholders' equity for compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes -- (63) (6) -------- ------- -------- $(20,069) $(5,444) $(18,273) ======== ======= ========
Income tax expense (benefit) attributable to income (loss) for continuing operations consists of the following: Year ended December 31, ---------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Current: Federal $ 522 $ -- $ -- State 21 -- -- -------- ------- -------- 543 -- -- -------- ------- -------- Deferred: Federal (exclusive of change in the deferred tax asset valuation allowance) (6,564) (19,321) (18,274) Change in deferred tax asset valuation allowance (14,001) 14,001 -- State (47) (61) 7 -------- ------- -------- (20,612) (5,381) (18,267) -------- ------- -------- Total $(20,069) $(5,381) $(18,267) ======== ======= ======== The reconciliation between the tax expense computed by multiplying pretax income (loss) by the U.S. federal statutory rate and the reporting amounts of income tax benefit is as follows:
Year ended December 31, -------------------------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Loss at statutory rate $ (9,920) $(18,409) $(18,107) Change in the deferred tax asset valuation allowance (14,001) 14,001 - Non-deductible deferred compensation 3,954 - - State income taxes, net of federal benefit (47) (373) (167) Other (55) (600) 7 -------- -------- -------- Income tax benefit $(20,069) $ (5,381) $(18,267) ======== ======== ========
(Continued) F-17 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
December 31, --------------------------- 1999 1998 ---- ---- (in thousands) Deferred tax assets (liabilities): Net operating loss $18,176 $ 30,353 Compensation, principally due to accrual for financial reporting purposes -- 3,883 Property, plant and equipment, principally due to differences in basis upon acquisition, depletion, impairment, and the deduction of intangible drilling costs for tax purposes 1,023 (4,249) Investments in affiliates -- (18,027) Other 1,413 2,041 ------- -------- Net deferred tax asset (liability) 20,612 14,001 Valuation allowance of deferred tax assets -- (14,001) ------- -------- Net deferred tax asset (liability), net of valuation allowance $20,612 $ - ======= ========
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Based on expectations for the future and the availability of certain tax planning strategies that would generate taxable income to realize the net tax benefits, if implemented, management has determined that it is not more likely than not that a portion of the deferred tax assets will not be realized. During the year ended December 31, 1999, commodity prices for the Company's products improved significantly. As a result, based on the Company's analysis of the expected future results of operations based on current prices, the associated reserve volumes and the availability of tax planning strategies (such as elective capitalization of intangible drilling costs) it does not appear more likely than not that the Company will be unable to generate the $51.6 million in taxable income necessary to utilize net operating loss carryforwards over the carryforward period. The change in the outlook for commodity prices is the major factor that changed management's view with respect to the reversal of the deferred tax asset valuation as of December 31, 1998. In addition, for the year ended December 31, 1999, the Company would have generated significant operating income if impairments were not considered. This was not the case for the year ended December 31, 1998. Future estimated revenues, net of operating expenses from proved properties as disclosed in unaudited reserve disclosures in Note 22, amount to over $775 million based on current prices and costs. This net revenue, when considered together with estimated future general and administrative expenses and existing tax basis expected to be deductible in future years is not more likely than not to yield insufficient taxable income to utilize the current tax net operating loss carryforwards during the carryforward period. A similar analysis of expected future results as of December 31, 1998 did not yield a similar result. Changes in future economic conditions, future business combinations or other factors may significantly alter this assessment. At December 31, 1999, the Company had net operating loss carryforwards ("NOLs") for U.S. federal income tax purposes of approximately $51.6 million, which are available to offset future regular taxable income, if any. The carryforwards begin to expire in 2011. (12) Related Party Transactions During 1998 and 1997, the Company received $7,536 and $9,656, respectively, for administrative services from a related party. During 1999, the Company reimbursed the related party $3,303 for past overcharges for administrative services. Director's fees of $36,250, $45,000 and $45,000 were incurred during 1999, 1998 and 1997, respectively. Certain properties that were owned or controlled by certain shareholders were acquired by the Company for $100,000 in 1997, which approximates the predecessor cost of the properties. During 1999, 1998 and 1997, the Company received (paid) approximately ($1,595,000), $2,232,000 and $551,000 from (to) Enron Capital and Trade Corp., an affiliate of a significant stockholder of the Company relating to financial instruments associated, primarily, with the Company's hedging activities. (Continued) F-18 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements The Company uses certain aircraft and receives services from an entity owned by an affiliate. The Company is billed for use of such aircraft and related services by the Company. Payments made for the use of such aircraft and related services were $279 and $3,371 for the years ended December 31, 1998 and 1997, respectively. The President, Chief Executive Officer and Chairman of the Board of the Company, and certain of his affiliates have a common ownership interest in oil and gas properties that are operated by the Company and, in accordance with a standard industry operating agreement, make payments to the Company of leasehold costs and lease operating and supervision charges. These payments were approximately $9,671, $43,019 and $88,473 in 1999, 1998 and 1997, respectively. Revenue received in connection with these oil and gas properties was $3,769, $12,350 and $16,098 in 1999, 1998 and 1997, respectively. These interests were owned by the Chief Executive Officer and his affiliates prior to the formation of the Company on March 31, 1995. During 1999 and 1998, the Company received fees of approximately $445,800 and $275,000, respectively, for managing the commercial and construction operations of DIGP. (13) Notes Receivable - Officers and Employees On November 11, 1999, certain officers and employees of the Company entered into promissory notes with the Company for the purpose of receiving funds to exercise stock options and pay tax obligations related to the option exercises. The option agreements of these officers and employees provided for the use of the promissory notes to exercise the options. The promissory notes and related interest are recourse to the officers and employees. The promissory notes are primarily secured by the Company's common stock issued pursuant to the option exercises. The interest rate on the promissory notes is initially 6.34% and will be adjusted each September 30 to the Company's cost of funds for the preceding twelve months. The principal and interest associated with the promissory notes is due in full on November 11, 2002. (14) Company Option Plans Stock Option Plan In 1996, the Company issued options to purchase 3,631,350 shares of Common Stock, at an exercise price of $2.08 per share in exchange for partnership unit options previously held by certain officers and employees in the Company's predecessor partnership. Deferred compensation was recorded based on the value of the Company's common stock on September 30, 1996, and was amortized to expense over a 39 month period. Deferred compensation of approximately $17,576,000 (before reduction by amounts previously amortized to expense) was recorded at September 30, 1996. On June 10, 1999, the board of directors of the Company extended the expiration date of all the options outstanding at June 9, 1999, under the Company's original stock option plan, to December 31, 2003. There were no other changes to the terms of the related options. The new measurement required by the extension of expiration date resulted in a lower amount of total compensation than originally measured. Consequently, neither the amount nor the amortization of compensation originally determined were adjusted. At December 31, 1999, all options under the Stock Plan were exercised. 1996 Incentive Plan The Board of Directors and the stockholders of the Company approved the adoption of the Company's 1996 Incentive Plan (the "1996 Incentive Plan") as of October 1, 1996. The purpose of the 1996 Incentive Plan is to (Continued) F-19 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements reward selected officers and key employees of the Company and others who have been or may be in a position to benefit the Company, compensate them for making significant contributions to the success of the Company and provide them with a proprietary interest in the growth and performance of the Company. Participants in the 1996 Incentive Plan are selected by the Board of Directors or such committee of the Board as is designated by the Board to administer the 1996 Incentive Plan (the Compensation Committee of the Board of Directors) from among those who hold positions of responsibility with the Company and whose performance, in the judgment of the Compensation Committee, can have a significant effect on the success of the Company. An aggregate of 850,000 shares of Common Stock have been authorized and reserved for issuance pursuant to the 1996 Incentive Plan. These options vest ratably on each of the first through fourth anniversaries of the grant date. In November 1998, 105,000 stock options of an officer, with a weighted average exercise price of $11.12 per share, were cancelled. The officer received 200,000 new stock options at an exercise price of $6.25 per share. The vesting of the new options is ratable over a four-year period from date of grant. Subject to the provisions of the 1996 Incentive Plan, the Compensation Committee will be authorized to determine the type or types of awards made to each participant and the terms, conditions and limitations applicable to each award. In addition, the Compensation Committee will have the exclusive power to interpret the 1996 Incentive Plan and to adopt such rules and regulations as it may deem necessary or appropriate in keeping with the objectives of the 1996 Incentive Plan. Pursuant to the 1996 Incentive Plan, participants will be eligible to receive awards consisting of (i) stock options, (ii) stock appreciation rights, (iii) stock, (iv) restricted stock, (v) cash or (vi) any combination of the foregoing. Stock options may be either incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, or nonqualified stock options. On June 10, 1999 the board of directors of the Company extended the expiration date two years for all the options outstanding at June 9, 1999, under the 1996 Incentive Plan. As the exercise price exceeded the current market price for the stock in all cases, no compensation expense was recorded. There were no other changes to the terms of the related options. OEDC Stock Awards Plan Pursuant to the OEDC merger agreement, the Company converted the outstanding stock options of OEDC to stock options of the Company at the agreed common stock exchange rate. At the date of the OEDC merger, there were 118,175 and 340,200 options to purchase shares of the Company common stock at $5.73 and $19.05 per share, respectively, and all options were exercisable. 1999 Option Plan The Board of Directors adopted the Company's 1999 Stock Option Plan (the "1999 Option Plan") on June 10, 1999. The purpose of the 1999 Option Plan is to retain and attract certain employees (non-officers) of the Company to encourage the sense of proprietorship of such employees and to stimulate the active interest of the employees in the development and financial success of the Company. Participants in the 1999 Option Plan are selected by the Board of Directors or such committee of the Board as is designated by the Board to administer the 1996 Option Plan (the Compensation Committee of the Board of Directors) from among those who hold positions of responsibility with the Company and whose performance, in the (Continued) F-20 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements judgment of the Compensation Committee, can have a significant effect on the success of the Company. An aggregate of 200,000 shares of Common Stock have been authorized and reserved for issuance pursuant to the 1999 Option Plan. These options vest ratably on each of the first through fourth anniversaries of the grant date. Subject to the provisions of the 1999 Option Plan, the Compensation Committee will be authorized to determine the terms, conditions and limitations applicable to each award. In addition, the Compensation Committee will have the exclusive power to interpret the 1999 Option Plan and to adopt such rules and regulations as it may deem necessary or appropriate in keeping with the objectives of the 1999 Option Plan. Stock options may be either incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, or nonqualified stock options. The Company applies APB 25 and related interpretations in accounting for its stock option plans. If compensation expense for the stock option plans had been determined in a manner consistent with Statement of Financial Accounting Standards 123, "Accounting for Stock-Based Compensation ("FAS 123"), the Company's net loss and net loss per share would have been adjusted to the pro forma amounts indicated below:
For the year ended December 31, ---------------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands, except per share amounts) Net loss $(5,981) $(46,314) $(39,676) Net loss per common share (.16) (1.19) (1.17) Net loss per share - assuming dilution (.16) (1.19) (1.17)
The pro forma net loss and pro forma net loss per share amounts noted above are not likely to be representative of the pro forma amounts to be reported in future years. Pro forma adjustments in future years will include compensation expense associated with the options granted in 1999, 1998 and 1997 plus compensation expense associated with any options awarded in future years. As a result, such pro forma compensation expense is likely to be higher than the levels experienced in 1999, 1998 and 1997. The total fair value of stock options granted in 1999, 1998 and 1997 was approximately $1,323,000, $1,273,000 and $3,349,000, respectively. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used: 1999 1998 1997 ---- ---- ---- Risk-free interest rate 5.32% 4.50% 5.25% Expected life 4.0 4.0 7.0 Expected volatility 49% 48% 46% Expected dividend yield - - - (Continued) F-21 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements A summary of the Company's stock option plans as of December 31, 1999, 1998 and 1997, and changes during the periods ended on those dates is presented below:
