-----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, DaoAmGOviv4EHVU74yD6Av9/1OhQ9KO1AHH7SV7HhtEK/i9wdzOVmaSskIZY1B9s rlN5GMJYGKc38qMh+A+08g== 0000319019-00-000011.txt : 20000316 0000319019-00-000011.hdr.sgml : 20000316 ACCESSION NUMBER: 0000319019-00-000011 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HALLWOOD ENERGY CORP CENTRAL INDEX KEY: 0000319019 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 751319083 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-09579 FILM NUMBER: 570693 BUSINESS ADDRESS: STREET 1: 4610 SOUTH ULSTER ST STREET 2: SUITE 200 CITY: DENVER STATE: CO ZIP: 80237 BUSINESS PHONE: 3038507373 MAIL ADDRESS: STREET 1: 4582 SOUTH ULSTER STREET PARKWAY STREET 2: SUITE 1700 CITY: DENVER STATE: CO ZIP: 80237 FORMER COMPANY: FORMER CONFORMED NAME: SAXON OIL CO DATE OF NAME CHANGE: 19891121 10-K405 1 HALLWOOD ENERGY CORPORATION 12/31/99 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K 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 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-9579 HALLWOOD ENERGY CORPORATION (Exact name of registrant as specified in its charter) Delaware 84-1489099 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 4610 South Ulster Street Suite 200 Denver, Colorado 80237 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (303) 850-7373 Securities Registered Pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered None None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share Series A Cumulative Preferred Stock, par value $.01 per share 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. [ ] The aggregate market value of the common shares held by nonaffiliates of the registrant as of March 6, 2000 was approximately $37,353.000. Number of Shares outstanding as of March 6, 2000: Common Stock 9,999,754 Series A Cumulative Preferred Stock 2,290,349 Documents Incorporated by Reference The information called for by Part III of Form 10-K is incorporated by reference to the definitive proxy statement for the annual meeting of stockholders of the Company to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1999. PART I ITEM 1 - BUSINESS Hallwood Energy Corporation ("HEC" or the "Company") is a Delaware corporation engaged in the development, exploration, acquisition and production of oil and gas properties. HEC began operations June 8, 1999, in connection with the consolidation ("Consolidation") of Hallwood Energy Partners, L.P. ("HEP") and Hallwood Consolidated Resources Corporation ("HCRC") and the acquisition of the direct energy interests of The Hallwood Group Incorporated ("Hallwood Group"). For accounting purposes, the Consolidation has been treated as a purchase by HEP of the common stock of HCRC and the direct energy interests of Hallwood Group. Accordingly, the assets and liabilities of HEP, including its 46% share of assets and liabilities of HCRC owned prior to the Consolidation, have been recorded at historical cost, and the remaining assets and liabilities of HCRC and the direct energy interests of Hallwood Group have been recorded at estimated fair values as of the date of purchase. All information presented for periods prior to June 8, 1999 represents the historical information of HEP because HEP was considered to be the acquiring entity for accounting purposes. The financial statements for periods prior to June 8, 1999 have been retroactively restated to reflect the corporate structure of HEC, and all share and per share information assumes that the shares of HEC issued to HEP in connection with the Consolidation were outstanding for all periods prior to June 8, 1999. The Company's properties are primarily located in the Rocky Mountain, Greater Permian and Gulf Coast regions of the United States. On March 6, 2000, HEC had 100 employees. Marketing The oil and gas produced from the properties owned by HEC has typically been marketed through normal channels for such products. The Company generally sells its oil at local field prices generally paid by the principal purchasers of crude oil in the areas where the majority of producing properties are located. In response to the volatility in the oil markets, HEC has entered into financial contracts for hedging the price of between 12% and 54% of its estimated oil production for 2000 through 2001. All of HEC's natural gas production is sold on the spot market or in short-term contracts and is transported in intrastate and interstate pipelines. HEC has entered into financial contracts for hedging the price of between 34% and 43% of its estimated gas production for 2000 through 2002. The purpose of the hedges is to provide protection against price decreases and to provide a measure of stability in the volatile environment of oil and natural gas spot pricing. The amounts received or paid upon settlement of these contracts are recognized as an increase or decrease in oil or gas revenue at the time the hedged volumes are sold. Both oil and natural gas are purchased by refineries, major oil companies, public utilities, industrial customers and other users and processors of petroleum products. HEC is not confined to, nor dependent upon, any one purchaser or small group of purchasers. Accordingly, the loss of a single purchaser, or a few purchasers, would not materially affect HEC's business because there are numerous other purchasers in the areas in which HEC sells its production. However, for the years ended December 31, 1999, 1998 and 1997, purchases by the following companies exceeded 10% of the total oil and gas revenues of the Company: 1999 1998 1997 ---- ---- ---- Conoco Inc. 19% 23% 20% El Paso Field Services Company 14% 11% 11% Plains All American Inc. 14% Marathon Petroleum Company 16% Factors, if they were to occur, which might adversely affect HEC include decreases in oil and gas prices, the reduced availability of a market for production, rising operational costs of producing oil and gas, compliance with, and changes in, environmental control statutes and increasing costs of transportation. Competition HEC encounters competition from other oil and gas companies in all areas of its operations, including the acquisition of exploratory prospects and proven 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. As described above under "Marketing," production is sold on the spot market, thereby reducing sales competition; however, oil and gas must compete with coal, atomic energy, hydro-electric power and other forms of energy. Regulation Production and sale of oil and gas is subject to federal and state governmental regulation in a variety of ways, including environmental regulations, labor laws, interstate sales, excise taxes and federal and Indian lands royalty payments. Failure to comply with these regulations may result in fines, cancellation of licenses to do business and cancellation of federal, state or Indian leases. The production of oil and gas is subject to regulation by the state regulatory agencies in the states in which HEC does business. These agencies make and enforce regulations to prevent waste of oil and gas and to protect the rights of owners to produce oil and gas from a common reservoir. The regulatory agencies regulate the amount of oil and gas produced by assigning allowable production rates to wells capable of producing oil and gas. Title to Properties The Company believes it has satisfactory title to all of its material producing properties in accordance with standards generally accepted in the oil and gas industry. As is customary in the industry in the case of undeveloped properties, little investigation of record title is made at the time of acquisition. Investigations, including a title opinion of legal counsel, generally are made before commencement of drilling operations. To the extent title opinions or other investigations reflect title defects, the Company, rather than the seller of undeveloped property, typically is responsible to cure any such title defects at the Company's expense. If the Company was unable to remedy or cure title defects of a nature such that it would not be prudent to commence drilling operations on the property, the Company could suffer a loss of its entire investment in such property. The Company's properties are subject to customary royalty, overriding royalty, carried, net profits, working and other similar interests, liens incident to operating agreements, liens for current taxes and other burdens. In addition, the Company's credit facility is secured by approximately 80% in value of the oil and natural gas interests of the Company and other assets of the Company. Environmental Considerations The exploration for, and development of, oil and gas involves the extraction, production and transportation of materials which, under certain conditions, can be hazardous or can cause environmental pollution problems. In light of the current interest in environmental matters, the Company cannot predict what effect possible future public or private action may have on the business of HEC. The Company is continually taking actions it believes are necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations. As of December 31, 1999, HEC has not been fined or cited for any environmental violations which would have a material adverse effect upon capital expenditures, earnings, cash flows or the competitive position of HEC in the oil and gas industry. Insurance Coverage HEC is subject to all the risks inherent in the exploration for, and development of, oil and gas, including blowouts, fires and other casualties. HEC maintains insurance coverage as is customary for entities of a similar size engaged in operations similar to that of HEC, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon HEC's earnings, cash flows and financial position. Year 2000 In prior years, the Company discussed the nature and progress of its plans to become Year 2000 compliant. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in it critical information technology and non-information technology systems, and believes those systems successfully responded to the Year 2000 date change. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its computer applications and those of its suppliers and vendors throughout the Year 2000 to ensure that any latent Year 2000 matters that may arise are addressed properly. Cautionary Statement Regarding Forward-Looking Statements In the interest of providing the shareholders with certain information regarding the Company's future plans and operations, certain statements set forth in this Form 10-K relate to management's future plans and objectives. Such statements are forward-looking statements within the meanings of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although any forward-looking statements contained in this Form 10-K or otherwise expressed by or on behalf of the Company are, to the knowledge and in the judgment of the officers and directors of the Company, expected to prove true and come to pass, there can be no assurances that any of these expectations will prove correct or that any of the actions that are planned will be taken. Forward-looking statements involve known and unknown risks and uncertainties which may cause the Company's actual performance and financial results in future periods to differ materially from any projection, estimate or forecasted result. These risks and uncertainties include, among others: Volatility of oil and gas prices. It is impossible to predict future oil and gas price movements with certainty. Declines in oil and gas prices may materially adversely affect HEC's financial condition, liquidity, ability to finance planned capital expenditures and results of operations. Lower oil and gas prices may also reduce the amount of oil and gas that HEC can produce economically. HEC's revenues, profitability, future growth and ability to borrow funds or obtain additional capital, as well as the carrying value of its properties, will be substantially dependent upon prevailing prices of oil and gas. Historically, the markets for oil and gas have been volatile, and they are likely to continue to be volatile in the future. Prices for oil and gas are subject to wide fluctuation in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond HEC's control. Hedging arrangements may expose the Company to financial loss. In order to reduce its exposure to short-term fluctuations in the prices of oil and gas, the Company periodically enters into hedging arrangements. The hedging arrangements apply to only a portion of its production and provide only partial price protection against declines in oil and gas prices. Such hedging arrangements may expose the Company to risk of financial loss in some circumstances, including instances where production is less than expected or where the other party to any hedging arrangement fails to perform. In addition, the hedging arrangements may limit the benefit to the Company of increases in the prices of oil or gas. Similarly, in order to reduce its exposure to short-term fluctuations in interest rates and to provide a measure of predictability for a portion of its interest payments under its debt facilities, the Company has entered into contracts to hedge its interest payments on a portion of its variable rate debt. These hedges provide only partial protection against increases in interest rates. These hedging arrangements may expose the Company to risk of financial loss in some circumstances, including instances where the other party to any hedging arrangement fails to perform. In addition, the hedging arrangements may limit the benefit to the Company of declines in interest rates. Competition from larger, more established oil and gas companies. HEC encounters competition from other oil and gas companies in all areas of its operation, including the acquisition of exploratory prospects and proven properties. HEC'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 HEC's and, in many instances, have been engaged in the oil and gas business for a much longer time than HEC. Those companies may be able to pay more for exploratory prospects and productive oil and gas properties, and may be able to define, evaluate, bid for and purchase a greater number of properties and prospects than HEC's financial or human resources permit. HEC's ability to explore for oil and gas prospects and to acquire additional properties in the future will be dependent upon its ability to conduct its operations, to evaluate and select suitable properties and to consummate transactions in highly competitive environments. Risks of drilling activities. HEC's success will be materially dependent upon the continued success of its drilling program. HEC's future drilling activities may not be successful and, if drilling activities are unsuccessful, such failure will have an adverse effect on HEC's future results of operations and financial condition. Oil and gas drilling involves numerous risks, including the risk that no commercially productive oil or gas reservoirs will be encountered, even if the reserves targeted are classified as proved. The cost of drilling, completing and operating wells is often uncertain, and drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including unexpected drilling conditions, pressure or irregularities in formations, equipment failures or accidents, adverse weather conditions, compliance with governmental requirements and shortages or delays in the availability of drilling rigs and the delivery of equipment. Although HEC has identified numerous drilling prospects, there can be no assurance that such prospects will be drilled or that oil or gas will be produced from any such identified prospects or any other prospects. Availability of capital is important to the Company's ability to grow. The acquisition of reserves is capital intensive, and funding for the costs of acquisition may be greater than the Company's cash flow can provide. As a result, additional financing may be required, and the availability or terms of any such additional financing cannot be assured. In the event sufficient capital resources are not available to the Company, it may negatively affect the Company's flexibility in planning for and reacting to possible acquisition activities. Risks relating to the acquisition of oil and gas properties. The successful acquisition of producing properties requires an assessment of recoverable reserves, future oil and gas prices, operating costs, potential environmental and other liabilities and other factors. Such assessments are necessarily inexact and their accuracy inherently uncertain. In connection with such an assessment, HEC will perform a review of the subject properties that it believes to be generally consistent with industry practices. This usually includes on-site inspections and the review of reports filed with various regulatory entities. Such a review, however, will not reveal all existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to fully assess their deficiencies and capabilities. Inspections may not always be performed on every well, and structural and environmental problems are not necessarily observable even when an inspection is undertaken. Even when problems are identified, the seller may be unwilling or unable to provide effective contractual protection against all or part of these problems. There can be no assurances that any acquisition of property interests by HEC will be successful and, if an acquisition is unsuccessful, that the failure will not have an adverse effect on HEC's future results of operations and financial condition. Hazards relating to well operations and lack of insurance. The oil and gas business involves certain hazards such as well blowouts; craterings; explosions; uncontrollable flows of oil, gas or well fluids; fires; formations with abnormal pressures; pollution; and releases of toxic gas or other environmental hazards and risks, any of which could result in substantial losses to HEC. In addition, HEC may be liable for environmental damages caused by previous owners of property purchased or leased by HEC. As a result, substantial liabilities to third parties or governmental entities may be incurred, the payment of which could reduce or eliminate the funds available for exploration, development or acquisitions or result in the loss of HEC's properties. While HEC believes that it maintains all types of insurance commonly maintained in the oil and gas industry, it does not maintain business interruption insurance. In addition, HEC cannot predict with certainty the circumstances under which an insurer might deny coverage. The occurrence of an event not fully covered by insurance could have a materially adverse effect on HEC's financial condition and results of operations. Future oil and gas production depends on continually replacing and expanding reserves. In general, the volume of production from oil and gas properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. HEC's future oil and gas production is, therefore, highly dependent upon its ability to economically find, develop or acquire additional reserves in commercial quantities. Except to the extent HEC acquires properties containing proved reserves or conducts successful exploration and development activities, or both, the proved reserves of HEC will decline as reserves are produced. The business of exploring for, developing or acquiring reserves is capital-intensive. To the extent cash flow from operations is reduced, and external reserves of capital become limited or unavailable, HEC's ability to make the necessary capital investments to maintain or expand its asset base of oil and gas reserves would be impaired. In addition, there can be no assurance that HEC's future exploration, development and acquisition activities will result in additional proved reserves or that HEC will be able to drill productive wells at acceptable costs. Furthermore, although HEC's revenues could increase if prevailing prices for oil and gas increase significantly, HEC's finding and development costs could also increase. Estimates of reserves and future cash flows are imprecise. Reservoir engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. Estimates of economically recoverable oil and gas reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions, such as historical production from the area compared with production from other producing areas, the assumed effects of regulations by governmental agencies, and assumptions concerning future oil and gas prices, future operating costs, severance and excise taxes, development costs and workover and remedial costs, all of which may in fact vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil and gas attributable to any particular group of properties, classifications of such reserves based on risk of recovery, and estimates of the future net cash flows expected from them prepared by different engineers, or by the same engineers but at different times, may vary substantially, and such reserve estimates may be subject to downward or upward adjustment based upon such factors. In addition, the status of the exploration and development program of any oil and gas company is ever-changing. Consequently, reserve estimates also vary over time. Actual production, revenues and expenditures with respect to HEC's reserves will likely vary from estimates, and such variances may be material. ITEM 2 - PROPERTIES Exploration and Development Projects and Acquisitions In 1999, HEC incurred $24,162,000 in direct property additions, development, exploitation, and exploration costs. The costs were comprised of $11,093,000 for property acquisitions and approximately $13,069,000 for domestic exploration and development. HEC's 1999 capital program led to the replacement, including revisions to prior year reserves, of 95% of 1999 production using year-end prices of $24.32 per bbl and $2.00 per mcf. Excluded from these calculations are the reserves of HCRC and the direct interests of Hallwood Group acquired in the Consolidation. Also excluded from the calculations are sales of reserves in place in 1999, which were approximately 9% of 1999 production. Property Sales During 1999, HEC received approximately $388,000 for the sale of approximately 420 non-strategic wells located principally in Texas but also included wells located in Louisiana, Mississippi, North Dakota, New Mexico, Oklahoma, and Utah. Regional Area Descriptions and 1999 Capital Budget The following discussion of HEC's properties and capital projects contains forward-looking statements that are based on current expectations, estimates and projections about the oil and gas industry, management's beliefs and assumptions made by management. Words such as "projects," "believes," "expects," "anticipates," "estimates," "plans," "could," variations of such words and similar expressions are intended to identify such forward-looking statements. Please refer to the section entitled "Cautionary Statement Regarding Forward-Looking Statements" under Item 1. for a discussion of factors which could affect the outcome of the forward-looking statements. Since HEP was considered the acquiring entity for accounting purposes, the expenditures discussed below represent the costs incurred by HEP prior to June 8, 1999, plus the costs incurred on a consolidated basis after June 8, 1999. Gulf Coast Region HEC has significant interests in the Gulf Coast Region in Louisiana and South and East Texas. The Louisiana interests are located in Lafayette Parish and consist of 13 producing gas wells and the associated water handling and gas treating facilities. The wells produce principally from the Bol Mex formation at 13,500 to 14,500 feet and seven are operated by HEC. In South and East Texas, HEC has interests in approximately 151 producing wells, 45 of which are operated by the Company and produce primarily from the Austin Chalk, Paluxy, Lower Frio and Cotton Valley formations at depths from 7,000 to 13,000 feet. During 1999, HEC expended approximately $16,251,000 (67%) of its capital budget in this region. Of this amount, approximately $7,230,000 was for the Seisgen Exploration, Inc. ("Seisgen") acquisition described below. The following discussion relates to major 1999 capital projects within the region. Seisgen Acquisition. In October 1999, HEC acquired from Seisgen, interests in 34 wells located principally in the Yoakum Gorge area of Lavaca County, Texas. The proven reserves have a net present value, discounted at 10% of $5,182,000, using non-escalated prices of $2.50 mcf of gas and $18.50 per barrel of oil. HEC also acquired significant non-producing assets including drilling locations, exploration acreage and 3-D seismic data. HEC believes that the acquisition has significant upside potential value and expands opportunities in the Yoakum Gorge area where HEC has been active since 1998. Specifically, in 1998 HEC participated in a successful non-operated exploration discovery in the Wilcox formation using proprietary 3-D seismic data. In 1999, HEC participated in five additional non-operated directional wells testing the Wilcox Steven Sands. Three of the wells are producing and two of the wells are drilling or are in the process of being completed as of December 31, 1999. The average rate of the producing wells at December 31, 1999 is approximately 12,775 gross mcf per well per day. HEC owns an average 28% working interest in four of the producing wells and 12.5% working interests in the remaining two wells. HEC's 1999 drilling costs incurred are approximately $3,130,000. During 2000, HEC plans to drill at least three additional development wells and three exploration wells. Bell Project. During 1998, HEC drilled one successful well within the Bell prospect located in Houston County, Texas. HEC owns a 60% working interest in this operated well. In 1999, HEC sidetracked another well to test reserves in the Buda and Georgetown formations using a stacked dual lateral well. Initial tests of the Georgetown formation showed it water prone, but the Buda formation is currently being tested and is producing oil. At December 31, 1999, HEC was also drilling a dual lateral Buda formation development well which is currently being completed. HEC owns 36% working interests in the wells drilling or being completed. The horizontal lateral sections are between 4,000-8,000 feet, and the total vertical depth of the wells range from 9,000-10,000 feet. HEC's costs in 1999 were approximately $1,446,000 for all drilling and prospect costs in the area. During 2000, HEC plans to drill as many as five wells in the area. Scott Field Area. During 1999, the two most significant wells in the Field, the A.L. Boudreaux #1, and the G.S. Boudreaux Estate #1 went offline. The A.L. Boudreaux #1 was successfully restored to commercial production of 11.7 mmcf per day and 250 bopd following a workover, although post-workover reserves are less than had been previously estimated. The G.S. Boudreaux well was lost, but an alternate unit well began drilling in the fourth quarter of 1999 to recover additional gas believed to be remaining in the fault block. Also drilling at December 31, 1999, was a well in a fault block adjacent to the A. L. Boudreaux. In February of 2000, based on the drilling results, this well was plugged and abandoned. In 2000, HEC's plans include an exploration test of the deeper Klump Sands productive in nearby fields. Mirasoles Project. In 1999, HEC began completion of a 17,000-foot Frio Formation exploration well located in Kenedy County, Texas. In 1998, eight prospective horizons were identified while drilling this large structural prospect defined by 63 miles of proprietary 3-D seismic data. Stimulation of the deepest and highest potential zone was not possible due to mechanical problems. HEC then tested three shallower Frio zones, but found only subcommercial oil production rather than gas as anticipated. In 1999, HEC incurred approximately $1,473,000 related to this project. HEC operates the well and owns a 35% working interest. The well is temporarily abandoned and HEC, as operator, is currently proposing the abandonment of the well and project. Boca Chica Project. In 1999, HEC incurred approximately $313,000 for seismic data and all costs associated with its participation in an exploration well, which was directionally drilled from the shore to a bottom hole location under the waters of the Gulf of Mexico. This 10,000-foot exploration well in the Big Hum formation tested wet, yet the exploration results were sufficiently encouraging that working interest owners shot 3-D seismic over the area in the third quarter of 1999. Though the 3-D seismic interpretation is still underway, HEC anticipates that during 2000 another well will be drilled. HEC owns a 25% working interest in the well. Greater Permian Region HEC has significant interests in the Greater Permian Region, which includes West Texas and Southeast New Mexico. In this region, HEC has interests in 436 productive oil and gas wells (359 of which are operated), 30 shut-in oil and gas wells (28 operated) and 13 operated salt water disposal wells or injection wells. In 1999, HEC expended approximately $1,362,000 (6%) of its capital budget on projects in this area. The following is a description of the significant areas and 1999 capital projects within the Greater Permian Region. Carlsbad/Catclaw Area. HEC's interests in the Carlsbad/Catclaw Area as of December 31, 1999 consisted of 59 producing wells that produce primarily natural gas and two shut-in wells. The wells are located on the northwestern edge of the Delaware Basin in Lea, Eddy and Chaves Counties, New Mexico. The Company operates 33 of these wells. The wells produce at depths ranging from approximately 2,500 feet to 14,000 feet from the Delaware, Atoka, Bone Springs and Morrow formations. In 1999, HEC spent approximately $475,000 recompleting or drilling four producing development wells. HEC expects to continue operated development drilling in Lea County. Spraberry Area. HEC's interests in the Spraberry Area consist of 377 producing wells, 13 salt-water disposal wells, and 28 shut-in wells in Dawson, Upton, Reagan and Irion Counties, Texas. The Company operates 326 of the producing oil and gas wells. Current production is predominately from the Upper and Lower Spraberry, Clearfork Canyon, Dean, and Fusselman formations at depths ranging from 5,000 feet to 9,000 feet. During 1999, HEC plugged 66 wells in the area and anticipates an additional 10 wells will be plugged in 2000. The Spraberry area is a mature operation where aggressive operating expense control and limited development drilling typify the management of the area. Rocky Mountain Region HEC has significant interests in the Rocky Mountain Region, which include producing properties in Colorado, Montana, North Dakota and Northwest New Mexico. The Company has interests in 218 producing oil and gas wells, 176 of which are operated by HEC, 22 shut-in wells, and five salt-water disposal wells. HEC expended approximately $4,183,000 (17%) of its 1999 capital budget in this area. A discussion of the major projects in the region follows. Colorado Western Slope Project. HEC drilled and completed three 5,500-foot Dakota Formation wells in 1999. The wells are located in Garfield County, Colorado. HEC owns 100% working interests in the wells. Sales of production for all three wells in November 1999 had combined rates of approximately 1,450 gross mcf per day. HEC's total costs in 1999 for the three wells were approximately $1,854,000. HEC has identified 13 additional development locations and in 2000, plans to drill up to nine additional wells and to recomplete two wells. Toole County Area. HEC's interests in the Toole County Area consist of 61 producing wells and 17 shut-in wells, 66 of which are operated by the Company. The oil wells produce from the Nisku formation at depths of approximately 3,000 feet, and the gas wells produce from the Bow Island formation at depths of 900 to 1,200 feet. HEC plans to divest this area in 2000. San Juan Basin Project - Colorado and New Mexico. HEC's interest in the San Juan Basin consists of 80 producing gas wells (75 operated), 12 operated shut-in wells and three operated salt water disposal wells located in San Juan County, New Mexico and LaPlata County, Colorado. HEC operates 52 producing wells in New Mexico, 31 of which produce from the Fruitland Coal formation at approximately 2,200 feet and 21 of which produce from the Picture Cliffs, Mesa Verde and Dakota formations at 1,200 to 7,000 feet. HEC also operates 23 producing wells in La Plata County, Colorado. The wells in Colorado produce from the Fruitland Coal formation at depths of 1,800-2,200 feet. During 1999, $676,500 was spent for the purchase of overriding royalty interests and working interests in 18 coal bed methane properties already operated by HEC, located in San Juan County, New Mexico. Most of the interests purchased qualify for tax credits under Section 29 of the Internal Revenue Code. In order to monetize these credits, the majority of the acquired interests were sold to 44 Canyon LLC ("44 Canyon"), a special purpose entity owned by a large East Coast financial institution, by HEC, in exchange for cash, a production payment, and promissory notes. In 1999, HEC along with some of its peers, petitioned the Colorado Oil & Gas Commission to allow for optional infill drilling on 160 acre spacing in the Colorado Fruitland Coal formation. If approved, additional drilling of as many as 17 wells would result in the area. Although no application for additional drilling has been made in New Mexico, with regulatory approval, 14 new drilling opportunities would be created in the area, as well. In addition, in 1999, HEC installed an additional gas-gathering pipeline in LaPlata County, Colorado. HEC anticipates that the additional line will help lower system pressures and will increase production by 1,000 mcf per day. Additional water disposal capacity was completed in the fourth quarter of 1999. HEC's costs incurred in 1999 for the additional pipeline and water disposal facilities were approximately $395,000. Other At December 31, 1999, HEC owned various other interests in properties in Kansas, Oklahoma, California, and South Central Texas. The remaining $2,366,000 (10%) of HEC's capital expenditures incurred in 1999 were devoted to technical general and administrative expenditures, delay rental costs, and for numerous other projects which were completed or are underway and which are individually less significant. Future Plans At December 31, 1999, HEC's plans were to sell its interests in approximately 500 non-strategic oil and gas wells in 2000. These sales are being made in an effort to better focus the Company on its core areas of Colorado, Utah, New Mexico, Texas, and Louisiana and at the same time reduce its level of debt and administrative overhead. These wells represent approximately 34% of HEC's total well count, approximately 16% of HEC's reserve value, and approximately 11% of its operating cash flow based on five year average reserve pricing. Proceeds from the sales will be used initially to reduce debt. Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 of the non-strategic oil and gas wells located in the Keystone, Merkle, and Weesatche areas of Texas, as well as various oil and gas wells in Oklahoma, North Dakota and Montana have been sold. As a result of successful sales negotiations, sales proceeds in four of the five areas exceeded the net present value, discounted at 10%, recorded in HEC's January 1, 2000, five year average price reserve report. Purchase and sale agreements for properties located in Williston Basin, Montana, North Dakota and Kansas are currently being negotiated. Efforts to sell the remainder of the non-strategic oil and gas wells are ongoing. For 2000, HEC's capital budget, which will be provided by cash generated from operations and cash on hand has been set at $24,000,000. The Company expects to allocate its capital budget for 2000 among its core areas as follows: Gulf Coast Region $14,500,000 Greater Permian Region 500,000 Rocky Mountain Region 7,000,000 Other 2,000,000 ----------- $24,000,000 Company Reserves, Production and Discussion by Significant Regions The following table presents the December 31, 1999 reserve data by significant regions.