Year ended December 31, -------------------------------------------------------------------- 1999 1998 1997 ---------------------- --------------------- --------------------- Weighted Weighted Weighted Number Average Number Average Number Average of Shares Price of Shares Price of Shares Price ---------- -------- --------- -------- --------- -------- Stock options: Outstanding at beginning of year 4,260,147 $ 3.64 4,429,440 $ 4.15 3,716,350 $ 2.28 Options canceled/forfeited (219,545) $15.29 (356,614) $15.51 - - OEDC options assumed - - - - 458,375 $15.61 Options exercised (3,459,168) $ 2.08 (202,178) $ 2.71 (4,285) $ 2.08 Options granted 486,309 $ 4.79 389,499 $ 8.19 259,000 $10.95 ----------- ---------- ---------- Outstanding at end of year 1,067,743 $ 6.74 4,260,147 $ 3.64 4,429,440 $ 4.15 =========== ========== ========== Exercisable at end of year 295,351 $ 8.42 3,339,117 $ 3.09 2,470,133 $ 4.72 =========== ========== ========== Weighted average fair value of options granted during the year $ 4.79 $ 11.33 $ 10.95 =========== ========== ==========
The following table summarizes information about the stock options outstanding at December 31, 1999:
Options Outstanding Options Exercisable --------------------------------------------- ---------------------------- Number of Weighted- Weighted Number of Weighted- Shares Average Average Shares Average Outstanding at Remaining Exercise Exercisable at Exercise Range of Exercise Prices December 31, 1999 Contractual Life Price December 31, 1999 Price ------------------------ ----------------- ---------------- -------- ----------------- -------- $3.69 - $5.73 482,066 $6.82 $ 4.61 83,175 $ 5.73 $6.25 - $8.79 322,535 $5.72 $ 6.66 73,500 $ 6.83 $9.375 - $12.75 263,142 $4.39 $10.76 138,676 $10.88
(Continued) F-22 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (15) Net Loss per Common Share The following table sets forth the computation of basic and diluted net loss per common share:
Year ended December 31, ---------------------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Numerator: Net loss and numerator for basic and diluted net loss per common share - income available to common stockholders $(8,274) $(47,217) $(33,467) ======= ======== ======== Denominator: Denominator for basic net loss per common share - weighted average common shares 38,038 38,808 33,942 Effect of dilutive securities - employee stock options - - - ------- -------- -------- Denominator for diluted net loss per common share - adjusted weighted average common shares and assumed conversions 38,038 38,808 33,942 ======= ======== ======== Basic net loss per common share $ (.22) $ (1.22) $ (.99) ======= ======== ======== Diluted net loss per common share $ (.22) $ (1.22) $ (.99) ======= ======== ========
Employee stock options to purchase 1,067,743, 4,260,147 and 4,429,440 shares of common stock were outstanding during 1999, 1998 and 1997, respectively, but were not included in the computation of diluted net loss per common share because either (i) the employee stock options' exercise price was greater than the average market price of the common stock of the Company or (ii) the Company had a loss from continuing operations; and, therefore, the effect would be antidilutive. (16) 401(k) Plan The Company has established a qualified cash or deferred arrangement under IRS code section 401(k) covering substantially all employees. Under the plan, the employees have an option to make elective contributions of a portion of their eligible compensation, not to exceed specified annual limitations, to the plan and the Company has an option to match a portion of the employee's contribution. The Company has made matching contributions to the plan totaling $493,927, $632,883 and $110,981 in 1999, 1998 and 1997, respectively. (Continued) F-23 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (17) Major Customers The following purchasers accounted for 10% or more of the Company's oil and gas sales: 1999 1998 1997 ---- ---- ---- Purchaser A (a) 36% 31% 36% Purchaser B 16% 13% 12% Purchaser C 7% 13% 9% ________________ (a) Purchaser A is an affiliate of Enron Corp., a significant stockholder of the Company. (18) Derivative Financial Instruments The Company utilizes various option and swap contracts and other financial instruments to hedge the effect of price changes on future oil and gas production. The index price for the natural gas collars settles based on NYMEX Henry Hub, while the oil collar settles based on the prices for West Texas Intermediate on NYMEX. The basis swaps lock in the basis differential between NYMEX Henry Hub and the El Paso/Permian delivery point or the Waha West Texas delivery point. The following table sets forth the future volumes hedged by year and the range of prices to be received based upon the fixed price of the individual option and swap contracts and other financial instruments outstanding at December 31, 1999:
2000 2001 ---- ---- Gas related derivatives: Collar options: Volume (MMBtu) 5,475,000 -- Index price per MMBtu (floor - ceiling prices) $ 2.50 - $2.95 $ -- Basis swaps: Volume (MMBtu) 8,215,000 -- Index Price per MMBtu $ .132 $ -- Oil related derivatives: Collar options (a): Volume (Bbls) 1,463,000 452,500 Index price per Bbl (floor - ceiling prices) $17.06 - $21.47 $16.50 - $20.48
________________ (a) Includes amounts in which a counterparty has the option to extend the collar option from July 1, 2000 to June 30, 2001, on volumes of 2,500 Bbls per day at a floor and ceiling price of $16.50 and $20.48 per barrel, respectively. (Continued) F-24 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (19) Impairment of Long-Lived Assets Assets Held for Use The Company, in accordance with FAS 121, estimated expected future cash flows of its oil and gas properties by amortization unit and compared the amounts determined to the carrying amount of its oil and gas properties to determine if the carrying amount was recoverable. For those oil and gas properties for which the carrying amount exceeded the estimated future net cash flows, an impairment was determined to exist; therefore, the Company adjusted the carrying amount of those oil and gas properties to their estimated fair value as determined by discounting their expected future net cash flows at a discount rate commensurate with the risks involved in the industry. As a result of this process, the Company recognized an impairment of approximately $5.9 million, $22.2 million and $69.0 million related to its oil and gas properties during 1999, 1998 and 1997, respectively. The impairment expense of $5.9 million and $22.2 million in 1999 and 1998, respectively, relates principally to negative revisions to reserve volumes. The impairment expense of $69.0 million recorded at December 31, 1997 was principally as a result of the low pricing environment existing at that date and the limited prospects for commodity price improvements. Estimated future cash flows for purposes of determining impairment of oil and gas properties are determined using the following assumptions: . Reserve economics are adjusted for known changes such as extensions and discoveries, acquisitions and dispositions of proved properties and changes in production rates and projected decline characteristics. . Only cash flows from proved oil and gas properties, such as disclosed in Note 22, are considered in the analysis. . The prices used for determining cash flows are determined based on the near-term (a period of one to three years, depending on management's current views of future market conditions) NYMEX futures index adjusted for property specific qualitative and location differentials. The latest futures price in the near-term price outlook is then held constant for the remaining life of the properties. Prices estimated for future periods may be above or below current pricing levels. For example, futures prices for periods following December 31, 1998 were significantly higher than the actual prices for oil and gas as of that date, and futures prices for the period following December 31, 1999 were significantly below the actual prices for oil and gas as of that date. Consequently, the prices used in the Company's impairment analysis were adjusted accordingly. . If production is subject to hedges, future product prices are further adjusted to reflect the prices to be realized under these arrangements. In 1998, the Company recognized an impairment of approximately $2.2 million on its investment in a limited partnership. This impairment was due to a significant decrease in the fair value of publicly traded securities held by the limited partnership. Assets Held for Sale The Company, in accordance with FAS 121, records its assets held for sale at the lower the carrying amounts or fair value. When the carrying amount of the assets held for sale exceed fair value an impairment is recognized. Fair value for the Company's assets held for sale is generally the estimated sales proceeds for the assets less estimated costs to sell the assets. The Company generally determines the estimated sales proceeds at each measurement period based on a number of factors, including: . Prices at which similar assets are presently being bought and sold. . Reserve report evaluations of the properties' future cash flows. . Current industry oil and gas price outlook. . Information from financial firms. . Other available industry data. In the fourth quarter of 1998, the Company approved a plan to dispose of its Gulf of Mexico, Gulf Coast and non-strategic Permian Basin assets. The assets to be disposed of were primarily proved and unproved oil and gas properties or investments in midstream oil and gas assets. The Company's reason for disposing of these assets varied depending on the portfolio of assets being considered. The disposition would allow the Company to (a) realize full value for certain assets whose value was not fully reflected in the public valuation of the Company, (b) redeploy capital to higher return projects or acquisitions, (c) invest in projects that would accelerate cash flow to the Company, (d) eliminate certain administrative costs and (e) reduce the Company's debt obligations. The Company's basis in the assets held for sale (net of any impairment) at December 31, 1998 was approximately $110 million. In 1998, the Company recognized an impairment of approximately $1.3 million on the assets held for sale. The impairment was the result of comparing the estimated sales proceeds, less costs to sell, to the underlying net cost basis of each specific portfolio of assets. In the first quarter of 1999, the Company recognized an impairment of $25.9 million on the assets held for sale, related to its Gulf Coast and Gulf of Mexico assets. The impairment was the result of comparing the revised estimated sales proceeds, less costs to sell, to the underlying net cost basis of each specific portfolio of assets. The downward revision in the estimated sales proceeds leading to the impairment was primarily the result of (a) continued low oil and gas prices, (b) decreases in prices for which similar assets were being bought and sold and (c) receipt of offers for the Gulf Coast and Gulf of Mexico assets which lowered management's estimation of ultimate sales proceeds. In April 1999, the Company sold the Gulf Coast assets, which were comprised of proved and unproved oil and gas properties, for approximately $5.4 million. In May 1999, the Company sold the Gulf of Mexico assets, which were comprised of proved and unproved oil and gas properties and investments in midstream oil and gas assets, for approximately $71.3 million. In the fourth quarter of 1999, the Company reclassified from assets held for sale approximately $15.2 million of Permian Basin assets to assets held for use. When these assets were evaluated in conjunction with the properties involved in the Unocal merger it became apparent that these properties had location and leasehold attributes which may be valuable to the combined assets. The assets were reclassified at their lower of the carrying amount or fair value. (Continued) F-25 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements The following are the results of operations of the assets held for sale and other assets sold (in thousands):
1999 1998 1997 ---- ---- ---- Oil and gas sales $ 3,106 $ 9,646 $ 1,980 Oil and gas production costs (1,566) (6,134) (986) Production and other taxes (59) (188) (79) General and administrative expenses (745) (2,215) - Exploration and abandonment costs (383) (2,111) - Depletion, depreciation and amortization (1,570) (6,259) - Impairment of long-lived assets (25,900) (16,463) (14,651) Equity loss in net loss of affiliates (115) (458) - Other 541 579 - -------- -------- -------- $(26,691) $(23,603) $(13,736) ======== ======== ========
The Company suspends depreciation, depletion and amortization expense on assets once they are classified as assets held for sale. In 1999, the suspended depreciation, depletion and amortization expense was approximately $1.9 million. In 1998, the Company had no suspended depreciation, depletion and amortization expense as the reclassification to assets held for sale occurred at December 31, 1998. (20) Other Liabilities The other current and noncurrent liabilities consist of the following (in thousands):
December 31, --------------------------------- 1999 1998 ---- ---- Other current liabilities: Capital costs and operating expenses $6,079 $2,220 Gas processing obligation - 564 Restructuring costs - 625 Oil and gas payable 1,108 1,106 Other 1,116 1,137 ------ ------ $8,303 $5,652 ====== ====== Other noncurrent liabilities: Gas processing obligation $ - $1,130 Environmental reserve 804 824 Plugging and abandonment reserve - 2,483 Gas and pipeline imbalances - 225 Other 23 591 ------ ------ $ 827 $5,253 ====== ======
(Continued) F-26 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (21) Exploration and Abandonments Exploration and abandonments expense consist of the following (in thousands):
1999 1998 1997 ---- ---- ---- Geological and geophysical staff $ 770 $ 1,283 $ - Uneconomical exploratory wells 4,948 2,593 723 Impaired unproved properties 775 9,870 331 Seismic costs 3,416 1,130 1,436 Delay rentals 276 1,685 205 Plugging and abandonment reserve 134 525 - Other 730 510 360 ------- ------- ------ $11,049 $17,596 $3,055 ======= ======= ======
(Continued) F-27 TITAN EXPLORATION, INC. Notes to Consolidated Financial Statements (22) Unaudited Supplementary Information Capitalized Costs
December 31, --------------------------- 1999 1998 ---- ---- (in thousands) Oil and gas properties: Proved oil and gas properties $ 345,349 $299,412 Unproved properties 13,438 6,699 --------- -------- 358,787 306,111 Accumulated depletion (128,686) (96,934) --------- -------- Net capitalized costs for oil and gas properties $ 230,101 $209,177 ========= ========