Proved Reserve Quantities Present Value of Future Net Cash Flows Proved Proved Mcf of Gas Bbls of Oil Undeveloped Developed Total ---------- ----------- ----------- --------- ----- (In thousands) Gulf Coast Region 24,945 1,328 $11,743 $ 29,593 $ 41,336 Greater Permian Region 30,071 5,540 3,123 52,896 56,019 Rocky Mountain Region 93,838 1,322 1,415 89,590 91,005 Other 2,814 3,491 783 18,857 19,640 -------- ------- ------- -------- -------- 151,668 11,681 $17,064 $190,936 $208,000 ======= ====== ====== ======= =======
The following table presents the oil and gas production for significant regions for the periods indicated.
Production for the Production for the Year Ended December 31, 1999 Year Ended December 31, 1998 ---------------------------- ---------------------------- Mcf of Gas Bbls of Oil Mcf Gas Bbls of Oil ---------- ----------- ------- ----------- (In thousands) Gulf Coast Region 5,234 189 5,291 175 Greater Permian Region 2,758 437 2,893 401 Rocky Mountain Region 9,862 151 5,233 133 Other 409 148 620 78 -------- --- -------- ----- 18,263 925 14,037 787 ====== === ====== ====
The following table presents the Company's extensions and discoveries by significant regions.
For the Year Ended December 31, 1999 For the Year Ended December 31, 1998 ------------------------------------ ------------------------------------ Mcf of Gas Bbls of Oil Mcf of Gas Bbls of Oil ---------- ----------- ---------- ----------- (In thousands) Gulf Coast Region 5,708 113 1,201 164 Greater Permian Region 291 58 217 167 Rocky Mountain Region 4,346 9 78 83 Other 584 46 1 -------- ------- -------- ------ 10,929 180 1,542 415 ====== === ===== ====
Average Sales Prices and Production Costs The following table presents the average oil and gas sales price and average production costs per equivalent mcf of gas computed at the ratio of six mcf of gas to one barrel of oil.
1999 1998 1997 ------ ------ ----- Oil and condensate - includes the effects of hedging (per bbl) $16.52 $13.65 $19.08 Natural gas - includes the effects of hedging (per mcf) 1.90 2.02 2.31 Production costs (per equivalent mcf of gas) .72 .65 .67
Productive Oil and Gas Wells The following table summarizes the productive oil and gas wells as of December 31, 1999 attributable to HEC's direct interests. Productive wells are producing wells and wells capable of production. Gross wells are the total number of wells in which HEC has an interest. Net wells are the sum of HEC's fractional interests owned in the gross wells. Gross Net Productive Wells Oil 826 526 Gas 435 228 ------ --- Total 1,261 754 ===== === Oil and Gas Acreage The following table sets forth the developed and undeveloped leasehold acreage held directly by HEC as of December 31, 1999. Developed acres are acres which are spaced or assignable to productive wells. Undeveloped acres are acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether or not such acreage contains proved reserves. Gross acres are the total number of acres in which HEC has a working interest. Net acres are the sum of HEC's fractional interests owned in the gross acres. Gross Net (in thousands) Developed acreage 272 144 Undeveloped acreage 666 168 --- --- Total 938 312 === === At December 31, 1999, HEC held undeveloped acreage in Texas, Louisiana, Montana, Utah, Oklahoma, New Mexico, Kansas, Colorado, North Dakota and California. Drilling Activity The following table sets forth the number of wells attributable to HEC's direct interests drilled in the most recent three years.
Year Ended December 31, 1999 1998 1997 ------ ------ ----- Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Development Wells: Productive 1 .5 12 3.6 23 4.5 Dry 1 .5 5 1.5 5 .8 --- --- --- --- --- ---- Total 2 1 17 5.1 28 5.3 === === == === == === Exploratory Wells: Productive 11 4.1 17 4.3 14 2.2 Dry 8 2.4 17 3.0 22 5.4 --- --- -- --- -- --- Total 19 6.5 34 7.3 36 7.6 === === == === == ===
Office Space HEC leases office space in Denver, Colorado, for approximately $600,000 per year under a lease that terminates on December 31, 2006. HEC also sub-leases office space in Houston, Texas for approximately $42,000 per year under a lease that terminates on October 14, 2001. ITEM 3 - LEGAL PROCEEDINGS See Notes 12 and 13 to the financial statements included in Item 8 - Financial Statements and Supplementary Data. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1999. PART II ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS HEC's common stock began trading over the counter on NASDAQ National Market System under the symbol "HECO" on June 9, 1999. HEC's Series A Preferred Stock began trading on the NASDAQ under the symbol "HECOP" on June 11, 1999. As of March 6, 2000, there were 18,808 registered holders of record of HEC's common stock and 12,566 registered holders of record of HEC's Series A Preferred Stock. The following table sets forth, for the periods indicated, the high and low closing bid quotations for each class of stock as reported by the Nasdaq Stock Market, Inc. and the dividends paid per Series A Preferred share for the corresponding periods. No common stock dividends were paid during the periods shown.
Common Stock High Low Dividends - ------------ ---- --- --------- Second quarter 1999 (from June 9, 1999) $8 3/8 $5 3/8 Third quarter 1999 7 3/4 5 1/8 Fourth quarter 1999 7 3 1/2 Series A Preferred Stock Second quarter 1999 (from June 11, 1999) $8 3/4 $7 3/4 $ .25 Third quarter 1999 8 7/8 8 1/8 .25 Fourth quarter 1999 8 5/16 7 .25 ---- $ .75
Prior to the Consolidation, HEP's Class A Units were traded on the American Stock Exchange (the "Exchange") under the symbol "HEP" through June 8, 1999. The following table sets forth, for the periods indicated, the high and low reported sales prices for the Class A Units as reported on the Exchange and the distributions paid per Class A Unit for the corresponding periods.
Class A Units High Low Distributions - ------------- ---- --- ------------- First quarter 1998 $8 5/8 $6 3/8 $.13 Second quarter 1998 7 .13 6 Third quarter 1998 7 4 .13 11/16 Fourth quarter 1998 5 7/8 3 .13 --- $.52 First quarter 1999 $4 3/8 $3 $.13 Second quarter 1999 (through June 8, 1999) 4 3/8 3 1/2 -- ---- $.13
On January 17, 1996, HEP's Class C Units began trading on the Exchange under the symbol "HEPC." On February 17, 1998, HEP closed its public offering of 1.8 million Class C Units which were priced at $10.00 per Unit. HEP's Class C Units stopped trading on June 8, 1999. The following table sets forth, for the periods indicated, the high and low reported sales prices for the Class C Units as reported on the Exchange and distributions paid per Class C Unit for the corresponding periods.
Class C Units High Low Distributions - ------------- ---- --- ------------- First quarter 1998 $11 $9 1/8 $ .25 Second quarter 1998 9 13/16 8 3/8 .25 Third quarter 1998 8 1/2 6 3/4 .25 Fourth quarter 1998 7 15/16 5 7/8 .25 ----- $1.00 First quarter 1999 $ 8 1/2 $6 3/16 $ .25 Second quarter 1999 (through June 8, 1999) 8 9/16 7 3/16 -- ------ $ .25
HEC's debt agreements limit aggregate dividends paid by HEC in any twelve month period to 50% of cash flow from operations before working capital changes and 50% of distributions received from affiliates, if the principal amount of debt of HEC is 50% or more of the borrowing base. Aggregate dividends paid by HEC are limited to 65% of cash flow from operations before working capital changes and 65% of distributions received from affiliates, if the principal amount of debt is less than 50% of the borrowing base. On February 18, 2000, HEC repurchased and retired 43,816 shares of Series A Preferred Stock from its affiliate, Hallwood Group for $303,426. The shares were repurchased for $6.925 per share which represented the average of the closing prices of the stock during the five days prior to February 18, 2000. ITEM 6 - SELECTED FINANCIAL DATA The following table sets forth selected financial data regarding HEC's financial position and results of operations as of the dates indicated. All information presented for periods prior to June 8, 1999 represents the historical information of HEP because HEP was considered to be the acquiring entity for accounting purposes. The financial information for periods prior to June 8, 1999 have been retroactively restated to reflect the corporate structure of HEC, and all share and per share information assumes that the shares of HEC issued to HEP in connection with the Consolidation were outstanding for all periods prior to June 8, 1999.
As of and For the Year Ended December 31, ----------------------------------------- 1999 1998 1997 1996 1995 ------ ------ ------- ------ ----- (In thousands except per Share) Summary of Operations Oil and gas revenues and pipeline operations $ 56,523 $ 43,177 $ 44,707 $ 50,644 $ 43,454 Total revenue 56,881 43,586 45,103 51,066 43,780 Production operating expense 17,100 12,175 11,060 11,511 11,298 Depreciation, depletion and amortization 21,027 15,720 11,961 13,500 15,827 Impairment 14,000 10,943 General and administrative expense 7,395 5,045 5,333 4,540 5,580 Net income (loss) 2,880 (13,895) 12,803 15,726 (9,031) Basic net income (loss) per share .06 (2.92) 2.17 2.69 (1.61) Diluted net income (loss) per share .06 (2.92) 2.14 2.69 (1.61) Dividends per common share .21 1.26 1.25 1.34 1.78 Dividends per preferred share 1.00 1.00 1.00 1.00 Balance Sheet Working capital (deficit) $ 3,371 $ (8,722) $ (973) $ (1,355) $ (4,363) Property, plant and equipment, net 181,621 105,005 94,331 88,549 94,926 Total assets 212,774 139,091 131,603 122,792 125,152 Long-term debt 109,357 40,381 34,986 29,461 37,557 Long-term contract settlement obligation 2,512 2,397 Deferred liability and other 1,066 1,050 1,180 1,533 1,718 Minority interest in affiliates 582 2,788 3,258 3,336 3,042 Stockholders' equity 75,387 62,632 69,064 64,215 57,572
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES Overview HEC began operations on June 8, 1999, in connection with the Consolidation of HEP and HCRC and the acquisition of the direct property interests of Hallwood Group. For accounting purposes, the Consolidation has been treated as a purchase by HEP of the common stock of HCRC and the direct energy interests of Hallwood Group. Generally accepted accounting principles require reporting of results on a basis that makes it difficult to compare to prior years. Therefore, this Overview provides certain information on a pro forma basis to facilitate the comparison with prior periods. Pro Forma Results The following pro forma information is prepared as if the Consolidation had been completed on January 1, 1997. For the Year Ended December 31, ------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands except prices) Prices Gas (per mcf) $1.88 $1.96 $2.25 Oil (per bbl) $15.84 $13.33 $19.01 Production Gas (mcf) 22,360 22,291 17,786 Oil (bbl) 1,177 1,386 1,362 Gas revenue $42,111 $43,752 $40,095 Oil revenue 18,638 18,477 25,888 Lease operating expense 21,187 21,705 19,318 Liquidity and Capital Resources Cash Flow HEC generated $18,238,000 of cash flow from operating activities during 1999. The other primary cash inflows were: o Proceeds from long-term debt of $13,000,000; o Distributions received from affiliate of $1,833,000; o Proceeds from the sale of property of $388,000; Cash was used primarily for: o Additions to property, exploration and development costs of $24,162,000; o Costs incurred in connection with the Consolidation of $2,933,000; o Payments of long-term debt of $3,000,000 and, o Dividends to shareholders of $4,061,000. When combined with miscellaneous other cash activity during the year, the result was a decrease of $1,394,000 in HEC's cash and cash equivalents from $11,874,000 at December 31, 1998 to $10,480,000 at December 31, 1999. Property Purchases, Sales and Capital Budget In 1999, HEC incurred $24,162,000 in direct property additions, development, exploitation, and exploration costs. The costs were comprised of $11,093,000 for property acquisitions and approximately $13,069,000 for domestic exploration and development. HEC's 1999 capital program led to the replacement, including revisions to prior year reserves, of 95% of 1999 production using year-end prices of $24.32 per bbl and $2.00 per mcf. Excluded from these calculations are the reserves of HCRC and the direct interests of Hallwood Group acquired in the Consolidation. Also excluded are sales of reserves in place in 1999, which were approximately 9% of 1999 production. Regional Area Descriptions and 1999 Capital Budget Since HEP was considered the acquiring entity for accounting purposes, the expenditures discussed below represent the costs incurred by HEP prior to June 8, 1999, plus the costs incurred on a consolidated basis after June 8, 1999. In the Gulf Coast Region, HEC expended approximately $7,230,000 acquiring interests in 34 wells and significant non-producing assets including drilling locations, exploration acreage and 3-D seismic. Most of the assets are located in Yoakum Gorge area of Lavaca County, Texas. In addition, in the Yoakum Gorge area, HEC participated in a successful non-operated exploration discovery in 1998, and in 1999, HEC participated in five additional non-operated directional wells testing the Wilcox Steven Sands. HEC's 1999 drilling costs incurred in the Yoakum Gorge area were approximately $3,130,000. HEC drilled one successful well and sidetracked two additional wells within the Bell prospect located in Houston County, Texas. HEC's costs in 1999 were approximately $1,446,000 for all drilling and prospect costs within the Bell area. HEC spent approximately $1,473,000 for completion attempts on the Mirasoles exploration well located in Kenedy County, Texas. In 1999, HEC incurred approximately $313,000 for seismic and all costs associated with its participation in the Boca Chica exploration well. In the Greater Permian Region, HEC spent approximately $475,000 recompleting or drilling four producing development wells. In the Rocky Mountain Region, HEC drilled and completed three wells located in Garfield County, Colorado. Drilling costs were approximately $1,854,000. HEC incurred $676,500 for the purchase of overriding royalty interests and working interests in 18 coal bed methane properties already operated by HEC, located in San Juan County, New Mexico. In the same area, HEC incurred approximately $395,000 for additional pipeline and water disposal facilities. See Item 2 - Properties, for further discussion of HEC's exploration and development projects. Long-lived assets, other than oil and gas properties, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. To date, the Company has not recognized any impairment losses on long-lived assets other than oil and gas properties. Dividends On December 13, 1999, HEC declared a quarterly dividend of $.25 per Series A Cumulative Preferred share, which was paid on February 15, 2000 to shareholders of record on December 31, 1999. This amount was accrued as of the year-end. The Series A Cumulative Preferred Stock has a dividend preference of $1.00 per share per year. HEC may not declare or pay dividends to common shareholders unless full cumulative dividends have been paid on the preferred stock. Stock Option Plans On June 9, 1999, HEC granted options to purchase 600,000 shares of common stock at an exercise price of $7.00 per share which was equal to the fair market value on the date of grant. On November 22, 1999, HEC granted an additional 61,500 options to purchase common stock at an exercise price of $7.00 per share which was greater than the fair market value of the common stock on the date of the grant. The options expire on June 9, 2006, unless sooner terminated pursuant to the provisions of the plan. One-third of the options vested on the grant date, and the remainder vest one-third on June 8, 2000 and one-third on June 8, 2001. On January 28, 2000, HEC granted options to purchase 238,500 shares of common stock at an exercise price of $4.625 per share which was equal to the fair market value of the common stock on the date of grant. The options expire on January 28, 2007, unless sooner terminated pursuant to the provisions of the plan. One-third of the options vested on the grant date and the remainder vest one-third on January 28, 2001 and one-third on January 28, 2002. Prior to the Consolidation, the following HEP options were outstanding. All of these options were cancelled on June 8, 1999.
Number of Options Outstanding Exercisable Exercise Price Class A Unit Options 390,400 390,400 $ 5.75 Class A Unit Options 25,500 17,000 $ 6.625 Class C Unit Options 120,000 120,000 $10.00
Financing On June 8, 1999, HEC and its lenders entered into an Amended and Restated Credit Agreement (as amended, the "Credit Agreement") to extend the term date of its line of credit to May 31, 2002. The lenders are Morgan Guaranty Trust Company, First Union National Bank and Bank of America. The terms of the Credit Agreement were amended on October 15, 1999, to, among other matters, increase HEC's borrowing base to $90,000,000. At December 31, 1999, HEC had amounts outstanding of $86,200,000. HEC's plans are to sell its interests in approximately 500 non-strategic oil and gas wells during 2000. These property sales will enable HEC to better focus on its core areas while at the same time reduce its level of outstanding debt. Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 oil and gas properties have been sold and HEC has repaid $6,000,000 of its borrowings under the Credit Agreement. On January 27, 2000, the Credit Agreement was further amended to reduce HEC's borrowing base to reflect the property sales made by the Company and to waive compliance with an asset sale covenant. On February 9, 2000, HEC's borrowing base was further reduced to $84,479,000 to reflect the most recent property sales, and therefore HEC's unused borrowing base totaled $4,279,000 at March 6, 2000. Borrowings against the Credit Agreement bear interest at the lower of the Certificate of Deposit rate plus from 1.375% to 2.125%, prime plus 1/2% or the Euro-Dollar rate plus from 1.25% to 2.0%. The applicable interest rate was 8.5% at December 31, 1999. Interest is payable monthly. Quarterly principal payments of $11,457,000 are calculated to include repayments of the borrowing made subsequent to December 31, 1999 and commence May 31, 2002. The borrowing base for the Credit Agreement is typically redetermined semiannually, although the lenders have the right to make a redetermination at anytime. The Credit Agreement is secured by a first lien on approximately 80% in value of HEC's oil and gas properties. Additionally, aggregate dividends paid and stock repurchased by HEC in any 12 month period are limited to 50% of cash flow from operations before working capital changes and distributions received from affiliates, if the principal amount of debt of HEC is 50% or more of the borrowing base. Aggregate dividends paid and stock repurchased by HEC are limited to 65% of cash flow from operations before working capital changes and distributions received from affiliates, if the principal amount of debt is less than 50% of the borrowing base. At the time of the Consolidation, HCRC had $25,000,000 of 10.32% Senior Subordinated Notes ("Subordinated Notes") due December 23, 2007 and warrants to purchase common stock which were held by The Prudential Insurance Company of America ("Prudential"). On June 8, 1999, the Amended and Restated Subordinated Note and Warrant Purchase Agreement (the "Note Agreement") was amended to issue warrants to Prudential to purchase 309,278 shares of HEC's Common Stock at an exercise price of $7.00 per share. The terms of the Note Agreement were further amended on October 15, 1999 to exclude certain hedging transactions of the subsidiaries of HEC from the calculation of indebtedness. In connection with this amendment, the Company received a written waiver under the Credit Agreement of the restriction on amendments to the Note Agreement. The Subordinated Notes bear interest at the rate of 10.32% per annum on the unpaid balance, payable quarterly. Annual principal payments of $5,000,000 are due December 23, 2003 through December 23, 2007. HEC recorded the Subordinated Notes and the warrants based upon the relative fair values of the Subordinated Notes without the warrants and of the warrants themselves at the time of Consolidation. The allocated value of the warrants of $1,956,000 was recorded as additional paid-in-capital. The discount on the Subordinated Notes is being amortized over the term of the Subordinated Notes using the interest method of amortization. As part of its risk management strategy, HEC enters into financial contracts to hedge the interest rate payments under its Credit Agreement. HEC does not use the hedges for trading purposes, but rather to protect against the volatility of interest rates under its Credit Agreement, which has a floating interest rate. The amounts received or paid upon settlement of these transactions are recognized as interest expense at the time the interest payments are due. All contracts are interest rate swaps with fixed rates. As of March 6, 2000, HEC was a party to eight contracts with three different counterparties. The following table provides a summary of HEC's financial contracts. Average Amount of Contract Period Debt Hedged Floor Rate 2000 $45,000,000 5.65% 2001 36,000,000 5.23 2002 37,500,000 5.23 2003 37,500,000 5.23 2004 6,000,000 5.23 Gas Balancing HEC uses the sales method for recording its gas balancing. Under this method, HEC recognizes revenue on all of its sales of production, and any over-production or under-production is recovered or repaid at a future date. As of December 31, 1999, HEC had a net over-produced position of 496,000 mcf ($992,000 valued at year-end gas prices). The Company believes that this imbalance can be made up from production on existing wells or from wells which will be drilled as offsets to existing wells and that this imbalance will not have a material effect on HEC's results of operations, liquidity and capital resources. The reserves disclosed in Item 8 have been decreased by 496,000 mcf in order to reflect HEC's gas balancing position. Recently Issued Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS 133 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. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative (gains and losses) depends on the intended use of the derivative and the resulting designation. The Company is required to adopt SFAS 133 on January 1, 2001. The Company has not completed the process of evaluating the impact that will result from adopting SFAS 133. Forward Looking Statements Please refer to the section entitled "Cautionary Statement Regarding Forward Looking Statements under Item 1. for a discussion of factors which could affect the outcome of forward looking statements used by the Company. Inflation and Changing Prices Prices obtained for oil and gas production depend upon numerous factors that are beyond the control of HEC, including the extent of domestic and foreign production, imports of foreign oil, market demand, domestic and worldwide economic and political conditions, storage capacity and government regulations and tax laws. Prices for both oil and gas fluctuated from 1997 through 1999, with a distinct downward trend in both oil and gas prices occurring in the calendar year 1998 through the first quarter of 1999. Prices began to rebound in April 1999. The following table presents the weighted average prices received per year by HEC, and the effects of the hedging transactions discussed below.
Oil Oil Gas Gas (excluding effects (including effects (excluding effects (including effects of hedging of hedging of hedging of hedging transactions) transactions) transactions) transactions) ------------ ------------ ------------ ------------ (per bbl) (per bbl) (per mcf) (per mcf) 1999 $18.16 $16.52 $2.06 $1.90 1998 12.82 13.65 1.99 2.02 1997 19.35 19.08 2.54 2.31
As part of its risk management strategy, HEC enters into financial contracts to hedge the price of its oil and natural gas. The purpose of the hedges is to provide protection against price decreases and to provide a measure of stability in the volatile environment of oil and natural gas spot pricing. The amounts received or paid upon settlement of hedge contracts are recognized as oil or gas revenue at the time the hedged volumes are sold. HEC's philosophy is to use derivatives to provide a measure of stability in the volatile price environment of oil and gas, and to furnish an element of predictability in the cash flow of the Company. In general, the Company expects to hedge up to 50%, on a total equivalent volume basis, of its oil and gas production for the next two forward years, and 30% for each of the three years thereafter. The Company does not ordinarily intend to hedge more than 65% of any one commodity. In addition, HEC will, in most cases, enter into transactions with minimum fixed prices for the production subject to the contracts. This philosophy may be modified as circumstances require. The financial contracts used by HEC to hedge the price of its oil and natural gas production are swaps, collars and participating hedges. Under the swap contracts, HEC sells its oil and gas production at spot market prices and receives or makes payments based on the differential between the contract price and a floating price which is based on spot market indices. As of March 6, 2000, HEC was a party to 16 financial contracts with three different counterparties. The following table provides a summary of HEC's financial contracts. Oil Percent of Production Contract Period Hedged Floor Price ------ ---------- ----------- (per bbl) 2000 54% $18.47 2001 12% 19.16 Gas Percent of Production Contract Period Hedged Floor Price ------ ---------- ----------- (per mcf) 2000 42% $1.97 2001 43% $1.99 2002 34% $1.95 Between 11% and 13% of the gas volumes hedged in each year are subject to a collar agreement whereby HEC will receive the contract price if the spot price is lower than the contract price, the cap price if the spot price is higher than the cap price, and the spot price if that price is between the contract price and the cap price. The cap prices range from $2.54 per mcf to $2.65 per mcf. During the first quarter through March 6, 2000, the weighted average oil price (for barrels not hedged) was approximately $26.50 per barrel, and the weighted average price of natural gas (for mcf not hedged) was approximately $2.25 per mcf. Inflation Inflation did not have a material impact on HEC in 1999, 1998 and 1997 and is not anticipated to have a material impact in 2000. Results of Operations For accounting purposes, the Consolidation has been treated as a purchase by HEP of the common stock of HCRC and the direct energy interests of Hallwood Group. Accordingly, all information presented for periods prior to June 8, 1999 represents the historical information of HEP because HEP was considered to be the acquiring entity for accounting purposes. 1999 Compared to 1998 The following table is presented to contrast HEC's oil and gas price and production for discussion purposes. Significant fluctuations are discussed in the accompanying narrative. 1999 1998 ---- ---- Gas Production (mcf) 18,263,000 14,037,000 Price (per mcf) $1.90 $2.02 Oil Production (bbl) 925,000 787,000 Price (per bbl) $16.52 $13.65 Gas Revenue Gas revenue increased $6,373,000 during 1999 compared with 1998. The increase is comprised of an increase in gas production from 14,037,000 mcf during 1998 to 18,263,000 mcf during 1999, partially offset by a decrease in the average gas price from $2.02 per mcf in 1998 to $1.90 per mcf in 1999. The increase in production is primarily due to the Consolidation which caused a 4,478,000 mcf increase in gas production. This increase was partially offset by decreased production resulting from a production decline on two significant wells in Louisiana caused by increased rates of water production on the wells and normal production declines. The effect of HEC's hedging transactions as described under "Inflation and Changing Prices" was to decrease HEC's average gas price from $2.06 per mcf to $1.90 per mcf, representing a $2,922,000 decrease in gas revenues for 1999. Oil Revenue Oil revenue increased $4,539,000 during 1999 compared with 1998. The increase is comprised of an increase in the average oil price from $13.65 per barrel in 1998 to $16.52 per barrel in 1999, combined with an increase in production, from 787,000 barrels in 1998 to 925,000 barrels in 1999. The Consolidation caused a production increase of 242,000 barrels of oil which was partially offset by the production decline on two wells in Louisiana, as discussed above, and normal production declines. The effect of HEC's hedging transactions was to decrease HEC's average oil price from $18.16 per barrel to $16.52 per barrel, resulting in a $1,517,000 decrease in oil revenue for 1999. Pipeline and Other Pipeline and other revenue consists primarily of facilities income from two gathering systems located in New Mexico, revenues derived from salt water disposal and incentive payments related to certain wells in San Juan County, New Mexico and LaPlata County, Colorado. Pipeline facilities and other revenue increased $2,434,000 during 1999 compared with 1998. The increase is comprised of a $1,716,000 increase due to the Consolidation and a $718,000 increase primarily due to an increase in incentive payment income resulting from HEC's acquisition of a volumetric production payment during May 1998. Interest Income The decrease in interest income of $51,000 during 1999 compared with 1998 resulted from a lower average cash balance during 1999. Production Operating Expense Production operating expense increased $4,925,000 during 1999 compared with 1998. The increase is comprised of a $5,527,000 increase due to the Consolidation, partially offset by a decrease of $602,000 primarily resulting from cost savings measures implemented in Kansas and West Texas during 1999. Facilities Operating Expense Facilities operating expense represents operating expenses associated with various smaller gathering systems operated by HEC. The increase in facilities operating expense of $128,000 is primarily due to increased maintenance activity during 1999 compared with 1998. General and Administrative Expense General and administrative expense includes costs incurred for direct administrative services such as legal, audit and reserve reports, as well as allocated internal overhead incurred by the operating company on behalf of HEC. These expenses increased $2,350,000 during 1999 compared with 1998 primarily due to the Consolidation. Depreciation, Depletion and Amortization Expense Depreciation, depletion and amortization expense increased $5,307,000 during 1999 compared with 1998. The increase is due to as higher capitalized costs during 1999 primarily due to the Consolidation and property acquisitions during 1999. Impairment of Oil and Gas Properties Impairment of oil and gas properties during 1998 represents the property impairments recorded during 1998 because capitalized costs exceeded the present value (discounted at 10%) of estimated future net revenues from proved oil and gas reserves at June 30, 1998, September 30, 1998 and December 31, 1998, based on prices of $13.00 per barrel of oil and $2.00 per mcf of gas, $12.80 per bbl of oil and $1.90 per mcf of gas and $10.00 per bbl of oil and $1.90 per mcf of gas, respectively. Interest Expense Interest expense increased $4,018 during 1999 as compared with 1998. The increase is due to a higher average outstanding debt balance during 1999 resulting from the Consolidation and additional borrowings. Equity in Earnings (Loss) of HCRC Equity in earnings (loss) of HCRC represents HEC's share of its equity investment in HCRC prior to the Consolidation. HEC's equity in loss of HCRC during 1998 represents twelve months of activity whereas the 1999 balance represents activity until June 8, 1999. Additionally, the 1998 balance includes HEC's share of the property impairments recorded by HCRC. Minority Interest in Net Income of Affiliates Minority interest in net income of affiliates represents unaffiliated partners' interest in the net income of the May Partnerships. The decrease of $647,000 during 1999 compared with 1998 is primarily due to the liquidation of three of the six May Partnerships on March 31, 1999. Litigation Litigation income during 1999 represents insurance proceeds received by HEC which reimbursed costs previously paid in connection with a property related claim partially offset by costs accrued for the settlement of a take-or-pay related claim. Litigation expense during 1998 includes the settlement of the Ellender lawsuit described in Item 8, Note 13, and the costs related to the Arcadia arbitration described in Item 8, Note 12. 