Costs Incurred
Year ended December 31, ----------------------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Property acquisition costs: Proved $ 7,892 $ 404 $100,871 Unproved 8,211 4,994 24,532 Exploration 17,087 21,316 2,856 Development 12,176 30,663 44,896 ------- ------- -------- $45,366 $57,377 $173,155 ======= ======= ========
Reserve Quantity Information The estimates of proved oil and gas reserves, which are located principally in the United States and offshore Gulf of Mexico, were prepared and/or audited (audits are of significant value properties) by independent petroleum consultants as of December 31, 1999, 1998 and 1997. Reserves were estimated in accordance with guidelines established by the SEC and FASB which require that reserve estimates be prepared under existing economic and operating conditions with no provision for price and cost escalations except by contractual arrangements. The Company has presented the reserve estimates utilizing an oil price of $24.48, $9.49 and $16.11 per Bbl and a gas price of $1.73, $1.57 and $1.83 per Mcf as of December 31, 1999, 1998 and 1997, respectively. Oil and gas reserve quantity estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. The accuracy of such estimates is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of subsequent drilling, testing and production may cause either an upward or downward revision of previous estimates. Further, the volumes considered to be commercially recoverable fluctuate with changes in prices and operating costs. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of currently producing oil and gas properties. Accordingly, these estimates are expected to change as additional information becomes available in the future. (Continued) F-28 TITAN EXPLORATION, INC. Notes of Consolidated Financial Statements Oil And Gas Producing Activities
Oil and Natural Condensate (MBbl) Gas (MMcf) ----------------- ---------- Total Proved Reserves: Balance, December 31, 1996 19,456 301,378 Purchases of minerals-in-place 7,128 43,501 Extensions and discoveries 20 40,633 Revision of previous estimates 5,551 (18,036) Production (1,880) (22,104) ------ ------- Balance, December 31, 1997 30,275 345,372 Purchase of minerals-in-place 1,540 11,175 Sales of minerals-in-place (77) - Extensions and discoveries 2,127 12,742 Revision of previous estimates - price (7,877) (16,029) Revision of previous estimates - other (485) 5,441 Production (2,492) (26,731) ------ ------- Balance, December 31, 1998 (a) 23,011 331,970 Purchase of minerals-in-place 962 7,364 Sales of minerals-in-place (2,729) (59,911) Extensions and discoveries 1,631 35,641 Revision of previous estimates - price 11,425 6,969 Revision of previous estimates - other (198) (54,138) Production (2,272) (23,190) ------ ------- Balance, December 31, 1999 31,830 244,705 ====== ======= Proved Developed Reserves: December 31, 1996 16,024 180,161 December 31, 1997 23,604 219,307 December 31, 1998 13,233 202,203 December 31, 1999 22,374 149,908
_____________ (a) At December 31, 1998, total proved reserves included 2,735 MBbl and 42,945 MMcf of oil and natural gas, respectively, which are associated with oil and gas properties classified as assets held for sale in the consolidated balance sheets. (Continued) F-29 TITAN EXPLORATION, INC. Notes of Consolidated Financial Statements Standardized Measure Of Discounted Future Net Cash Flows The standardized measure of discounted future net cash flows is computed by applying year-end prices of oil and gas (with consideration of price changes only to the extent provided by contractual arrangements) to the estimated future production of proved oil and gas reserves, less estimated future expenditures (based on period-end costs) to be incurred in developing and producing the proved reserves, less estimated future income tax expenses (based on period-end statutory tax rates, with consideration of future tax rates already legislated) to be incurred on pretax net cash flows less tax basis of the properties and available credits, and assuming continuation of existing economic conditions. The estimated future net cash flows are then discounted using a rate of 10% per year to reflect the estimated timing of the future cash flows. Discounted future cash flow estimates like those shown below are not intended to represent estimates of the fair value of oil and gas properties. Estimates of fair value should also consider probable reserves, anticipated future oil and gas prices, interest rates, changes in development and production costs and risks associated with future production. Because of these and other considerations, any estimate of fair value is necessarily subjective and imprecise.
Year ended December 31, ------------------------------------------------------------- 1999 1998 1997 ------------------- ------------------- ------------------- (in thousands) Future: Cash inflows $1,203,070 $ 738,683 $1,121,526 Production costs (424,660) (241,570) (345,598) Development costs (63,657) (59,976) (46,877) Future income taxes (150,689) (34,387) (153,100) ---------- --------- ---------- Future net cash flows 564,064 402,750 575,951 10% annual discount for estimated timing of cash flows (230,701) (166,122) (226,901) ---------- --------- ---------- Standardized measure of discounted net of cash flows $ 333,363 $ 236,628 (a) $ 349,050 ========== ========= ==========
_______________ (a) At December 31, 1998, the standardized measure of discounted net cash flows included approximately $39.2 million which are associated with oil and gas properties classified as assets held for sale in the consolidated balance sheets. (Continued) F-30 TITAN EXPLORATION, INC. Notes of Consolidated Financial Statements Standardized Measure Of Discounted Future Net Cash Flows Changes in Standardized Measure of Discounted Future Net Cash Flows
Year ended December 31, ---------------------------------------------------------- 1999 1998 1997 ------------------ ------------------ ------------------ (in thousands) Standardized measure, beginning of period $236,628 $ 349,050 $ 387,863 Extensions and discoveries and improved recovery, net of future production and development costs 34,054 15,155 36,439 Accretion of discount 23,663 34,905 38,786 Net change in sales prices, net of production costs 169,586 (106,032) (180,281) Net change in income taxes (73,789) 80,444 40,115 Purchase of minerals-in-place 16,907 11,338 72,241 Sales of minerals-in-place (54,847) (235) - Revision of quantity estimates and revenues added by development drilling 18,530 (33,892) 11,615 Sales, net of production costs (50,959) (40,073) (51,846) Changes in estimated future development costs (32,601) (23,040) (7,904) Changes in production rates and other 46,191 (50,992) 2,022 -------- --------- --------- Standardized measure, end of period $333,363 $ 236,628 $ 349,050 ======== ========= =========
(Continued) F-31 TITAN EXPLORATION, INC. Notes to Consoliadated Financial Statements (23) Selected Quarterly Financial Results (Unaudited)
Quarter ---------------------------------------------------------------------- First Second Third Fourth ---------------- ---------------- ---------------- ---------------- (in thousands, except per share data) 1999: Total revenues $ 14,780 $17,441 $21,225 $ 22,271 Total expenses (a) 44,783 19,216 17,351 2,641 Net income (loss) (30,003) (1,775) 3,874 19,630 Net income (loss) per common share (.79) (.05) .10 .51 Net income (loss) per common share - assuming dilution (.79) (.05) .10 .50 1998: Total revenues $ 22,107 $18,361 $16,671 $ 15,737 Total expenses (b) 23,432 26,260 23,103 47,298 Net loss (1,325) (7,899) (6,432) (31,561) Net loss per common share (.03) (.20) (.17) (.83) Net loss per common share - assuming dilution (.03) (.20) (.17) (.83)
______________________ (a) Total expenses in the first and fourth quarter of 1999 includes impairment of long-lived assets of approximately $25.9 million and $5.9 million, respectively. The fourth quarter of 1999 includes a deferred tax benefit of approximately $23.5 million related to the reduction in the deferred tax assets valuation allowance. (b) Total expenses in the second, third and fourth quarter of 1998 includes impairment of long-lived assets of approximately $8.0 million, $5.1 million and $12.6 million, respectively. F-32 EX-10.19 2 EMPLOY. AGREE. - JACK D. HIGHTOWER EXHIBIT 10.19 EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT (this "Agreement") is made between Titan Resources Holdings, Inc., a Delaware corporation (the "Company"), and Jack D. Hightower ("Executive"); W I T N E S S E T H: - - - - - - - - - - WHEREAS, pursuant to the terms and conditions of that certain Agreement and Plan of Merger (the "Merger Agreement"), dated December 13, 1999, among Union Oil Company of California, a California corporation ("Union Oil"), the Company, TRH, Inc., a Delaware corporation ("TRH"), and Titan Exploration, Inc., a Delaware corporation ("Titan"), TRH will be merged with and into Titan, which will be the surviving corporation and become a wholly-owned subsidiary of the Company; and WHEREAS, Executive is the Chairman of the Board, Chief Executive Officer and President of Titan; and WHEREAS, the Board of Directors of the Company (the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued dedication of Executive, notwithstanding the consummation of the transactions contemplated by the Merger Agreement or the possibility, threat or occurrence of a Change of Control (as defined below) of the Company; and WHEREAS, the Board believes it is imperative to diminish the inevitable distraction of Executive by virtue of the personal uncertainties and risks created by a pending or threatened Change of Control and to encourage Executive's full attention and dedication to the Company in the event of any pending or threatened Change of Control, and to provide Executive with compensation and benefits upon a Change of Control which ensure that the compensation and benefits expectations of Executive will be satisfied and which are competitive with those of other corporations; and WHEREAS, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement; NOW, THEREFORE, in consideration of the mutual promises contained herein, the parties, intending to be legally bound, agree as follows: 1. Effective Date. This Agreement shall become effective as of the date -------------- on which the transactions contemplated by the Merger Agreement are consummated (the "Effective Date") and shall terminate and be of no force or effect if the Merger Agreement is terminated in accordance with its terms. 2. Employment and Duties. Executive shall have such duties, functions, --------------------- responsibilities, and authority customarily appertaining to the position of President, Chief Executive Officer and Chairman of the Board in a corporation; subject, however, to the directives of the Board of Directors of the Company. Executive shall devote his full time, skill, and attention and his best efforts during normal business hours to the business and affairs of the Company, and in furtherance of the business and affairs of the Company and its subsidiaries; except for usual, ordinary, and customary periods of vacation and absence due to illness or other disability; provided, however, that Executive may devote reasonable periods of time in connection with the following activities, if such activities do not materially interfere with the performance of Executive's duties and services hereunder and do not consume more than 10% of Executive's working hours (which for purposes hereof will generally constitute a 40 hour work week): (a) serving as a director or a member of a committee of any organization, if serving in such capacity does not involve any conflict with the business of the Company and its subsidiaries and such organization is not in competition in any manner whatsoever with the business of the Company and its subsidiaries (it being acknowledged by the parties that Employee's service as an advisory director of Chase Bank, Midland, Texas is permissible hereunder); (b) fulfilling speaking engagements; (c) engaging in charitable and community activities; and (d) managing his personal investments. 3. Base Compensation. ----------------- (a) Salary. The Company shall pay Executive for his services under this ------ Agreement a base annual salary as may be determined by the Board of Directors from time to time, provided that such salary shall not be less than $480,000 (before federal and state withholdings). The base salary shall be payable semi- monthly or in such other installments as shall be consistent with the Company's general payroll practices. (b) Bonus. In addition to his annual base salary, Executive shall be ----- entitled to an annual cash bonus in an amount, as may be determined by the Board of Directors from time to time, provided that such cash bonus shall not be less than $240,000. 4. Fringe Benefits. During the term hereof, Executive shall be entitled --------------- to participate in any benefit programs and incentive plans applicable to all employees or to executive employees of the Company on the same basis as such benefits and plans are customarily made available by the Company from time to time, including without limitation all employee retirement, insurance, vacation, sick leave, long-term disability and other benefit programs, and grants of rights or options to acquire equity interests or other awards provided for under the Company's incentive plans, as such benefits and plans may be modified, amended or terminated from time to time. 5. Professional Organization Dues. The Company shall pay the initiation ------------------------------ fees and periodic dues for membership in any oil and gas professional organizations including the National Petroleum Council in which Executive is currently a member, or which are otherwise approved by 2 the Board of Directors of the Company, and the Company shall pay all charges and expenses, including reasonable travel expenses, incurred by Executive in connection with membership in such organizations. 6. Vacations. Executive shall be entitled to take such vacations as he --------- may desire, with pay, provided that such vacations do not interfere with the performance of his duties and services hereunder. 7. Business Expenses. Executive shall be reimbursed by the Company for ----------------- expenses reasonably paid or incurred by him in connection with the performance of his duties hereunder upon presentation of expense statements, receipts or vouchers or such other supporting information reasonably evidencing such expenses. 