1998 Compared to 1997 The following table is presented to contrast HEC's oil and gas price and production for discussion purposes. Significant fluctuations are discussed in the accompanying narrative. 1998 1997 ---- ---- Gas Production (mcf) 14,037,000 11,774,000 Price (per mcf) $2.02 $2.31 Oil Production (bbl) 787,000 770,000 Price (per bbl) $13.65 $19.08 Gas Revenue Gas revenue increased $1,146,000 during 1998 compared with 1997. The increase is comprised of an increase in gas production from 11,774,000 mcf during 1997 to 14,037,000 mcf during 1998, partially offset by a decrease in the average gas price from $2.31 per mcf in 1997 to $2.02 per mcf in 1998. Production increased because two temporarily shut-in wells were back on line. The two wells were temporarily shut-in during the second quarter of 1997 while workover procedures were performed. The increase in gas production is also due to an expansion of the gathering system in San Juan County, New Mexico during 1998. The effect of HEC's hedging transactions was to increase HEC's average gas price from $1.99 per mcf to $2.02 per mcf, representing a $421,000 increase in gas revenues for 1998. Oil Revenue Oil revenue decreased $3,949,000 during 1998 compared with 1997. The decrease is comprised of a decrease in the average oil price from $19.08 per barrel in 1997 to $13.65 per barrel in 1998, partially offset by an increase in production, from 770,000 barrels in 1997 to 787,000 barrels in 1998. Production increased slightly because two temporarily shut-in wells were back on line. The two wells were temporarily shut-in during the second quarter of 1997 while workover procedures were performed. The production increase was partially offset by normal production declines. The effect of HEC's hedging transactions was to increase HEC's average oil price from $12.82 per barrel to $13.65 per barrel, resulting in a $653,000 increase in oil revenue for 1998. Pipeline and Other Pipeline facilities and other revenue increased $1,273,000 during 1998 compared with 1997 primarily due to an increase in incentive payment income resulting from HEC's acquisition of a volumetric production payment during May 1998. Interest Income The increase in interest income of $13,000 during 1998 compared with 1997 resulted from a higher average cash balance during 1998 compared with 1997. Production Operating Expense Production operating expense increased $1,115,000 during 1998 compared with 1997. The increase is due to increased operating costs resulting from the drilling projects completed during 1997 as well as the additional operating expenses related to the properties acquired in the Arcadia acquisition during October 1998. Facilities Operating Expense The decrease in facilities operating expense of $143,000 is primarily due to decreased maintenance activity during 1998 compared with 1997. General and Administrative Expense General and administrative expense decreased $288,000 during 1998 compared with 1997 primarily due to a decrease in performance based compensation during 1998. Depreciation, Depletion and Amortization Expense Depreciation, depletion and amortization expense increased $3,759,000 during 1998 compared with 1997. The increase is due to a higher depletion rate resulting from the increased production discussed above as well as higher capitalized costs during 1998. Impairment of Oil and Gas Properties Impairment of oil and gas properties during 1998 represents the property impairments recorded during 1998 because capitalized costs exceeded the present value (discounted at 10%) of estimated future net revenues from proved oil and gas reserves at June 30, 1998, September 30, 1998 and December 31, 1998, based on prices of $13.00 per barrel of oil and $2.00 per mcf of gas, $12.80 per bbl of oil and $1.90 per mcf of gas and $10.00 per bbl of oil and $1.90 per mcf of gas, respectively. Interest Expense Interest expense decreased $299,000 during 1998 compared with 1997. The decrease is due to a lower average outstanding debt balance during 1998 as compared to 1997. Equity in Earnings (Loss) of HCRC HEC's equity in HCRC's earnings decreased $6,236,000 during 1998 as compared to 1997. The decrease is primarily the result of property impairments recorded by HCRC during 1998. Minority Interest in Net Income of Affiliates Minority interest in net income of affiliates decreased $821,000 during 1998 compared with 1997 due to a decrease in the net income of the May Partnerships resulting primarily from lower oil and gas prices and decreased production from their properties. Litigation Litigation expense during 1998 includes the settlement of the Ellender lawsuit described in Item 8, Note 13 and the costs related to the Arcadia arbitration described in Item 8, Note 12. Litigation income during 1997 is comprised of insurance proceeds which reimbursed a portion of expense incurred in a prior period to settle certain litigation. ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK HEC's primary market risks relate to changes in interest rates and in the prices received from sales of oil and natural gas. HEC's primary risk management strategy is to partially mitigate the risk of adverse changes in its cash flows caused by increases in interest rates on its variable rate debt and decreases in oil and natural gas prices, by entering into derivative financial and commodity instruments, including swaps, collars and participating commodity hedges. By hedging only a portion of its market risk exposures, HEC is able to participate in the increased earnings and cash flows associated with decreases in interest rates and increases in oil and natural gas prices; however, it is exposed to risk on the unhedged portion of its variable rate debt and oil and natural gas production. Historically, HEC has attempted to hedge the exposure related to its variable rate debt and its forecasted oil and natural gas production in amounts which it believes are prudent based on the prices of available derivatives and, in the case of production hedges, the Company's deliverable volumes. HEC attempts to manage the exposure to adverse changes in the fair value of its fixed rate debt agreements by issuing fixed rate debt only when business conditions and market conditions are favorable. HEC does not use or hold derivative instruments for trading purposes nor does it use derivative instruments with leveraged features. HEC's derivative instruments are designated and effective as hedges against its identified risks, and do not of themselves expose HEC to market risk because any adverse change in the cash flows associated with the derivative instrument is accompanied by an offsetting change in the cash flows of the hedged transaction. Notes 1, 4 and 6 to the financial statements provide further disclosure with respect to derivatives and related accounting policies. All derivative activity is carried out by personnel who have appropriate skills, experience and supervision. The personnel involved in derivative activity must follow prescribed trading limits and parameters that are regularly reviewed by the Board of Directors and by senior management. HEC uses only well-known, conventional derivative instruments and attempts to manage its credit risk by entering into financial contracts with reputable financial institutions. Following are disclosures regarding HEC's market risk sensitive instruments by major category. Investors and other users are cautioned to avoid simplistic use of these disclosures. Users should realize that the actual impact of future interest rate and commodity price movements will likely differ from the amounts disclosed below due to ongoing changes in risk exposure levels and concurrent adjustments to hedging positions. It is not possible to accurately predict future movements in interest rates and oil and natural gas prices. Interest Rate Risks (non trading) - HEC uses both fixed and variable rate debt to partially finance operations and capital expenditures. As of December 31, 1999, HEC's debt consists of $86,200,000 in borrowings under its Credit Agreement which bears interest at a variable rate, and $25,000,000 in borrowings under its 10.32% Senior Subordinated Notes which bear interest at a fixed rate. HEC hedges a portion of the risk associated with this variable rate debt through derivative instruments, which consist of interest rate swaps and collars. Under the swap contracts, HEC makes interest payments on its Credit Agreement as scheduled and receives or makes payments based on the differential between the fixed rate of the swap and a floating rate plus a defined differential. These instruments reduce HEC's exposure to increases in interest rates on the hedged portion of its debt by enabling it to effectively pay a fixed rate of interest or a rate which only fluctuates within a predetermined ceiling and floor. A hypothetical increase in interest rates of two percentage points would cause a loss in income and cash flows of $1,724,000 during 2000, assuming that outstanding borrowings under the Credit Agreement remain at current levels. This loss in income and cash flows would be offset by a $900,000 increase in income and cash flows associated with the interest rate swap and collar agreements that are in effect for 2000. A hypothetical decrease in interest rates of two percentage points would cause an increase in the fair market value of $1,989,000 in HEC's Senior Subordinated Notes from their fair value at December 31, 1999. Commodity Price Risk (non trading) - HEC hedges a portion of the price risk associated with the sale of its oil and natural gas production through the use of derivative commodity instruments, which consist of swaps and collars. These instruments reduce HEC's exposure to decreases in oil and natural gas prices on the hedged portion of its production by enabling it to effectively receive a fixed price on its oil and gas sales or a price that only fluctuates between a predetermined floor and ceiling. As of March 6, 2000, HEC has entered into derivative commodity hedges covering an aggregate of 445,000 barrels of oil and 21,243,000 mcf of gas that extend through 2002. Under these contracts, HEC sells its oil and natural gas production at spot market prices and receives or makes payments based on the differential between the contract price and a floating price which is based on spot market indices. The amount received or paid upon settlement of these contracts is recognized as oil or natural gas revenues at the time the hedged volumes are sold. A hypothetical decrease in oil and natural gas prices of 10% from the prices in effect as of December 31, 1999 would cause a loss in income and cash flows of $5,999,000 during 2000, assuming that oil and gas production remain at 1999 levels. This loss in income and cash flows would be offset by a $2,914,000 increase in income and cash flows associated with the oil and natural gas derivative contracts that are in effect for 2000. ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page No. FINANCIAL STATEMENTS: Independent Auditors' Report 28 Consolidated Balance Sheets at December 31, 1999 and 1998 29-30 Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997 31 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997 32 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 33 Notes to Consolidated Financial Statements 34-51 SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) 52-55 INDEPENDENT AUDITORS' REPORT To the Shareholders of Hallwood Energy Corporation: We have audited the consolidated financial statements of Hallwood Energy Corporation as of December 31, 1999 and 1998 and for each of the three years in the period ended December 31, 1999, listed in the index at Item 8. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Hallwood Energy Corporation at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Denver, Colorado March 6, 2000
HALLWOOD ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands) December 31, -------------- 1999 1998 ------ ----- CURRENT ASSETS Cash and cash equivalents $ 10,480 $ 11,874 Accounts receivable: Oil and gas revenues 12,442 5,911 Trade 4,918 4,040 Due from affiliates 704 119 Prepaid expenses and other current assets 1,209 1,338 Net working capital of affiliate 236 ------------- ---------- Total 29,753 23,518 -------- -------- PROPERTY, PLANT AND EQUIPMENT, at cost Oil and gas properties (full cost method): Proved mineral interests 758,473 664,799 Unproved mineral interests 6,543 2,694 Furniture, fixtures and other 1,941 3,411 --------- --------- Total 766,957 670,904 Less accumulated depreciation, depletion, amortization and property impairment (585,336) (565,899) ------- ------- Total 181,621 105,005 ------- ------- OTHER ASSETS Investment in common stock of HCRC 10,160 Deferred expenses and other assets 1,400 408 --------- ---------- Total 1,400 10,568 --------- -------- TOTAL ASSETS $212,774 $139,091 ======= ======= (Continued on the following page)
HALLWOOD ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except shares) December 31, ------------ 1999 1998 ------ ----- CURRENT LIABILITIES Accounts payable and accrued liabilities $ 26,382 $ 22,921 Current portion of long-term debt 9,319 ------------- --------- Total 26,382 32,240 -------- -------- NONCURRENT LIABILITIES Long-term debt 109,357 40,381 Deferred revenue and other 1,066 1,050 --------- --------- Total 110,423 41,431 ------- -------- Total liabilities 136,805 73,671 ------- -------- MINORITY INTEREST IN AFFILIATES 582 2,788 ---------- --------- COMMITMENTS AND CONTINGENCIES (NOTE 14) STOCKHOLDERS' EQUITY Series A Cumulative Preferred Stock; 5,000,000 shares authorized; 2,334,165 shares issued and outstanding in 1999 and 1998 21,386 21,386 Common Stock par value $.01 per share; 25,000,000 shares authorized; 9,999,754 shares issued and outstanding in 1999 and 5,599,754 shares issued and outstanding in 1998 100 56 Additional paid-in capital 67,883 58,052 Accumulated deficit (13,982) (16,862) -------- -------- Stockholders' equity - net 75,387 62,632 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $212,774 $139,091 ======= ======= The accompanying notes are an integral part of the consolidated financial statements.
HALLWOOD ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except per share data) For the Year Ended December 31, ------------------------------- 1999 1998 1997 ------ ------ ----- REVENUES: Gas revenue $ 34,739 $ 28,366 $ 27,220 Oil revenue 15,280 10,741 14,690 Pipeline, facilities and other 6,504 4,070 2,797 Interest 358 409 396 --------- --------- --------- 56,881 43,586 45,103 ------- ------- ------- EXPENSES: Production operating 17,100 12,175 11,060 Facilities operating 626 498 641 General and administrative 7,395 5,045 5,333 Depreciation, depletion and amortization 21,027 15,720 11,961 Impairment of oil and gas properties 14,000 Interest 6,815 2,797 3,096 -------- -------- -------- 52,963 50,235 32,091 ------- ------- ------- OTHER INCOME (EXPENSES): Equity in earnings (loss) of HCRC (419) (4,888) 1,348 Minority interest in net income of affiliates (329) (976) (1,797) Litigation 48 (1,382) 240 ---------- -------- -------- (700) (7,246) (209) --------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES 3,218 (13,895) 12,803 PROVISION FOR INCOME TAXES: Current 338 --------- ------------ NET INCOME (LOSS) 2,880 (13,895) 12,803 PREFERRED DIVIDENDS 2,368 2,464 664 -------- -------- -------- NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS $ 512 $ (16,359) $ 12,139 ========= ======== ======== NET INCOME (LOSS) PER SHARE - BASIC $ .06 $ (2.92) $ 2.17 ========== ========== ========= NET INCOME (LOSS) PER SHARE - DILUTED $ .06 $ (2.92) $ 2.14 ========== ========== ========= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 8,083 5,600 5,600 ======== ======== ======== PRO FORMA INFORMATION ASSUMING PROVISION FOR INCOME TAXES APPLIED RETROACTIVELY (NOTE 1) Income (loss) before income taxes $ 3,218 $(13,895) $ 12,803 Provision for income taxes ------- -------- ------- Net income (loss) $ 3,218 $ (13,895) $ 12,803 ======== ========== ======== Net income (loss) attributable to common shareholders $ 850 $ (16,359) $ 12,139 ========== ======== ========= Net income (loss) per share - basic $ .11 $ (2.92) $ 2.17 ===== =========== =========== Net income (loss) per share - diluted $ .11 $ (2.92) $ 2.14 ===== =========== ====== The accompanying notes are an integral part of the consolidated financial statements.
HALLWOOD ENERGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands) ries A Cumulative Preferred Stock Common Additional Accumulated Stock Paid-in-Capital Deficit Total --------- --------------- -------------- -------- Balance, December 31, 1996 $ 4,868 $ 56 $ 75,061 $ (15,770) $ 64,215 Dividends (7,676) (7,676) Net income 12,803 12,803 Other (278) (278) ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1997 4,868 56 67,107 (2,967) 69,064 Issuance of preferred stock, net of syndication costs 16,518 16,518 Capital contribution 171 171 Exercise of stock options 199 199 Dividends (9,495) (9,495) Net loss (13,895) (13,895) Other 70 70 ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1998 21,386 56 58,052 (16,862) 62,632 Issuance of common stock in the Consolidation 44 13,892 13,936 Dividends (4,061) (4,061) Net income 2,880 2,880 ------------ ------------ ------------ --------- --------- Balance, December 31, 1999 $ 21,386 $ 100 $ 67,883 $ (13,982) $ 75,387 ======== ======== ======== ======== ======== The accompanying notes are an integral part of the consolidated financial statements.
HALLWOOD ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) For the Year Ended December 31, --------------------------------- 1999 1998 1997 ------ ------ ----- OPERATING ACTIVITIES: Net income (loss) $ 2,880 $ (13,895) $ 12,803 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion and amortization 21,027 15,720 11,961 Impairment of oil and gas properties 14,000 Depreciation charged to affiliates 220 249 221 Gain on asset disposals (188) Amortization of deferred loan costs and debt discount 282 82 81 Noncash interest expense 15 241 Minority interest in net income 329 976 1,797 Recoupment of take-or-pay liability (416) (130) (126) Equity in (earnings) loss of HCRC 419 4,888 (1,348) Undistributed (earnings) loss of affiliates (1,177) (1,319) 197 Changes in operating assets and liabilities provided (used) cash net of noncash activity: Oil and gas revenues receivable (2,642) 2,861 633 Trade receivables (529) 1,029 (562) Due from affiliates (3,992) (362) (2,948) Prepaid expenses and other assets 385 (247) (163) Deferred expenses and other assets 193 (408) Accounts payable and accrued liabilities 1,259 3,006 4,730 Due to affiliates (133) ------------- ------------ ---------- Net cash provided by operating activities 18,238 26,277 27,384 -------- -------- -------- INVESTING ACTIVITIES: Additions to property, plant and equipment (11,093) (28,756) (3,233) Exploration and development costs incurred (13,069) (12,180) (12,983) Costs incurred in connection with the Consolidation (2,933) Proceeds from sales of property, plant and equipment 388 454 133 Distributions received from affiliate 1,833 1,583 Investment in affiliates (20) (76) Other investing activities (29) ------------- ------------- ----------- Net cash used in investing activities (24,874) (38,919) (16,188) -------- -------- -------- FINANCING ACTIVITIES: Payments of long-term debt (3,000) (18,286) (7,285) Proceeds from equity offering, net of syndication costs 16,518 Proceeds from long-term debt 13,000 33,000 7,000 Dividends paid (4,061) (9,495) (7,676) Distributions paid by consolidated affiliates to minority interest (429) (1,446) (1,875) Payment of contract settlement (2,767) Exercise of options 199 Capital contribution 171 Debt issuance costs (268) Other financing activities (278) ------------- ------------- ---------- Net cash provided by (used in) financing activities 5,242 17,894 (10,114) --------- -------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,394) 5,252 1,082 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR 11,874 6,622 5,540 -------- --------- --------- END OF YEAR $ 10,480 $ 11,874 $ 6,622 ======== ======== ========= The accompanying notes are an integral part of the consolidated financial statements.
HALLWOOD ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Hallwood Energy Corporation ("HEC" or the "Company") is a Delaware corporation engaged in the development, exploration, acquisition and production of oil and gas properties. HEC began operations June 8, 1999, in connection with the consolidation ("Consolidation") of Hallwood Energy Partners, L.P. ("HEP") and Hallwood Consolidated Resources Corporation ("HCRC") and the acquisition of the direct energy interests of The Hallwood Group Incorporated ("Hallwood Group"). For accounting purposes, the Consolidation has been treated as a purchase by HEP of the common stock of HCRC and the direct energy interests of Hallwood Group. Accordingly, the assets and liabilities of HEP, including its 46% share of assets and liabilities of HCRC owned prior to the Consolidation, have been recorded at historical cost, and the remaining assets and liabilities of HCRC and the direct energy interests of Hallwood Group have been recorded at estimated fair values as of the date of purchase. All information presented for periods prior to June 8, 1999 represents the historical information of HEP because HEP was considered to be the acquiring entity for accounting purposes. The financial statements for periods prior to June 8, 1999 have been retroactively restated to reflect the corporate structure of HEC, and all share and per share information assumes that the shares of HEC issued to HEP in connection with the Consolidation were outstanding for all periods prior to June 8, 1999. The Company's properties are primarily located in the Rocky Mountain, Mid-Continent, Greater Permian and Gulf Coast regions of the United States. The following pro forma information presents the financial information of HEP, HCRC and the direct property interests of Hallwood Group as if the Consolidation had taken place on January 1 of each year presented. Any additional provision or benefit for income taxes is excluded because of the Company's net operating loss carryforwards and related valuation allowance.
For the Year Ended December 31, 1999 1998 -------------------------------------------- ------------------------ As Acquired As Acquired Reported Interests Pro Forma Reported Interests Pro Forma -------- ---------- --------- -------- --------- --------- (In thousands except per Share data) Revenues $56,881 $11,874 $68,755 $ 43,586 $ 25,181 $ 68,767 Net income (loss) 2,880 (1,163) 1,717 (13,895) (21,597) (35,492) Net income (loss) attributable to common shareholders 512 (1,163) (651) (16,359) (21,597) (37,956) Net income (loss) per share - basic $ .06 $ (.08) $ (2.92) $ (6.78) ======== ========= ========= ========== Net income (loss) per share - diluted $ .06 $ (.08) $ (2.92) $ (6.78) ======== ========= ========= ==========
Accounting Policies Consolidation HEC fully consolidates entities in which it owns a greater than 50% equity interest and reflects a minority interest in the consolidated financial statements. The accompanying financial statements include the majority owned affiliates, the May Limited Partnerships 1984-1, 1984-2 and 1984-3 for all periods and the May Limited Partnerships 1983-1, 1983-2 and 1983-3 through March 31, 1999 when they were liquidated. Pro Forma Information The pro forma information included in the statements of operations has been presented to reflect the provision for income taxes, using statutory rates, as though the Company had been a taxable corporation for all periods presented. Because of the Company's net operating loss carryforwards and its recent operating losses, it is assumed that the Company would have had a full valuation allowance. Accordingly, no provision or benefit for income taxes has been recorded in any period. Derivatives As of March 6, 2000, HEC was a party to 16 financial contracts to hedge the price of its oil and natural gas. The purpose of the hedges is to protect against price decreases and to provide a measure of stability in the volatile environment of oil and natural gas spot pricing. The amounts received or paid upon settlement of these contracts are recognized as oil or gas revenue at the time the hedged volumes are sold. As of March 6, 2000, HEC was a party to eight financial contracts to hedge the interest payments under its Credit Agreement. The purpose of the hedges is to protect against the variability of the interest rates under its Credit Agreement which has a floating interest rate. The amounts received or paid upon settlement of these transactions are recognized as interest expense at the time the interest payments are due. Gas Balancing HEC uses the sales method for recording its gas balancing. Under this method, HEC recognizes revenue on all of its sales of production, and any over-production or under-production is recovered at a future date. As of December 31, 1999, HEC had a net over-produced position of 496,000 mcf ($992,000 valued at year-end gas prices). The Company believes that this imbalance can be made up with production on existing wells or from wells which will be drilled as offsets to existing wells and that this imbalance will not have a material effect on HEC's results of operations, liquidity and capital resources. HEC's oil and gas reserves as of December 31, 1999 have been decreased by 496,000 mcf in order to reflect HEC's gas balancing position. Property, Plant and Equipment HEC follows the full cost method of accounting whereby all costs related to the acquisition and development of oil and gas properties are capitalized in a single cost center ("full cost pool") and are amortized over the productive life of the underlying proved reserves using the units of production method. Proceeds from property sales are generally credited to the full cost pool. Capitalized costs of oil and gas properties may not exceed an amount equal to the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves plus the cost, or estimated fair market value, if lower, of unproved properties. Should capitalized costs exceed this ceiling, an impairment is recognized. The present value of estimated future net revenues is computed by applying current prices of oil and gas to estimated future production of proved oil and gas reserves as of year-end, less estimated future expenditures to be incurred in developing and producing the proved reserves assuming continuation of existing economic conditions. During the second, third and fourth quarters of 1998, using oil and gas prices of $13.00 per barrel of oil and $2.00 per mcf of gas, $12.80 per barrel of oil and $1.90 per mcf of gas and $10.00 per barrel of oil and $1.90 per mcf of gas, respectively, HEC recorded oil and gas property impairments totaling $14,000,000. HEC did not record any property impairments during 1999 or 1997. HEC does not accrue costs for future site restoration, dismantlement and abandonment costs related to proved oil and gas properties because the Company estimates that such costs will be offset by the salvage value of the equipment sold upon abandonment of such properties. The Company's estimates are based upon its historical experience and upon review of current properties and restoration obligations. Unproved properties are withheld from the amortization base until such time as they are either developed or abandoned. The properties are evaluated periodically for impairment. Long-lived assets, other than oil and gas properties which are evaluated for impairment as described above, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. To date, HEC has not recognized any impairment losses on long-lived assets other than oil and gas properties. Dividends On December 13, 1999, HEC declared a quarterly dividend of $.25 per Series A Cumulative Preferred share, which was paid on February 15, 2000 to shareholders of record on December 31, 1999. This amount was accrued as of year-end. The Series A Cumulative Preferred Stock has a dividend preference of $1.00 per share per year. HEC may not declare or pay dividends to common shareholders unless full cumulative dividends have been paid on the preferred stock. Cash and Cash Equivalents All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents. Computation of Net Income (Loss) Per Share Basic income (loss) per share is computed by dividing net income (loss) attributable to the common shareholders by the weighted average number of common shares outstanding during the periods. Diluted income per common share includes the potential dilution that could occur upon exercise of the options or warrants to acquire common stock computed using the treasury stock method which assumes that the increase in the number of shares is reduced by the number of shares which could have been repurchased by the Company with the proceeds from the exercise of the options or warrants (which were assumed to have been made at the average market price of the common shares during the reporting period). The warrants described in Note 6 have been ignored in the computation of diluted net income (loss) per share in all periods and the stock options described in Note 9 have been ignored in the computation of diluted income (loss) per share in 1999 and 1998 because their inclusion would be anti-dilutive. The following table reconciles the number of shares outstanding used in the calculation of basic and diluted income (loss) per share.