8. Term. The term of Executive's employment by the Company hereunder ---- shall initially be for a period of three (3) years commencing on the Effective Date of this Agreement. Beginning on the first anniversary of the Effective Date of this Agreement, and on each subsequent anniversary thereof (each such anniversary being referred to as an "Extension Date"), the term of this Agreement shall be extended for an additional one year period, unless either party provides written notice to the other prior to an Extension Date that the term of this Agreement shall not be extended. It is the express intent of both parties to this Agreement that the provisions of this Section 8 are intended to ensure that upon notice of an election not to extend the term of this Agreement, the remaining term of this Agreement will at all times be not less than three (3) years. 9. Termination. Executive's employment with the Company shall terminate ----------- upon the first to occur of the (i) expiration of the term of this Agreement (as extended pursuant to Section 9 hereof), (ii) death of Executive, (iii) disability of Executive, but only upon compliance with the provisions of Section 11 hereof, (iv) termination of Executive for Cause (as defined in Section 12), (v) termination by Executive pursuant to Section 13 hereof, or (vi) written consent of all parties to this Agreement. 10. Death of Executive. The employment of Executive hereunder shall cease ------------------ on the date of his death. The Company will purchase life insurance on the life of Executive in an amount not less than $3,000,000, the benefits of which will be payable one-half to Executive's beneficiary and one-half to the Company. Executive's "beneficiary" is the person or persons (who may be designated concurrently, successively or contingently) designated by Executive in his last effective writing filed with the Company prior to his death, or if Executive shall have failed to make an effective designation, Executive's beneficiary is his spouse, if Executive is married and his spouse is living at the time of each payment, and otherwise his surviving children. Executive shall assist the Company in procuring such insurance by submitting to such examinations and by signing such applications and other instruments as may be reasonable and as may be required by the insurance carriers to which application is made for any such insurance. Executive represents that, to the best of his knowledge, he is currently insurable at standard premium rates for life insurance policies. 3 11. Disability of Executive. If, as a result of Executive's incapacity ----------------------- due to physical or mental illness, Executive shall have been absent from his duties hereunder on a full-time basis for the entire period of six consecutive months, and within thirty (30) days after written notice of termination is given (which may occur before or after the end of such six-month period) shall not have returned to the performance of his duties hereunder on a full-time basis (a "Disability"), employment of Executive hereunder shall cease. The Company shall purchase disability insurance to cover such a contingency with coverage and benefits mutually agreeable to the Company and Executive. Executive shall assist the Company in procuring such insurance by submitting to such examinations and by signing such applications and other instruments as may be reasonable and as may be required by the insurance carriers to which application is made for any such insurance. Executive represents that, to the best of his knowledge, he is currently insurable at standard premium rates for disability insurance policies. During any period prior to termination during which Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("disability period"), Executive shall continue to receive his full salary at the rate then in effect for such period until his employment terminates pursuant to this Section 11. If employment of Executive hereunder terminates because of Executive's incapacity, Executive (or, in the event of his legal incapacity, a court- appointed guardian for his benefit) shall receive those benefits payable under the disability policy or policies (purchased in compliance with the foregoing provisions) in effect at such time. 12. Termination for Cause. The Company may terminate Executive's --------------------- employment hereunder for Cause. For purposes of this Agreement, the Company shall have "Cause" to terminate Executive's employment hereunder upon (A) Executive's conviction of, or plea of nolo contendere to, any felony of theft, fraud, embezzlement or violent crime; (B) the willful and continued failure by Executive to substantially perform Executive's duties with the Company (other than such failure resulting from Executive's incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to Executive by the Board, which specifically identifies the manner in which the Board believes that Executive has not substantially performed Executive's duties or (C) the willful engaging by Executive in misconduct which is materially injurious to the interests of the Company or any successor thereto (or any affiliate of the Company or a successor thereto). For purposes of this Section 12, no act, or failure to act, on Executive's part shall be considered "willful" unless done, or omitted to be done, by Executive not in good faith and without reasonable belief that Executive's action or omission was in the best interest of the Company. Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to Executive a copy of a notice of termination from the Board, after (x) reasonable notice to Executive, (y) an opportunity for Executive, together with Executive's counsel (the reasonable fees of which the Company shall pay promptly as incurred), to be heard before the Board, finding that, in the good faith opinion of the Board, Executive was guilty of conduct set forth above in clauses (A), (B) or (C) of the second sentence of this Section 12 and specifying the particulars thereof in detail, and (z) in the case of conduct set forth in clause (B), a period of not less than sixty (60) days to remedy same. 4 13. Termination by Executive. Executive may terminate his employment ------------------------ hereunder (i) for Good Reason, or (ii) for any other reason upon providing at least 30 days advance written notice. For purposes of this Agreement, "Good Reason" shall mean any of the following (without Executive's express written consent): (a) A failure by the Company to comply with any material provision of this Agreement which has not been cured within sixty (60) working days after notice of such noncompliance has been given by Executive to the Company; (b) A material change in the nature or scope of Executive's duties from those engaged in by Executive immediately prior to the date of this Agreement; (c) A reduction in Executive's annual base compensation from that provided to him pursuant to this Agreement; (d) A material diminution in Executive's eligibility to participate in or in the benefits provided to Executive under any bonus, stock option or other incentive compensation plans or employee welfare and pension benefit plans (including medical, dental, life insurance, retirement and long-term disability plans) from that provided to him on the date of this Agreement; (e) Any required relocation of Executive outside of Texas (including any required business travel in excess of the greater of 90 days per year or the level of business travel of Executive for the year prior to the date of this Agreement); (f) Executive and the Company, or any successor thereto, shall fail to reach an agreement on or prior to the date of closing of a transaction that constitutes a Change of Control as to the terms of Executive's employment following such Change of Control, which terms are acceptable to Executive in his sole discretion; or (g) Union Oil, together with all "affiliates" and "associates" (as such terms are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) of such person (as well as any "Person" or "group" as those terms are used in Sections 13(d) and 14(d) of the Exchange Act), shall become the "beneficial owner" or "beneficial owners" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of securities of the Company representing in the aggregate 85% or more of either the then outstanding shares of common stock of the Company or the Voting Securities of the Company. An election by Executive to terminate for Good Reason shall not be deemed a voluntary termination of employment by Executive for the purpose of this Agreement or any plan or practice of the Company. 14. Notice of Termination. Any termination of Executive's employment by --------------------- the Company or by Executive pursuant to Sections 11, 12 or 13 shall be communicated by written Notice of 5 Termination to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provisions in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed or provide a basis for termination of Executive's employment under the provision so indicated. 15. Termination of Employment for Cause or Without Good Reason. ---------------------------------------------------------- (a) If the Company shall terminate Executive's employment for Cause, then upon such termination all rights, benefits and compensation of Executive under this Agreement shall immediately terminate, except that equity options, if any, shall continue to be governed in accordance with their terms. The rights and remedies of the Company as set forth in this Section 15(a) shall be cumulative with and shall be in addition to (i) any and all other relief available to the Company for breach by Executive of any other provision of this Agreement, and (ii) any and all other general or equitable relief to which the Company may be entitled by reason of such breach. (b) If Executive shall voluntarily terminate his employment other than for Good Reason, then (i) within 30 days following such termination, the Company shall pay to Executive a sum equal to (A) the amount of Executive's annual base salary, plus (B) an amount equal to the average annual bonus received by Executive pursuant to Section 3(b) hereof during the immediately preceding three (3) years (but in no event less than $240,000), (ii) Executive shall be entitled to continue to participate in all benefit programs and incentive plans as provided in Section 4 of this Agreement during a period equal to the remainder of Executive's employment term hereunder, and (iii) all restricted stock, options or other rights with respect to equity interests in the Company and/or its affiliates granted to Executive on or before such date of termination shall continue to be governed in accordance with their terms. 16. Other Termination of Employment. If Executive shall terminate his ------------------------------- employment for Good Reason under Section 13 hereof or other than for death under Section 10, disability under Section 11 or pursuant to Section 15, then (i) within 30 days following such termination, upon Executive's execution of the General Release, the Company shall pay to Executive an amount equal to three (3) times the sum of (A) the amount of Executive's annual base salary, plus (B) an amount equal to the average annual bonus received by Executive pursuant to Section 3(b) hereof during the immediately preceding three (3) years (but in no event less than $240,000), (ii) Executive shall be entitled to continue to participate in all benefit programs and incentive plans as provided in Section 4 of this Agreement during a period equal to the remainder of Executive's employment term hereunder, (iii) all restricted stock, options or other rights with respect to equity interests in the Company and/or its affiliates granted to Executive on or before such date of termination shall immediately vest as of the date of such termination, and (iv) the Company or any successor thereto (or an affiliate of the Company or any successor thereto) shall take all such action as may be necessary or appropriate to amend any option to purchase the Company's common stock held by Executive to provide that such option will not terminate as a result of or in connection with Executive's termination of employment with the Company or any successor thereto (or an affiliate of the Company or any successor thereto), but may continue to be exercised following such termination of employment until the date on which such options otherwise would terminate or 6 expire; provided that, the Company shall also pay to Executive those amounts provided in Sections 10 and 11 pursuant to the terms thereof. 17. Change of Control. For purposes of this Agreement, a "Change of ----------------- Control" shall be deemed to have occurred if a Company Change of Control or a Unocal Change of Control (each as defined in Section 18) occurs. 18. Put Right. --------- (a) Upon the occurrence of a Put Event, Executive shall have the option (the "Put Option"), exercisable at any time before the 90th day after the Put Event, to sell to the Company all or part (in each case, subject to Section 18(e)) of his Continuing Company Shares at a price calculated in accordance with the provisions of Section 18(d); provided, however, that if Executive fails to exercise such Put Option (other than with respect to a Put Event described in clause (C) of the definition of Put Event) or exercises such Put Option for less than all of his Continuing Company Shares, Executive shall not have the right to require the Company to purchase any shares upon the occurrence of any future Put Event. If Executive exercises the Put Option within the specified period by giving notice (the "Put Notice") to the Company of his or her election to do so (the date such notice is given is the "Put Date"), the Company shall be required to purchase all (but, subject to Section 18(e), not less than all) of the Continuing Company Shares specified by Executive in the Put Notice, such purchase to be effected in the manner, upon the terms and for the consideration set forth hereafter. (b) The consummation of any purchase required under this Section 18 shall be held at a "Put Closing", and the time and date upon which the Put Closing shall take place shall constitute the "Put Closing Date". The Put Closing shall be held at the principal office of the Company on the date designated by Executive in the Put Notice or on such other date as shall be mutually agreed upon in writing by the Company and Executive; provided, however, that the Put Closing Date shall not be more than 30 days (or a period of such additional length as reasonably necessary to complete the additional valuations contemplated in the definition of Net Asset Value) nor less than three days after the delivery of the Put Notice. In addition to providing the Put Closing Date, the Put Notice shall set forth the number of shares to be purchased by the Company and the Purchase Price (as defined below). (c) At the Put Closing, Executive shall present to the Company all share certificates or option agreements for Continuing Company Shares required to be purchased, duly endorsed in blank and in proper form for transfer, or with separate stock powers attached, duly endorsed in blank and in proper form for transfer, free and clear of any encumbrances. At the Put Closing, the Company, upon receipt of a conforming tender from Executive, shall tender full payment of the Purchase Price in immediately available funds by confirmed wire transfer to a bank account to be designated by Executive (such designation to occur no later than the second business day prior to the Put Closing Date). 