Income (Loss) Shares Per Share ------ ------ --------- (In thousands except per Share data) For the Year Ended December 31, 1999 Net income per share - basic $ 512 8,083 $ .06 ---------- ------ ====== Net income per share - diluted $ 512 8,083 $ .06 ========== ====== ====== For the Year Ended December 31, 1998 Net loss per share - basic $(16,359) 5,600 $(2.92) ------ ----- ===== Net loss per share - diluted $(16,359) 5,600 $(2.92) ====== ===== ===== For the Year Ended December 31, 1997 Net income per share - basic $ 12,139 5,600 $ 2.17 ===== Effect of options 83 ------------- ------- Net income per share - diluted $ 12,139 5,683 $ 2.14 ======= ===== =====
Use of Estimates The preparation of the financial statements for the Company 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant Customers Although the Company sells the majority of its oil and gas production to a few purchasers, there are numerous other purchasers in the area in which HEC sells its production; therefore, the loss of its significant customers would not adversely affect HEC's operations. For the years ended December 31, 1999, 1998 and 1997, purchases by the following companies exceeded 10% of the total oil and gas revenues of the Company: 1999 1998 1997 ---- ---- ---- Conoco Inc. 19% 23% 20% El Paso Field Services Company 14% 11% 11% Plains All American Inc. 14% Marathon Petroleum Company 16% Environmental Concerns HEC is continually taking actions it believes are necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations. As of December 31, 1999, HEC has not been fined or cited for any environmental violations which would have a material adverse effect upon capital expenditures, earnings or the competitive position of HEC in the oil and gas industry. Other Comprehensive Income The Company does not have any items of other comprehensive income for the years ended December 31, 1999, 1998 and 1997. Therefore, total comprehensive income (loss) is the same as net income (loss) for those periods. Segments The Company engages in the development, production and sale of oil and gas, and the acquisition, exploration, development and operation of oil and gas properties in the continental United States. In addition, the Company's activities exhibit similar economic characteristics and involve the same products, production processes, class of customers, and methods of distribution. Management of the Company evaluates its performance as a whole rather than by product or geographically. As a result, HEC's operations consist of one reportable segment. Recently Issued Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS 133 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. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative (gains and losses) depends on the intended use of the derivative and the resulting designation. The Company is required to adopt SFAS 133 on January 1, 2001. The Company has not completed the process of evaluating the impact that will result from adopting SFAS 133. Reclassifications Certain reclassifications have been made to prior years' amounts to conform to the classifications used in the current year. NOTE 2 - OIL AND GAS PROPERTIES The following table summarizes cost information related to HEC's oil and gas activities: For the Year Ended December 31, ------------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Property acquisition costs: Proved $ 85,235 $28,397 $ 1,942 Unproved 3,849 379 1,071 Development costs 7,302 8,087 7,607 Exploration costs 5,767 6,043 6,950 --------- ------- ------- Total $102,153 $42,906 $17,570 ======= ====== ====== Depreciation, depletion, amortization and impairment expense related to proved oil and gas properties per equivalent mcf of production for the years ended December 31, 1999, 1998 and 1997, was $.88, $1.58 and $.73, respectively. At December 31, unproved properties consist of the following: 1999 1998 ---- ---- (In thousands) Texas $4,898 $1,857 North Dakota 1,009 499 Other 636 338 ------ ------ $6,543 $2,694 ===== ===== NOTE 3 - PRINCIPAL ACQUISITIONS AND SALES On October 20, 1999, HEC acquired oil and gas properties located principally in the Yoakum Gorge area of Lavaca County, Texas for $7,230,000 and future contingent consideration. The acquisition was comprised of interests in 34 wells, drilling locations, exploration acreage and 3-D seismic data. As a result of the arbitration discussed in Note 12, HEC completed an $8,200,000 acquisition of properties located primarily in Texas during October 1998. The acquisition included interests in 570 wells, numerous proven and unproven drilling locations, exploration acreage and 3-D seismic data. In July 1996, HEC and its affiliate, HCRC, acquired interests in 38 wells located primarily in LaPlata County, Colorado. An unaffiliated large East Coast financial institution formed an entity to utilize the tax credits generated from the wells. The project was financed by an affiliate of Enron Corp. through a volumetric production payment. During May 1998, a limited liability company owned equally by HEC and HCRC purchased the volumetric production payment from the affiliate of Enron Corp. HEC funded its $17,257,000 share of the acquisition price from operating cash flow and borrowings under its Credit Agreement. During 1997, HEC had no individually significant property acquisitions or sales. Subsequent to December 31, 1999 and through March 6, 2000, HEC sold approximately 145 oil and gas properties located in Texas, Oklahoma and North Dakota for approximately $7,100,000. HEC used $6,000,000 of the sales proceeds to pay down its outstanding debt and the remainder was used for general operations and capital projects. NOTE 4 - DERIVATIVES As part of its risk management strategy, HEC enters into financial contracts to hedge the price of its oil and natural gas. HEC does not use these hedges for trading purposes, but rather for the purpose of providing protection against price decreases and to provide a measure of stability in the volatile environment of oil and natural gas spot pricing. The amounts received or paid upon settlement of these contracts is recognized as oil or gas revenue at the time the hedged volumes are sold. The financial contracts used by HEC to hedge the price of its oil and natural gas production are swaps, collars and participating hedges. Under the swap contracts, HEC sells its oil and gas production at spot market prices and receives or makes payments based on the differential between the contract price and a floating price which is based on spot market indices. As of March 6, 2000, HEC was a party to 16 financial contracts with three different counterparties. The following table provides a summary of HEC's financial contracts: Oil Quantity of Production Period Hedged Contract Floor Price ------ ---------------- -------------------- (bbls) (per bbl) 1997 346,000 $17.78 1998 175,000 16.62 1999 325,000 15.43 2000 372,000 18.47 2001 73,000 19.16 Gas Quantity of Production Period Hedged Contract Floor Price ------ ---------------- -------------------- (mcf) (per mcf) 1997 5,386,000 $1.97 1998 7,101,000 2.09 1999 15,574,000 1.85 2000 9,040,000 1.97 2001 7,355,000 1.99 2002 4,848,000 1.95 From 1999 forward, between 11% and 13% of the gas volumes hedged in each year are subject to a collar agreement whereby HEC will receive the contract price if the spot price is lower than the contract price, the cap price if the spot price is higher than the cap price, and the spot price if that price is between the contract price and the cap price. The cap price ranges from $2.54 per mcf to $2.65 per mcf. In the event of nonperformance by the counterparties to the financial contracts, HEC is exposed to credit loss, but has no off-balance sheet risk of accounting loss. The Company anticipates that the counterparties will be able to satisfy their obligations under the contracts because the counterparties consist of well-established banking and financial institutions which have been in operation for many years. Certain of HEC's hedges are secured by the lien on HEC's oil and gas properties which also secures HEC's Credit Agreement described in Note 6. NOTE 5 - INVESTMENT IN AFFILIATED CORPORATION During 1998 and 1997, HEC accounted for its approximate 46% interest in HCRC using the equity method of accounting. As a result of the Consolidation, HEC's investment in HCRC was eliminated. The following presents summarized financial information for HCRC at December 31, 1998 and 1997. 1998 1997 ---- ---- (In thousands) Current assets $12,566 $15,145 Noncurrent assets 88,601 77,226 Current liabilities 18,262 11,007 Noncurrent liabilities 53,316 32,678 Revenue 32,410 32,411 Net income (loss) (20,279) 5,585 No other individual entity in which HEC owns an interest comprises in excess of 10% of the revenues, net income or assets of HEC. The following amounts represent HEC's share of the property related costs and reserve quantities and values of its equity investee HCRC as of December 31, 1998 and 1997, prior to its elimination on June 8, 1999 (in thousands): Capitalized Costs Relating to Oil and Gas Activities: As of December 31, 1998 1997 ---- ---- Unproved properties $ 1,286 $ 1,040 Proved properties 147,600 118,966 Accumulated depreciation, depletion, amortization and property impairment (100,890) (92,511) ------- ------- Net property $ 47,996 $ 27,495 ======= ======= Costs Incurred in Oil and Gas Activities: For the Year Ended December 31, 1998 1997 ---- ---- Acquisition costs $ 12,879 $ 1,303 Development costs 2,636 2,060 Exploration costs 2,606 2,851 -------- ------ Total $ 18,121 $ 6,214 ======= ====== For the Year Ended December 31, 1998 1997 ---- ---- Oil and gas revenue $ 10,372 $10,889 Production operating expense (4,272) (3,746) Depreciation, depletion, amortization and property impairment expense (13,773) (3,336) Income tax benefit (expense) (761) --------- -------- Net income (loss) from oil and gas activities $ (7,673) $ 3,046 ======== ======= Proved Oil and Gas Reserve Quantities: Gas Oil Mcf Bbl (unaudited) Balance, December 31, 1998 32,000 1,470 ====== ===== Balance, December 31, 1997 27,268 2,065 ====== ===== Standardized Measure of Discounted Future Net Cash Flows: (unaudited) December 31, 1998 $30,134 ====== December 31, 1997 $31,245 ====== NOTE 6 - DEBT HEC's long-term debt at December 31, 1999 and 1998 consisted of the following: 1999 1998 ---- ---- (In thousands) Credit Agreement $ 86,200 $ 49,700 Note Agreement 25,000 Debt discount (1,843) --------- ------- Total debt 109,357 49,700 Less current maturities (9,319) ------------- --------- Long-term debt $109,357 $ 40,381 ======= ======== On June 8, 1999, HEC and its lenders entered into an Amended and Restated Credit Agreement (as amended, the "Credit Agreement") to extend the term date of its line of credit to May 31, 2002. The lenders are Morgan Guaranty Trust Company, First Union National Bank and Bank of America. The terms of the Credit Agreement were amended on October 15, 1999, to, among other matters, increase HEC's borrowing base to $90,000,000. At December 31, 1999, HEC had amounts outstanding of $86,200,000. HEC's plans are to sell its interests in approximately 500 non-strategic oil and gas wells during 2000. These property sales will enable HEC to better focus on its core areas while at the same time reduce its level of outstanding debt. Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 oil and gas properties have been sold and HEC has repaid $6,000,000 of its borrowings under the Credit Agreement. On January 27, 2000, the Credit Agreement was further amended to reduce HEC's borrowing base to reflect the property sales made by the Company and to waive compliance with an asset sale covenant. On February 9, 2000, HEC's borrowing base was further reduced to $84,479,000 to reflect the most recent property sales, and therefore HEC's unused borrowing base totaled $4,279,000 at March 6, 2000. Borrowings against the Credit Agreement bear interest at the lower of the Certificate of Deposit rate plus from 1.375% to 2.125%, prime plus 1/2% or the Euro-Dollar rate plus from 1.25% to 2.0%. The applicable interest rate was 8.5% at December 31, 1999. Interest is payable monthly. Quarterly principal payments of $11,457,000 are calculated to include the repayments of the borrowing made subsequent to December 31, 1999 and commence May 31, 2002. The borrowing base for the Credit Agreement is typically redetermined semiannually, although the lenders have the right to make a redetermination at anytime. The Credit Agreement is secured by a first lien on approximately 80% in value of HEC's oil and gas properties. Additionally, aggregate dividends paid and stock repurchased by HEC in any 12 month period are limited to 50% of cash flow from operations before working capital changes and distributions received from affiliates, if the principal amount of debt of HEC is 50% or more of the borrowing base. Aggregate dividends paid and stock repurchased by HEC are limited to 65% of cash flow from operations before working capital changes and distributions received from affiliates, if the principal amount of debt is less than 50% of the borrowing base. At the time of the Consolidation, HCRC had $25,000,000 of 10.32% Senior Subordinated Notes ("Subordinated Notes") due December 23, 2007 and warrants to purchase common stock which were held by The Prudential Insurance Company of America ("Prudential"). On June 8, 1999, the Amended and Restated Subordinated Note and Warrant Purchase Agreement (the "Note Agreement") was amended to issue warrants to Prudential to purchase 309,278 shares of HEC's Common Stock at an exercise price of $7.00 per share. The terms of the Note Agreement were further amended on October 15, 1999 to exclude certain hedging transactions of the subsidiaries of HEC from the calculation of indebtedness. In connection with this amendment, the Company received a written waiver under the Credit Agreement of the restriction on amendment to the Note Agreement. The Subordinated Notes bear interest at the rate of 10.32% per annum on the unpaid balance, payable quarterly. Annual principal payments of $5,000,000 are due December 23, 2003 through December 23, 2007. HEC recorded the Subordinated Notes and the warrants based upon the relative