7 (d) The total purchase price (the "Purchase Price") for all the shares of Common Stock to be purchased pursuant to this Section 18 shall be equal to the number of shares of Continuing Company Shares held by, or issuable to, Executive which are subject to the Put Closing multiplied by the Price Per Share. The "Price Per Share" shall be equal to the Net Asset Value divided by the Fully- Diluted Outstanding Share Amount, each determined as of the Put Date. (e) If the Company is unable to consummate any desired purchase of Continuing Company Shares pursuant to the terms of this Agreement because of limitations contained in the Delaware Business Corporation Act (or a successor statute thereof) or other applicable law, the Company agrees to use its best efforts to take all such action as may be available to place the Company in a position to carry out any required purchase under this Agreement. If the Company, after the taking of any action by it as contemplated in the immediately preceding sentence, is unable to consummate the purchase of all the shares of Executive's Continuing Company Shares as required, the Company shall purchase at the applicable price all shares of Continuing Company Shares that the Company shall then be authorized to purchase under the provisions of applicable law, and shall purchase the remainder of such shares as soon thereafter as possible at the applicable price, plus accrued interest on such purchase price at the floating prime borrowing rate specified by the lead bank on the Company's principal revolving credit facility or, if there is no such bank, a comparable prime rate selected in good faith by the Board of Directors. (f) Each of the following terms has the meaning set forth below: (i) "Common Stock" means the common stock, par value $.01 per share, of the Company. (ii) A "Company Change of Control" shall be deemed to have occurred for purposes of this Agreement if: (A) individuals who, as of the date hereof, constitute the Board of Directors of the Company (the "Company Incumbent Board") cease for any reason to constitute at least 40% of such Board of Directors, provided that any person becoming a director subsequent to the date hereof whose election, or nomination for election by the stockholders of the Company was approved by a vote of at least a majority of the directors then comprising the Company Incumbent Board shall be, for purposes of this Agreement, considered as though such person were a member of the Company Incumbent Board; (B) the stockholders of the Company approve a reorganization, merger or consolidation, in each case, with respect to which persons who were the stockholders of the Company immediately prior to such reorganization, merger or consolidation do not, immediately thereafter, own voting securities representing more than 40% of the Voting Securities of the reorganized, merged or consolidated company; 8 (C) the Company sells, leases or exchanges or agrees to sell, lease or exchange all or substantially all of its assets to any other person or entity; (D) the Company adopts a plan of dissolution or liquidation; or (E) any "person," as that term is defined in Section 3(a)(9) of the Exchange Act (other than Union Oil or any affiliate thereof and other than the Company, any of its subsidiaries, any employee benefit plan of the Company or any of its subsidiaries, or any entity organized, appointed or established by the Company for or pursuant to the terms of such a plan), together with all "affiliates" and "associates" (as such terms are defined in Rule 12b-2 under the Exchange Act) of such person (as well as any "Person" or "group" as those terms are used in Sections 13(d) and 14(d) of the Exchange Act), shall become the "beneficial owner" or "beneficial owners" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of securities of the Company representing in the aggregate 40% or more of either the then outstanding shares of Common Stock or the Voting Securities of the Company. (iii) "Continuing Company Shares" means 1,888,582 shares of Common Stock, being the shares resulting from the conversion in TRH, Inc.'s merger with Titan pursuant to the Merger Agreement of shares of Titan common stock owned by Executive as of December 1, 1999, plus any shares of Common Stock acquired by Executive pursuant to the exercise of any stock options previously or hereafter granted to Executive pursuant to any stock option or similar stock incentive plan of the Company. (iv) "Fully-Diluted Outstanding Share Amount" means that number of shares of Common Stock that would be issued and outstanding after taking into account the conversion or exchange of all issued and outstanding securities of the Company or any of its affiliates which are convertible or exchangeable into Common Stock. (v) "Net Asset Value" means (A) 110% of the following amount: (1) the net equity ownership in the proved reserves of the Company, calculated using the average of the three-year strip price for the 120 days prior to the Put Date (NYMEX less applicable differentials) at a 10% discount rate and reflecting any increase or decrease resulting from hedges in place, plus (2) the proved reserves not included within the terms of the preceding clause (1), calculated as in clause (1), attributable to the Company's net equity interest in any corporation, partnership, limited liability company or other entity (including the Company's net equity interest in proved reserves resulting from any promoted interest, back-in after payout or other carried or increasing interest in such entities) as of the Put Date; less (B) the funded debt, including bank debt and senior and subordinated debt securities issued pursuant to indentures of the Company, as of the Put Date; and less (C) such funded debt attributable to the Company's net equity interest in each corporation, partnership, limited liability company or other entity referred to in clause (A)(1), as of the Put Date. In no event shall "Net Asset Value" include the value of public securities, purchased by the Company in the 9 open market, of issuers in which the Company has no control or board representation. For purposes of valuing the proved reserves of the Company, such proved reserves shall be determined at the sole discretion of the Board of Directors (the"First Valuation"); provided, however, that, if the First Valuation is not acceptable to Executive, he may request a second valuation to be performed at his cost by a third party, independent engineering firm (the "Second Valuation"); provided further, if the Second Valuation is not acceptable to the Company, the Executive and the Company shall select another third party firm to perform a final valuation (the "Final Valuation") and the cost of the Final Valuation shall be shared equally by the Company and the Executive. If the Final Valuation exceeds the Second Valuation, the Second Valuation shall be used in determining Net Asset Value. If the First Valuation exceeds the Final Valuation, the First Valuation shall be used in determining Net Asset Value. If the Final Valuation is between the First Valuation and the Second Valuation, an average of all three shall be used in determining Net Asset Value. (vi) "Put Event" means any of the following: (A) termination of Executive's employment by the Company without Cause (as defined in Section 12); (B) termination of Executive's employment for any reason on or after the third anniversary of the date of this Agreement; (C) occurrence of a Company Change of Control or a Unocal Change of Control; (D) the death or Disability (as defined in Section 11) of Executive; (E) the termination by Executive of his employment with the Company for Good Reason (as defined in Section 13); or (F) Union Oil, together with all "affiliates" and "associates" (as such terms are defined in Rule 12b-2 under the Exchange Act) of such person (as well as any "Person" or "group" as those terms are used in Sections 13(d) and 14(d) of the Exchange Act), shall become the "beneficial owner" or "beneficial owners" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of securities of the Company representing in the aggregate 85% or more of either the then outstanding shares of common stock of the Company or the Voting Securities of the Company. (vii) "Unocal" means Unocal Corporation, a Delaware Corporation. (viii) A "Unocal Change of Control" shall be deemed to have occurred for purposes of this Agreement if: 10 (A) individuals who, as of the date hereof, constitute the Board of Directors of Unocal (the "Unocal Incumbent Board") cease for any reason to constitute at least 50% of such Board of Directors, provided that any person becoming a director subsequent to the date hereof whose election, or nomination for election by the stockholders of Unocal was approved by a vote of at least a majority of the directors then comprising Unocal Incumbent Board shall be, for purposes of this Agreement, considered as though such person were a member of Unocal Incumbent Board; (B) the stockholders of Unocal approve a reorganization, merger or consolidation, in each case, with respect to which persons who were the stockholders of Unocal immediately prior to such reorganization, merger or consolidation do not, immediately thereafter, own voting securities representing more than 50% of the Voting Securities of the reorganized, merged or consolidated company; (C) Unocal sells, leases or exchanges or agrees to sell, lease or exchange all or substantially all of its assets to any other person or entity; (D) Unocal adopts a plan of liquidation or dissolution; or (E) any "person," as that term is defined in Section 3(a)(9) of the Exchange Act (other than Unocal, any of its subsidiaries, any employee benefit plan of Unocal or any of its subsidiaries, or any entity organized, appointed or established by Unocal for or pursuant to the terms of such a plan), together with all "affiliates" and "associates" (as such terms are defined in Rule 12b-2 under the Exchange Act) of such person (as well as any "Person" or "group" as those terms are used in Sections 13(d) and 14(d) of the Exchange Act), shall become the "beneficial owner" or "beneficial owners" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of securities of Unocal representing in the aggregate 50% or more of either the then outstanding shares of common stock of Unocal or the Voting Securities of Unocal. (ix) "Voting Securities" means the combined voting power entitled to vote generally in the election of directors. 19. Legal Fees. The Company shall pay all reasonable legal fees and ---------- expenses promptly as they are incurred by Executive in seeking to obtain or enforce any right or benefit provided by this Agreement. 20. Gross-Up Payment. Notwithstanding any provision in this Agreement to ---------------- the contrary, if it shall be determined that any payment, distribution or transfer of property or rights thereto by the Company or any successor thereto to or for the benefit of Executive (whether paid, payable, distributed, distributable, transferred or transferable pursuant to the terms of this Agreement or otherwise, including but not limited to the acceleration of vesting of stock options), but determined 11 without regard to any additional payments required pursuant to this Section 20 (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), or any interest or penalties are incurred by Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, hereinafter collectively referred to as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment from the Company or its successor (a "Gross-Up Payment") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, Executive retains an amount of Gross-Up Payment equal to the Excise Tax imposed upon the Payments. 21. Confidentiality; Non-Compete. During the time of Executive's ---------------------------- employment and for a period of one (1) year following the termination of Executive's employment with the Company, Executive agrees not to compete with the Company for any acquisition, prospect or project that the Company was pursuing prior to Executive's termination, and Executive shall hold in strict confidence and shall not, directly or indirectly, disclose or reveal to any person, or use for his own personal benefit or for the benefit of anyone else, any trade secrets, confidential dealings, or other confidential or proprietary information of any kind, nature, or description (whether or not acquired, learned, obtained, or developed by Executive alone or in conjunction with others) belonging to or concerning the Company or any of its subsidiaries, except (i) with the prior written consent of the Company duly authorized by its Board of Directors, (ii) in the course of the proper performance of Executive's duties hereunder, (iii) for information (x) that becomes generally available to the public other than as a result of unauthorized disclosure by Executive or his affiliates or (y) that becomes available to Executive on a nonconfidential basis from a source other than the Company or its subsidiaries who is not bound by a duty of confidentiality, or other contractual, legal, or fiduciary obligation, to the Company, or (iv) as required by applicable law or legal process. 22. Miscellaneous. (a) Notices. Any notice or communication required or ------------- ------- permitted hereunder shall be given in writing and shall be (i) sent by first class registered or certified United States mail, postage prepaid, (ii) sent by overnight or express mail or expedited delivery service, (iii) delivered by hand or (iv) transmitted by facsimile transmission, to the address or fax number for the party as set forth opposite such party's name on the signature page hereof, or to such other address or to the attention of such other person as hereafter shall be designated in writing by the applicable party in accordance herewith. Any such notice or communication shall be deemed to have been given as of the date of first attempted delivery at the address or fax number and in the manner provided above. (b) Successors and Assigns. This Agreement is personal in nature and ---------------------- neither of the parties hereto shall, without the consent of the other, assign or transfer this Agreement or any rights or obligations hereunder; provided, however, that in the event of a merger, consolidation or transfer or sale of all or substantially all of the assets of the Company, this Agreement shall be binding upon the successor to the Company's business and assets. 12 (c) Interpretation. When the context in which words are used in this -------------- Agreement indicates that such is the intent, words in the singular number shall include the plural and vice versa, and the words in masculine gender shall include the feminine and neuter genders and vice versa. (d) Severability. Every provision in this Agreement is intended to be ------------ severable. In the event that any provision of this Agreement shall be held to be invalid, the same shall not affect in any respect whatsoever the validity of the remaining provisions of this Agreement. (e) Captions. Any section or paragraph titles or captions contained in -------- this Agreement are for convenience only and shall not be deemed a part of the context of this Agreement. (f) Entire Agreement. This Agreement together with the Partnership ---------------- Agreement contains the entire understanding and agreement between the parties and supersedes any prior written or oral agreements between them respecting the subject matter contained herein. There are no representations, agreements, arrangements or understandings, oral or written, between and among the parties hereto relating to the subject matter of this Agreement which are not fully expressed herein or therein. (g) No Waiver. The failure of any party to insist upon strict performance --------- of a covenant hereunder or of any obligation hereunder, irrespective of the length of time for which such failure continues, shall not be a waiver of such party's right to demand strict compliance in the future. No consent or waiver, express or implied, to or of any breach or default in the performance of any obligation hereunder shall constitute a consent or waiver to or of any other breach or default in the performance of the same or any obligation hereunder. (h) Amendment. This Agreement may be changed, modified or amended only by --------- an instrument in writing duly executed by all of the parties hereto. Any such amendment shall be effective as of such date as may be determined by the parties hereto. (i) Enforcement. The Company may enforce this Agreement pursuant to the ----------- provisions of the Agreement of Limited Partnership of the Partnership, provided that in the event of a dispute, either General Partner of the Company shall have the right to enforce the provisions hereof. (j) Choice of Law. THIS AGREEMENT AND THE RIGHTS AND OBLIGATIONS OF THE ------------- PARTIES HEREUNDER SHALL BE GOVERNED BY TEXAS LAW. 13 IN WITNESS WHEREOF, the parties have executed this Agreement or caused the same to be executed by their duly authorized corporate officers, all as of the day and year first above written. "Executive" /s/ Jack D. Hightower ---------------------------------------- Jack D. Hightower "Company" TITAN RESOURCES HOLDINGS, INC. By: /s/ Phillip Ballard ------------------------------------- Phillip Ballard Vice President 14 EX-10.20 3 STOCKHOLDERS VOTING AGREEMENT Exhibit 10.20 PURE RESOURCES, INC. Amended and Restated Stockholders Voting Agreement ----------------------------- This AMENDED AND RESTATED STOCKHOLDERS VOTING AGREEMENT, dated April 10, 2000 (the "Agreement"), is made and entered into by and among Pure Resources, Inc., a Delaware corporation (the "Company"), Union Oil Company of California, a California corporation ("Union Oil"), and Mr. Jack D. Hightower, an individual who resides in Midland County, Midland, Texas ("CEO"). W I T N E S S E T H: WHEREAS, the Company (previously named Titan Resources Holdings, Inc.), Union Oil and CEO previously executed a Stockholders Voting Agreement dated December 13, 1999 (the "Original Agreement"); WHEREAS, the Company, Union Oil, TRH, Inc., a Delaware corporation and wholly-owned subsidiary of the Company ("Sub"), and Titan Exploration, Inc., a Delaware corporation ("Titan"), entered into an Agreement and Plan of Merger concurrently with the execution of the Original Agreement (the "Merger Agreement"), pursuant to which Sub shall be merged with and into Titan, which shall become a wholly-owned subsidiary of the Company (the "Merger"); WHEREAS, as a condition to the agreement of the parties to the Merger Agreement to enter into the Merger Agreement, the Company, Union Oil and CEO agreed to enter into the Original Agreement to provide for certain agreements relating to the composition of the Board of Directors of the Company following the Effective Time of the Merger (as defined in the Merger Agreement, the "Effective Time"); and WHEREAS, the Company, Union Oil and CEO now wish to modify, amend and restate the Original Agreement by this Agreement; NOW, THEREFORE, in consideration of the foregoing and the mutual agreements set forth herein the parties to this Agreement hereby agree as follows: 1. Definitions of Certain Agreement Terms. For purposes of this -------------------------------------- Agreement, the terms hereinafter set forth shall have the following definitions unless otherwise specifically stated: "Board" means the Board of Directors of the Company. "Bylaws" means the Bylaws of the Company as hereinafter amended or supplemented. "Capital Stock" means the Common Stock and any other capital stock of the Company. "Common Stock" means the common stock, par value $.01 per share, of the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Outside Director" means a person meeting the requirements of an "outside director" under the listing criteria policies of the New York Stock Exchange; provided that if none of the Company's securities are listed for trading on the New York Stock Exchange, then "Outside Director" means an "independent director" within the meaning of Rule 4200 of The Nasdaq Stock Market. "Person" means any individual, corporation, association, general or limited partnership, limited liability company, limited liability partnership, joint venture, trust, estate, other entity or organization or group. "SEC" means the United States Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended. "Union Oil Affiliate" means any natural person who is a partner, officer, director or employee of, or is (directly or indirectly) the owner of 10% or more of any class of equity securities of, Union Oil, Unocal Corporation, a Delaware corporation, or any of its subsidiaries (other than the Company or any of its subsidiaries). "Union Oil Ownership Percentage" means the percentage obtained by multiplying 100 by an amount equal to (i) the number of shares of Common Stock beneficially owned by Union Oil and its affiliates divided by (ii) the number of shares of Common Stock issued and outstanding. The terms "participant," "proxy" and "solicitation" shall be used as defined in Regulation 14A under the Exchange Act. The terms "beneficial ownership" and "group" shall be used as defined in Regulation 13D-G under the Exchange Act. The terms "affiliate" and "associate" shall be used as defined in Rule 12b-2 under the Exchange Act. 2. Shares Subject to Agreement. Each of Union Oil and CEO agrees that --------------------------- all shares of Capital Stock of the Company registered in its or his name or beneficially owned by it or him as of the date hereof and any and all other Capital Stock of the Company legally or beneficially acquired by Union Oil or CEO, as applicable, after the date hereof shall be subject to the provisions of this Agreement. 3. Term; Termination. This Agreement shall not become effective until ----------------- the Effective Time of the Merger, and shall terminate and be of no force or effect if the Merger Agreement is terminated in accordance with its terms. After the Effective Time of the Merger, this Agreement shall terminate upon the earlier to occur of (i) the sale or transfer by Union Oil or its affiliates of such number of shares of Capital Stock that causes the Union Oil Ownership Percentage to decline to 10% or less, or (ii) the date on which CEO is no longer Chief Executive Officer of the Company. 2 This Agreement may also be terminated by the written agreement of all parties hereto. In the event of the termination of this Agreement pursuant to this Section 3, this Agreement shall become void and have no effect. Nothing contained in this Section 3 shall relieve any party from liability for damages actually incurred as a result of any breach of this Agreement. 4. Merger Agreement. The parties acknowledge that pursuant to the Merger ---------------- Agreement, as amended, Union Oil has agreed to cause the directors of the Company from and after the Effective Time to consist of Darrell Chessum, Timothy H. Ling, Herbert C. Williamson, III, Graydon H. Laughbaum, Jr. and H.D. Maxwell as designees of Union Oil; CEO and George G. Staley as designees of CEO; until the next annual meeting of stockholders and until their respective successors are duly qualified and elected. If, prior to the consummation of the Merger, an Outside Director is nominated pursuant to Section 5(d) of this Agreement, the parties agree to cause the board size to be increased to eight persons and to cause such person to become a director designate of Union Oil from and after the Closing Date, to serve until the next annual meeting of stockholders and until his successor is duly qualified and elected. 5. Election of Directors. ---------------------- (a) At each election of directors of the Company during the term of this Agreement, each of Union Oil and CEO shall vote (including the taking of any action by written consent, as necessary or appropriate), and shall cause its affiliates to vote (including the taking of any action by written consent, as necessary or appropriate), all shares of Capital Stock which it or he is entitled to vote (or control the voting of, directly or indirectly) in favor of the slate of nominees as selected in accordance with Section 5(b), 5(c) and 5(d) for election to the Board. (b) Subject to the terms and conditions of this Section 5(b), for purposes of selecting the slate of nominees referred to in Section 5(a), Union Oil shall be entitled to nominate (i) five members of the Board, if the Union Oil Ownership Percentage is greater than 50%; (ii) four members of the Board, if the Union Oil Ownership Percentage is greater than 35% but not more than 50%; or (iii) two members of the Board, if the Union Oil Ownership Percentage is greater than 10% but not more than 35%. No more than two of the persons nominated pursuant to this Section 5(b) shall be Union Oil Affiliates. In the event that the Union Oil Ownership Percentage is greater than 35%, one of the Union Oil Affiliates nominated pursuant to this Section 5(b) must be approved by CEO and any non-Union Oil Affiliate nominated pursuant to this Section 5(b) must be approved by CEO, in each case such approval not to be unreasonably withheld. (c) Subject to the terms and conditions of this Section 5(c), CEO shall be entitled to nominate two members of the Board. Any person nominated pursuant to this Section 5(c) (other than CEO) must be approved by Union Oil, which approval shall not be unreasonably withheld. (d) In addition to the foregoing provisions of this Section 5, if at any time the Company is required to have, in addition to the seven directors nominated in accordance with the other provisions of this Section 5, an additional director who qualifies as an Outside Director to satisfy the listing requirements of principal securities exchange or quotation system on which the 3 Common Stock is then traded or quoted, then each of Union Oil and CEO shall propose two candidates who would qualify as Outside Directors. Union Oil and CEO shall attempt to agree on one candidate from among those proposed to be added to the Board as an Outside Director. If Union Oil and CEO cannot agree on one candidate from among those proposed within 30 days, then Union Oil will be entitled to nominate the Outside Director, subject to the approval of CEO, which approval may not be unreasonably withheld. Union Oil nor CEO shall be required to change one or more of their director nominations pursuant to Section 5(b) or (c) to satisfy an Outside Director requirement. (e) In the event that any director (a "Withdrawing Director") nominated in the manner set forth above is unable to serve, or once having commenced to serve, ceases for any reason to be a director, such Withdrawing Director's replacement (the "Substitute Director") on the Board shall be nominated by the party who nominated the Withdrawing Director, subject to the other provisions of this Section 5. The Company and each of the parties agree to take all action within their respective power, including, but not limited to, the voting of Capital Stock entitled to vote, to cause the election of such Substitute Director as soon as practicable following his designation, or instructing the directors it has previously nominated to serve as members of the Board, as the first order of business at the first meeting thereof after such Substitute Director has been so nominated, to vote to seat such nominated Substitute Director as a director in place of the Withdrawing Director. In the event any party entitled to nominate a director or directors pursuant to this Agreement fails to nominate a director or directors, such directorship or directorships shall remain vacant. (f) If the party who has nominated for election to the Board any director serving on the Board pursuant to the preceding provisions of this Section 5 requests that such director be removed (with or without cause) by written notice thereof to the other parties, then such director shall be removed (with or without cause) and each party hereby agrees to vote all shares of Capital Stock entitled to vote owned or held of record by such party to effect such removal upon any such request. No director nominated by a party shall otherwise be involuntarily removed as a director except for cause. For purposes of this Section 5(f), any Outside Director nominated in accordance with Section 5(d) shall be deemed to have been nominated by Union Oil. 6. Successors, Assigns and Transferees. The terms and provisions of this ----------------------------------- Agreement shall not bind, inure to the benefit of or be enforceable by or against the successors, assigns or transferees of each of the parties hereto. No party hereto may assign its rights under this Agreement provided that Union Oil may assign its rights and obligations hereunder to any Affiliate who agrees in writing to be bound by this Agreement. 7. Entire Agreement; Amendments. This Agreement, and such additional ---------------------------- instruments as may be concurrently executed and delivered pursuant to this Agreement, constitutes the entire understanding of the parties with respect to its subject matter. There are no restrictions, agreements, promises, representations, warranties, covenants or undertakings other than those expressly set forth herein or in the documents delivered concurrently herewith. This Agreement may be amended only by a written instrument duly executed by all the parties hereto. 4 8. Headings. The section headings contained in this Agreement are for -------- reference purposes only and shall not effect in any way the meaning or interpretation of this Agreement. 9. Notices, All notices, requests, claims, demands and other ------- communications hereunder shall be in writing and shall be given (and shall be deemed to have been duly given if so given) by hand delivery, facsimile or by mail (registered or certified, postage prepaid, return receipt requested) to the respective parties as follows: If to Union Oil: Union Oil Company of California One Sugar Creek Place 14141 Southwest Freeway Sugar Land, Texas 77478 Attention: Mr. Phil Ballard Fax No: (281) 287-5170 with a copy to: Union Oil Company of California 2141 Rosecrans Avenue, Suite 4000 El Segundo, California 90245 Attention: (1) General Counsel, and (2) Vice President, Corporate Development Fax No: (310) 726-7819 If to the Company: Pure Resources, Inc. 500 West Texas Suite 200 Midland, Texas 79701 Attention: Jack D. Hightower Fax: (915) 687-3863 with a copy to: Thompson & Knight L.L.P. 1700 Pacific Avenue Suite 3300 Dallas, Texas 75201 Attention: Mr. Joe Dannenmaier Fax: (214) 969-1751 5 or to such other address as the person to whom notice is given may have previously furnished to the others in writing in the manner set forth above. 10. Governing Law. This Agreement shall be governed by and construed and ------------- enforced in accordance with the laws of the State of Delaware, without reference to the conflict of laws principles thereof. 11. Waiver. Any waiver by any party of a breach of any provision of this ------ Agreement shall not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. 12. Challenges to Agreement. In the event that any part of this Agreement ----------------------- or any transaction contemplated hereby is temporarily, preliminarily or permanently enjoined or restrained by court of competent jurisdiction, the parties hereto shall use their reasonable best efforts to cause any such injunction or restraining order to be vacated or dissolved or otherwise declared or determined to be of no further force or effect. 13. Specific Performance. Each of Union Oil and CEO acknowledges and -------------------- agrees that irreparable harm would occur if any provision of this Agreement were not performed in accordance with the terms thereof, or were otherwise breached, and that such harm could not be remedied by an award of damages. Accordingly, each of Union Oil and CEO agree that any non-breaching party shall be entitled to an injunction to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof. 14. Counterparts. This Agreement may be executed in counterparts, each of ------------ which shall be an original, but each of which together shall constitute one and the same Agreement. * * * * * 6 IN WITNESS WHEREOF, and intending to be legally bound hereby, each of the undersigned parties has executed or caused this Agreement to be executed on the date first above written. PURE RESOURCES, INC. By: /s/ Phillip Ballard ------------------- Phillip Ballard Vice President UNION OIL COMPANY OF CALIFORNIA By: /s/ Timothy H. Ling ------------------- Timothy H. Ling Executive Vice President, North American Energy Operations and Chief Financial Officer /s/ Jack D. Hightower --------------------- JACK D. HIGHTOWER 7 EX-10.21 4 NON-DILUTION AGREEMENT EXHIBIT 10.21 Non-Dilution Agreement ---------------------- This NON-DILUTION AGREEMENT dated December 13, 1999 (the "Agreement"), is made and entered into by and between Titan Resources Holdings, Inc., a Delaware corporation (the "Company"), and Union Oil Company of California, a California corporation ("Union Oil"). W I T N E S S E T H: WHEREAS, Union Oil is a holder of shares of Common Stock (as defined) of the Company; WHEREAS, Union Oil, the Company, TRH, Inc., a Delaware corporation and wholly-owned subsidiary of the Company ("Sub"), and Titan Exploration Inc., a Delaware corporation ("Titan"), are parties to that certain Agreement and Plan of Merger dated as of the date hereof (the "Merger Agreement"), pursuant to which Sub shall be merged with and into Titan, which shall become a wholly-owned subsidiary of the Company; and WHEREAS, it is a condition to the consummation of the transactions contemplated by the Merger Agreement that the Company and Union Oil enter into this Agreement. NOW, THEREFORE, in consideration of the foregoing and the mutual agreements set forth herein the parties to this Agreement hereby agree as follows: 1. Definitions of Certain Agreement Terms. For purposes of this -------------------------------------- Agreement, the terms hereinafter set forth shall have the following definitions unless otherwise specifically stated: "Board" means the Board of Directors of the Company. "Capital Stock" means the Common Stock or any other capital stock of the Company which is convertible or exchangeable into Common Stock. "Common Stock" means the common stock, par value $.01 per share, of the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Excluded Securities" means Common Stock issued to officers, employees or directors of, or consultants to, the Company or its subsidiaries pursuant to the terms of any stock option or similar stock incentive plan adopted by the Board. "Maximum Ownership Percentage" means 65.4%. "Registration Rights Agreement" means the Registration Rights Agreement dated of even date herewith between the Company and Union Oil. "SEC" means the United States Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended. "Union Oil Ownership Percentage" means the percentage, not to exceed the Maximum Ownership Percentage, obtained by multiplying 100 by an amount equal to (i) the number of shares of Common Stock and other Voting Stock beneficially owned by Union Oil divided by (ii) the number of shares of Common Stock and other Voting Stock issued and outstanding. "Voting Stock" means any shares of Capital Stock having the right to vote generally with respect to the election of directors or convertible into Capital Stock having the right to vote generally with respect to the election of directors. For purposes of calculating Union Oil Ownership Percentage, the voting power of Capital Stock shall be determined on a fully diluted basis, such that (a) the total number of shares of Voting Stock outstanding shall be deemed to be the number of votes entitled to be cast by the holders of outstanding shares with respect to the election of directors or, if greater, the total number of votes that would be entitled to be cast by the holders of all outstanding shares upon conversion of all convertible Capital Stock that is convertible into Capital Stock with greater voting power than the Capital Stock so converted, and (b) the number of votes attributable to each share of Capital Stock owned by Union Oil shall be the number of votes attributable to such share or, if greater, attributable to the shares, if any, into which such share is convertible. The terms "beneficial ownership" and "group" shall be used as defined in Regulation 13D-G under the Exchange Act. The terms "affiliate" and "associate" shall be used as defined in Rule 12b-2 under the Exchange Act. 2. Term; Termination. This Agreement shall become effective upon ----------------- consummation of the transactions contemplated by the Merger Agreement and shall terminate if the Merger Agreement is terminated in accordance with its terms. Thereafter, this Agreement shall terminate upon the sale or transfer by Union Oil or its affiliates of such number of shares of Capital Stock that causes the Union Oil Ownership Percentage to decline to less than 10%. This Agreement may also be terminated by the written agreement of all parties hereto. In the event of the termination of this Agreement pursuant to this Section 2, this Agreement shall become void and have no effect. Nothing contained in this Section 2 shall relieve any party from liability for damages actually incurred as a result of any breach of this Agreement. In addition to the foregoing, Union Oil shall have the right at any time and from time to time to suspend its rights under this Agreement for any such period of time as it shall request. 3. Issuances for other than Cash. ----------------------------- (a) If the Company issues any Capital Stock in exchange for property other than cash or credit, it shall give Union Oil written notice of such issuance not later than 20 days prior to such issuance, describing the number of shares to be issued and the terms and conditions upon which the Company proposes to issue the same. Following any such issuance, Union Oil shall have 30 days from the date of such issuance to elect to exercise its rights under this Section 3 by giving written notice to the Company. 2 (b) If Union Oil provides the notice specified in Section 3(a), Union Oil shall have the right to purchase from the Company, and the Company shall be obligated to issue and sell to Union Oil, up to such additional number of shares of such Capital Stock as is necessary to cause the Union Oil Ownership Percentage immediately following the applicable issuance to equal the Union Oil Ownership Percentage immediately preceding such issuance, upon the terms and conditions set forth herein. The closing of such purchase and sale shall take place at the offices of the Company on such business day and time as Union Oil shall specify in its notice to the Company; provided, that in no event, unless otherwise agreed by the parties, shall such closing be earlier than five (5) business days after such notice or later than thirty (30) days after such notice. (c) The cash price per share to be paid by Union Oil pursuant to this Section 3 shall be the Market Value Per Share determined as of the close of business on the date of the issuance giving rise to Union Oil's purchase right hereunder. "Market Value Per Share" means, with respect to a share of Common Stock, the average of the closing price of the Common Stock on all domestic securities exchanges on which such security may at the time be listed, or, if there have been no sales on any such exchange on any day, the average of the highest bid and lowest asked prices on all such exchanges at the end of such day, or, if on any day such security is not so listed, the average of the representative bid and asked prices quoted in the NASDAQ System as of 4:00 P.M., New York time, on such day, or, if on any day such security is not quoted in the NASDAQ System, the average of the highest bid and lowest asked prices on such day in the domestic over-the-counter market as reported by the National Quotation Bureau, Incorporated, or any similar successor organization. With respect to Capital Stock other than Common Stock, the Market Value Per Share shall be as determined in good faith by the Board of Directors. 4. Issuances for Cash. If the Company issues Capital Stock (other than ------------------ Excluded Securities) for cash or credit (the "Offered Securities"), Union Oil shall have a preemptive right to purchase or subscribe for the number or amount of such Offered Securities up to the Union Oil Ownership Percentage (determined as of the time of the public announcement of such issuance) of the total number or amount of Offered Securities proposed to be issued. The Company shall provide Union Oil with notice of an issuance subject to this preemptive right at least 10 days prior to such issuance specifying the number of shares and terms of such issuance and, if Union Oil elects to exercise the right, it shall do so in such a way as not to delay pricing and closing of the issuance. If Union Oil exercises its right, it shall only be required to pay the same cash consideration per share as being paid by other purchasers for the Offered Securities. The preemptive right given by the Company shall terminate if unexercised within 10 days after receipt of the notice of the issuance of such Capital Stock. 5. Certain Limitations. Notwithstanding anything to the contrary in this ------------------- Agreement, the Company shall not be required to offer or sell any Capital Stock to Union Oil, and Union Oil shall have no preemptive rights, pursuant to this Agreement (i) to the extent that after a purchase by Union Oil pursuant to this Agreement the Union Oil Ownership Percentage would be greater than the Maximum Ownership Percentage or (ii) if such action would cause the Company to be in violation of applicable federal securities laws by virtue of such offer or sale. All shares of Capital Stock issued hereunder shall be entitled to the benefits of the Registration Rights Agreement. The Company will cause any shares of Capital Stock issued pursuant to this Agreement to be listed for 3 trading or quotation on any securities exchanges or quotation systems on which the securities of that class are then listed for trading or quotation. 6. Successors, Assigns and Transferees. The terms and provisions of this ----------------------------------- Agreement shall not bind, inure to the benefit of or be enforceable by or against the successors, assigns or transferees of each of the parties hereto. No party hereto may assign its rights under this Agreement; provided that Union Oil may at any time and from time to time assign any or all of its rights under this Agreement to an affiliate of Union Oil by giving written notice thereof to the Company. 7. Entire Agreement; Amendments. This Agreement, and such additional ---------------------------- instruments as may be concurrently executed and delivered pursuant to this Agreement, constitutes the entire understanding of the parties with respect to its subject matter. There are no restrictions, agreements, promises, representations, warranties, covenants or undertakings other than those expressly set forth herein or in the documents delivered concurrently herewith. This Agreement may be amended only by a written instrument duly executed by all the parties hereto. 8. Headings. The section headings contained in this Agreement are for -------- reference purposes only and shall not effect in any way the meaning or interpretation of this Agreement. 9. Notices. All notices, requests, claims, demands and other ------- communications hereunder shall be in writing and shall be given (and shall be deemed to have been duly given if so given) by hand delivery, facsimile or by mail (registered or certified, postage prepaid, return receipt requested) to the respective parties as follows: If to Union Oil: Union Oil Company of California c/o Mr. Phil Ballard Manager, Corporate Development Bengal Company of California One Sugar Creek Place 14141 Southwest Freeway Sugar Land, TX 77478 Fax: (281) 287-5170 And another copy to: Union Oil Company of California 2141 Rosecrans Avenue, Suite 4000 El Segundo, CA 90245 Attn: (1) General Counsel, and (2) Vice President, Corporate Development Fax: (310) 726-7819 4 If to the Company: Titan Resources Holdings, Inc. 500 West Texas Suite 200 Midland, Texas 79701 Attention: Mr. Jack D. Hightower Fax: (915) 687-3863 with a copy to: Thompson & Knight L.L.P. 1700 Pacific Avenue Suite 3300 Dallas, Texas 75201 Attention: Mr. Joe Dannenmaier Fax: (214) 969-1751 or to such other address as the person to whom notice is given may have previously furnished to the others in writing in the manner set forth above. 10. Governing Law. This Agreement shall be governed by and construed and ------------- enforced in accordance with the laws of the State of Delaware, without reference to the conflict of laws principles thereof. 11. Waiver. Any waiver by any party of a breach of any provision of this ------ Agreement shall not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. 12. Specific Performance. The parties hereto acknowledge and agree that -------------------- Union Oil would not have an adequate remedy at law for money damages in the event that this Agreement were not performed in accordance with its specific terms. It is accordingly agreed that Union Oil shall be entitled to enforce specifically the provisions of this Agreement, in any court of the United States or any state thereof having jurisdiction, in addition to any other remedy to which Union Oil may be entitled under this Agreement or at law or in equity. 13. Counterparts. This Agreement may be executed in counterparts, each of ------------ which shall be an original, but each of which together shall constitute one and the same Agreement. 5 IN WITNESS WHEREOF, and intending to be legally bound hereby, each of the undersigned parties has executed or caused this Agreement to be executed on the date first above written. TITAN RESOURCES HOLDINGS, INC. By: /s/ Phillip Ballard ------------------------------------ Phillip Ballard Vice President UNION OIL COMPANY OF CALIFORNIA By: /s/ Timothy H. Ling ------------------------------------ Timothy H. Ling Executive Vice President, North American Energy Operations and Chief Financial Officer 6 EX-10.22 5 BUSINESS OPPORTUNITIES AGREEMENT EXHIBIT 10.22 BUSINESS OPPORTUNITIES AGREEMENT This BUSINESS OPPORTUNITIES AGREEMENT (this "Agreement"), dated as of December 13, 1999, is entered into by Union Oil Company of California, a California corporation ("Union Oil"), Titan Resources Holdings, Inc., a newly formed Delaware corporation and wholly owned subsidiary of Union Oil (the "Company"), TRH, Inc., a newly formed Delaware corporation and a wholly owned subsidiary of the Company ("Sub"), and Titan Exploration, Inc., a Delaware corporation ("Titan"). This Agreement is being executed and delivered simultaneously with the execution and delivery of the Agreement and Plan of Merger dated December 13, 1999 (the "Merger Agreement") among Union Oil, the Company, Sub and Titan. Pursuant to the Merger Agreement, Sub will be merged with and into Titan, which will be the Surviving Corporation. All capitalized terms used and not defined herein (as well as the terms "affiliate" and "person") have the meanings attributable to them in the Merger Agreement. As a result of the Merger, Union Oil will own a majority of the outstanding capital stock of the Company, and the Company will own all of the outstanding capital stock of the Surviving Corporation. Titan believes that it and its stockholders will benefit from the Merger and that the Merger is in its best interest and in the best interest of its stockholders. Union Oil, however, is unwilling to enter into the Merger Agreement unless Titan and the Company enter into this Agreement because Union Oil engages in the exploration for and the development, production and marketing of natural gas and crude oil in the United States. The businesses in which Union Oil engages are similar to those in which Titan and its subsidiaries engage and in which the Company and its subsidiaries, including the Surviving Corporation, will engage following the Merger. As the owner of a controlling interest in the Company following the Merger, Union Oil may owe certain duties to the Company. Pursuant to a Stockholders Agreement entered into simultaneously with the execution and delivery of this Agreement, Union Oil will have the right to nominate certain persons ("Designees") to serve on the board of directors of the Company following the Merger. Certain of the Designees may be directors of or employed by Union Oil or companies in which Union Oil has an interest, other than the Company and its subsidiaries. These Designees will have duties to the Company and duties to Union Oil or such other companies. The law relating to duties that Union Oil or its Designees may owe to the Company is not clear. The application of such law to particular circumstances is often difficult to predict, and if a court were to hold that Union Oil or one of its Designees breached any such duty Union Oil or such Designee could be held liable for damages in a legal action brought on behalf of the Company. In order to induce Union Oil to enter into the Merger Agreement, Titan and the Company are willing to enter into this Agreement in order to renounce, effective upon 1 consummation of the Merger, any interest or expectancy either of them or their subsidiaries may have in the classes or categories of business opportunities specified herein that are presented to or identified by Union Oil or any of its Designees, as more fully described herein. As a result of this Agreement, Union Oil may continue to conduct its business and to pursue certain business opportunities without an obligation to offer such opportunities to the Company or any of its subsidiaries, and any Designee may continue to discharge his or her responsibilities as a director or employee of Union Oil or any company in which Union Oil has an interest. In consideration of the foregoing, the mutual covenants, rights, and obligations set forth in this Agreement, and the benefits to be derived herefrom, and other good and valuable consideration, the receipt and the sufficiency of which each of the parties hereto acknowledges and confesses, the parties hereto agree as follows: 1. Scope of Business of the Company and its Subsidiaries Following the ------------------------------------------------------------------- Merger. The Company and Titan covenant and agree that, following consummation of - ------ the Merger, except with the consent of Union Oil (which it may withhold in its sole discretion), the Company and its subsidiaries will not engage in any business other than the E&P Business and will not pursue any business opportunity that involves any direct or indirect ownership interest in any properties located outside the areas onshore shown on the map attached hereto (collectively, the "Designated Areas"). The Company and Titan hereby renounce, effective upon consummation of the Merger, any interest or expectancy in any business opportunity that does not consist exclusively of the E&P Business within the Designated Areas. "E&P Business" means the oil and gas exploration, exploitation, development and production business and includes without limitation (a) the ownership of oil and gas property interests (including working interests, mineral fee interests and royalty and overriding royalty interests), (b) the ownership and operation of real and personal property used or useful in connection with exploration for Hydrocarbons, development of Hydrocarbon reserves upon discovery thereof and production of Hydrocarbons from wells located on oil and gas properties and (c) debt of or equity interests in corporations, partnerships or other entities engaged in the exploration for Hydrocarbons, the development of Hydrocarbon reserves and the production and sale of Hydrocarbons from wells located on oil and gas properties in which the entity conducting the E&P Business owns an interest; but such term does not include the oilfield service business. "Hydrocarbons" means oil, gas or other liquid or gaseous hydrocarbons or other minerals produced from oil and gas wells. "Subsidiaries" means all entities controlled, directly or indirectly, by the Company. Notwithstanding the foregoing, nothing in this Agreement shall prohibit the Company and its subsidiaries from purchasing securities of any class registered under Section 12 of the Securities Exchange Act of 1934 (regardless of the types or locations of businesses in which the issuer thereof engages) if following any such purchase the Company and its subsidiaries own, in the aggregate, less than 5% of such class. 2. Corporate Opportunities. The Company and Titan recognize that Union ----------------------- Oil and its Designees (i) participate and will continue to participate in the E&P Business, directly and through affiliates, (ii) may have interests in, participate with, and maintain 2 seats on the boards of directors of or serve as officers or employees of other companies engaged in the E&P Business and (iii) may develop business opportunities for Union Oil and its affiliates and such other companies. The Company and Titan recognize that Union Oil, its Designees and such affiliates and other companies may be engaged in E&P Business in competition with the Company and/or its subsidiaries. The Company and Titan (a) acknowledge and agree that neither Union Oil, its affiliates nor its Designees nor any such company shall be restricted or proscribed by the relationship between Union Oil and the Company, or otherwise, from engaging in the E&P Business or any other business, regardless of whether such business activity is in direct or indirect competition with the business or activities of the Company and its subsidiaries, on any basis other than that which is inconsistent with the standards set forth in Section 3 hereof, (b) acknowledge and agree that, as long as their activities are conducted in accordance with the standards set forth in Section 3 hereof, neither Union Oil nor any Designee or affiliate of Union Oil nor any such other company shall have any obligation to offer the Company or any of its subsidiaries any business opportunity, (c) renounce any interest or expectancy in any business opportunity pursued by Union Oil, any affiliate of Union Oil, any Designee or any such company in accordance with the standards set forth in Section 3 hereof and (d) waive any claim that any business opportunity pursued by Union Oil, any affiliate of Union Oil, any Designee or any such company constitutes a corporate opportunity of the Company or any of its subsidiaries that should have been presented to the Company, unless such business opportunity was pursued in violation of the standards set forth in Section 3 hereof. 3. Standards for Separate Conduct of Business. Union Oil, any ------------------------------------------ affiliate of Union Oil, any Designee or any other company in which Union Oil has an interest or of which a Designee is a director, officer or employee shall be deemed to meet the standards set forth in this Section 3 if its businesses are conducted through the use of its own personnel and assets and not with the use of any personnel or assets of the Company. Without limiting the foregoing, such standards will be met with respect to a business opportunity only if (a) it is identified by or presented to personnel of Union Oil, such affiliate of Union Oil, such Designee or such other company and developed and pursued solely through the use of their personnel and assets (and not based on confidential information disclosed by or on behalf of the Company in or during the course of such Designee's relationship with the Company), and (b) it did not come to the attention of such Designee solely in, and as a direct result of, his or her capacity as a director of the Company; provided that (i) if such opportunity is separately identified by Union Oil or one of its affiliates or such other company or separately presented to Union Oil or one of its affiliates or such other company by a person other than such Designee, Union Oil, such affiliate or such company shall be free to pursue such opportunity even if it also came to the Designee's attention solely as a result of and in his or her capacity as a director of the Company and (ii) if such opportunity is presented to or identified by a Designee other than solely as a result of and in his or her capacity as a director of the Company, Union Oil or such affiliate or such other company shall be free to pursue such opportunity even if it also came to the Designee's attention as a result of and in his or her capacity as a director of the Company. Nothing in this Agreement will allow a Designee to usurp a corporate opportunity solely for his or her personal benefit (as opposed to 3 pursuing, for the benefit of Union Oil, an affiliate or Union Oil or any such other company, an opportunity in accordance with the standards set forth in this Section 3). 4. Termination of Section 1. Section 1 of this Agreement will terminate ------------------------ at such time as Union Oil no longer owns, directly or indirectly, capital stock of the Company representing at least 35% of the ordinary voting power for the election of directors of the Company. 5. Waiver. If the Company seeks a waiver of provisions of this ------ Agreement, the Company shall submit to Union Oil a written request, accompanied with materials that provide a basis for the request and assist Union Oil in considering the request. Union Oil shall respond to the request within five business days of its receipt of the request, unless it determines that it requires additional information before responding, in which case it shall notify the Company of its request for additional information. Within five business days of receipt of the Company's response to its request for additional information, Union Oil shall notify the Company of its decision as to the request for a waiver. Union Oil may withhold such waiver in its sole discretion or grant a conditional or limited waiver, and Union Oil shall have no duty, fiduciary or otherwise, to grant any such waiver. 4. Miscellaneous. ------------- This Agreement may be signed in any number of counterparts, each of which when so executed and delivered shall be deemed an original, and such counterparts together shall constitute one instrument. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware. 4 IN WITNESS WHEREOF, the undersigned have duly executed this Agreement as of the date set forth above. TITAN RESOURCES HOLDINGS, INC. By: /s/ Phillip Ballard ------------------------------ Phillip Ballard Vice President UNION OIL COMPANY OF CALIFORNIA By: /s/ Timothy H. Ling ------------------------------ Timothy H. Ling Executive Vice President, North American Energy Operations and Chief Financial Officer TRH, INC. By: /s/ Phillip Ballard ------------------------------ Phillip Ballard Vice President TITAN EXPLORATION, INC. By: /s/ Jack D. Hightower ------------------------------ Jack D. Hightower President and Chief Executive Officer 5 EX-23 6 KPMG CONSENT Exhibit 23 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Titan Exploration, Inc.: We consent to incorporation by reference in the registration statements No's. 333-62115, 333-30063, 333-30061, and 333-90801 on Form S-8, No. 333-72311 on Form S-3 and No. 333-40215 on Form S-4 of Titan Exploration, Inc. of our report dated February 1, 2000, relating to the consolidated balance sheets of Titan Exploration, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999, which report appears in the December 31, 1999, annual report on Form 10-K, as amended, of Titan Exploration, Inc. KPMG LLP Midland, Texas April 10, 2000 -----END PRIVACY-ENHANCED MESSAGE-----