fair values of the Subordinated Notes without the warrants and of the warrants themselves at the time of Consolidation. The allocated value of the warrants of $1,956,000 was recorded as additional paid-in-capital. The discount on the Subordinated Notes is being amortized over the term of the Subordinated Notes using the interest method of amortization. At December 31, 1999, HEC's debt maturity schedule is as follows. (In thousands) 2000 $ -- 2001 -- 2002 36,943 2003 54,257 2004 5,000 Thereafter 13,157 -------- Total $109,357 ======= As part of its risk management strategy, HEC enters into financial contracts to hedge the interest rate payments under its Credit Agreement. HEC does not use the hedges for trading purposes, but rather to protect against the volatility of the cash flows under its Credit Agreement, which has a floating interest rate. The amounts received or paid upon settlement of these transactions are recognized as interest expense at the time the interest payments are due. All contracts are interest rate swaps with fixed rates. As of March 6, 2000, HEC was a party to eight contracts with three different counterparties. The following table provides a summary of HEC's financial contracts. Average Amount of Contract Period Debt Hedged Floor Rate 1997 $15,000,000 6.56% 1998 15,000,000 6.84% 1999 40,000,000 5.70% 2000 45,000,000 5.65% 2001 36,000,000 5.23% 2002 37,500,000 5.23% 2003 37,500,000 5.23% 2004 6,000,000 5.23% NOTE 7 - STOCKHOLDERS' EQUITY HEC's stock trades on the NASDAQ under the symbol "HECO" for Common Stock and "HECOP" for Series A Cumulative Preferred Stock. Common Stock Under its charter, HEC is authorized to issue up to 25,000,000 shares of HEC common stock with a par value of $.01 per share. The common shareholders are entitled to one vote per share on all matters voted on by shareholders. After giving effect to any preferential rights of any series of preferred stock outstanding, the holders of HEC common stock are entitled to participate in dividends, if any, as may be declared from time to time by the board of directors of HEC. Upon liquidation, the common shareholders are entitled to receive a pro rata share of all of the assets of HEC that are available for distribution to such holders. The holders of HEC common stock have no preemptive rights with respect to future issuances of HEC common stock. Preferred Stock HEC is authorized to issue up to 5,000,000 shares of preferred stock from time to time, in one or more series, without shareholder approval and to fix the designation, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications and terms and conditions of redemption of any series that may be established by the HEC Board of Directors. In connection with the Consolidation, the Board of Directors of HEC has authorized the issuance of 2,334,165 shares of Series A cumulative preferred stock. Each share of preferred stock is entitled to one vote on all matters on which shareholders may vote. The preferred shareholders vote together with the common shareholders in the election of directors and vote as a separate class on all other matters. Preferred shareholders are entitled to receive cumulative cash dividends at the rate of $1.00 per share per year, if declared by the HEC Board of Directors. Dividends are paid quarterly in arrears commencing on June 30, 1999. The dividends are fully cumulative and accumulate, whether or not earned or declared and whether or not HEC has funds legally available to pay them, without interest on a daily basis. HEC may not declare or pay dividends to common shareholders unless full cumulative dividends have been paid on the preferred stock. Upon liquidation or dissolution of HEC, all accrued dividends must be paid to the preferred shareholders before any assets may be distributed to the common shareholders. Once all accrued preferred dividends are paid, the preferred shareholders are entitled to participate equally with the common shareholders in the distribution of the remaining assets of HEC in a liquidation or dissolution. The HEC preferred stock is redeemable at the option of HEC after December 31, 2003. After that date, HEC may redeem shares of preferred stock in whole or in part at any time at a redemption price of $10.00 per share, plus accrued dividends which are unpaid on the redemption date. Preferred stock may not be redeemed in part if full cumulative dividends have not been paid or set aside for payment with respect to all prior dividend periods. Rights Plan During the second quarter of 1999, the board of directors of HEC approved the adoption of a rights plan designed to protect shareholders in the event of a takeover action that would otherwise deny them the full value of their investment. Under the terms of the rights plan, one right was distributed for each common share of HEC to holders of record at the close of business on June 8, 1999. The rights trade with the common stock. The rights will become exercisable only in the event, with certain exceptions, that an acquiring party accumulates 15% or more of HEC's outstanding common stock. The rights will expire on June 7, 2009. HEC will generally be entitled to redeem the rights at one cent per right at any time until the tenth day following the acquisition of a 15% position in its common shares. Issuance of HEP Units On February 17, 1998, HEP closed its public offering of 1.8 million Class C Units, priced at $10.00 per Unit. Proceeds to HEP, net of underwriting expenses, were approximately $16,518,000. HEP used $14,000,000 of the net proceeds to repay borrowings under its Credit Agreement and applied the remaining proceeds toward the repayment of HEP's outstanding contract settlement obligation. NOTE 8 - INCOME TAXES The following is a summary of the income tax provision for the year ended December 31, 1999 (in thousands). HEC was not a taxable entity prior to the Consolidation on June 8, 1999: State $338 Federal - Current Deferred Total $338 === Reconciliation of the expected tax at the statutory tax rate to the effective tax is as follows for the year ended December 31, 1999 (in thousands): Expected tax expense at the statutory rate $1,094 State taxes net of federal benefit 223 Taxes on income prior to June 8, 1999 (440) Change in valuation allowance (789) Other 250 ------ Effective tax expense $ 338 ====== Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. The tax effects of significant items comprising the Company's deferred tax assets and liabilities as of December 31, 1999 (in thousands) are as follows: Deferred tax assets and (liabilities): Net operating loss carryforward $ 7,758 Capital loss carryforward 1,458 Minimum tax credit carryforward 534 Temporary differences between book and tax basis of property (215) -------- Total 9,535 Valuation allowance (9,535) ------ Net deferred tax asset $ -0- ========= The Company's net operating loss carryforwards expire between 2008 and 2019, the capital loss carryforward expires in 2001 and the minimum tax credit carryforward has no expiration date. NOTE 9 - EMPLOYEE INCENTIVE PLANS Every year beginning in 1992, the Boards of Directors of HEP and HCRC have adopted an incentive plan. Each year the Boards of Directors determine the percentage of each entities interest in the cash flow from certain wells drilled, recompleted or enhanced during the year allocated to the incentive plan for that year. The specified percentage was 2.80% for 1999, 2.75% for 1998, and 2.40% for 1997. The specified percentage of cash flow is then allocated among certain key employees who are designated by the boards as participants in the plan for that year. Each award under the plan (with regard to domestic properties) represents the right to receive for five years a portion of the specified share of the cash award, at the conclusion of which the participants are each paid a share of an amount equal to a specified percentage (80% for 1999, 1998 and 1997) of the remaining net present value of the qualifying wells, and the award for that year terminates. The expenses attributable to the plans were $220,000 in 1999, $125,000 in 1998 and $277,000 in 1997 and are included in general and administrative expense in the accompanying financial statements. On June 9, 1999, the Compensation Committee of HEC adopted an incentive plan that is substantially the same as the incentive plan of HEP and HCRC, and specified that the percentage of cash flow allocated to the new plan for the remainder of 1999 be 2.80%, the same as was allocated for the 1999 plan by HEP and HCRC. On June 9, 1999, the Compensation Committee of HEC granted options to purchase 600,000 shares of common stock at an exercise price of $7.00 per share which was equal to the fair market value on the date of grant. On November 22, 1999, HEC granted an additional 61,500 options to purchase common stock at an exercise price of $7.00 per share which was greater than the fair market value of the common stock on the date of the grant. The options expire on June 9, 2006, unless sooner terminated pursuant to the provisions of the plan. One-third of the options vested on the grant date, and the remainder vest one-third on June 8, 2000 and one-third on June 8, 2001. On January 28, 2000, the Compensation Committee of HEC granted options to purchase 238,500 shares of common stock at an exercise price of $4.625 per share which was equal to the fair market value of the common stock on the date of grant. The options expire on January 28, 2007, unless sooner terminated pursuant to the provisions of the plan. One-third of the options vested on the grant date and the remainder vest one-third on January 28, 2001 and one-third on January 28, 2002. Prior to the Consolidation, the following HEP options were outstanding. All of these options were cancelled on June 8, 1999. Number of Options Outstanding Exercisable Exercise Price Class A Unit Options 390,400 390,400 $ 5.75 Class A Unit Options 25,500 17,000 $ 6.625 Class C Unit Options 120,000 120,000 $10.00 A summary of options granted to purchase HEC common stock and the changes therein during the year-ended December 31, 1999 is presented below: Weighted Average Exercise Shares Price Outstanding at beginning of year -- $ -- Granted 661,500 7.00 ------- ---- Outstanding at end of year 661,500 $7.00 ======= ==== Options exercisable 220,500 $7.00 ======= ==== A summary of options granted to purchase Class A Units and the changes therein during the years-ended December 31, 1999, 1998, and 1997 is presented below:
1999 1998 1997 ------ ------ ----- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Units Price Units Price Units Price ----- ----- ----- ----- ----- ----- Outstanding at beginning of year 415,900 $ 5.80 425,000 $5.75 425,000 $5.75 Granted 25,500 6.625 Exercised (34,600) 5.75 Cancelled (415,900) $ 5.80 ------- ------ ------------- -------- ------------- Outstanding at end of year -- $ -- 415,900 $5.80 425,000 $5.75 ============= ========= ======= ==== ======= ==== Options exercisable at year-end -- $ -- 398,900 $5.80 425,000 $5.75 ============= ========= ======= ==== ======= ====
A summary of options granted to purchase Class C Unit Options and the changes therein during the year ended December 31, 1999 and 1998 is presented below:
1999 1998 ---- ---- Weighted Weighted Average Exercise Average Exercise Price Price Units Units Outstanding at beginning of year 120,000 $10.00 -- $ -- Granted 120,000 10.00 Cancelled (120,000) 10.00 ------- ----- -------------- Outstanding at end of year -- $ -- 120,000 $10.00 ============= ========= ======= ===== Options exercisable at year-end -- $ -- 60,000 $10.00 ============= ========= ======== =====
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). Accordingly, no compensation cost has been recognized for the options granted. Had compensation expense for options granted been determined based on the fair value at the grant date for the options, consistent with the provisions of SFAS 123, HEC's net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts indicated below:
1999 1998 1997 ---- ---- ---- Net income(loss): as reported $2,880,000 $(13,895,000) $12,803,000 pro forma 930,000 (14,022,000) 12,730,000 Net income (loss) per share - basic: as reported $ .06 $(2.92) $2.17 pro forma $(.18) $(2.94) $2.15 Net income (loss) per share - diluted: as reported $ .06 $(2.92) $2.14 pro forma $(.18) $(2.94) $2.12
The fair value of the common stock options granted during 1999, for disclosure purposes was estimated on the dates of grant using the Black-Scholes Model using the following assumptions.
Common Stock Options Granted Granted June 9, 1999 November 22, 1999 ------------ ----------------- Expected dividend yield -- -- Expected price volatility 68% 68% Risk-free interest rate 5.8% 6.4% Expected life of options 7 years 7 years
The fair value of the unit options granted during 1998 and 1995, for disclosure purposes was estimated on the dates of grant using the Binomial Option Pricing Model using the following assumptions: 1995 Class A 1998 Class A 1998 Class C Options Options Options Expected dividend yield 6% 8% 11% Expected price volatility 28% 27% 29% Risk-free interest rate 7.6% 6.4% 6.4% Expected life of options 10 years 10 years 10 years NOTE 10 - RELATED PARTY TRANSACTIONS The Company manages and operates certain oil and gas properties on behalf of independent joint interest owners and its affiliates. In such capacity, the Company pays all costs and expenses of operations and distributes all revenues associated with such properties. HEC has receivables from affiliates of $704,000 and $119,000 at December 31, 1999 and 1998, respectively, which represent net revenues net of operating costs and expenses. The balances with affiliates are settled monthly. During the years ended December 31, 1999, 1998 and 1997, HEC incurred approximately $124,000, $274,000 and $275,000, respectively, of consulting fees under a consulting agreement with Hallwood Group. The consulting agreement was terminated effective June 8, 1999 in connection with the Consolidation. HEC also incurred $195,000, $317,000 and $301,000 in 1999, 1998 and 1997, respectively, representing costs incurred by Hallwood Group and its affiliates on behalf of the Company. On February 18, 2000, HEC repurchased and retired 43,816 shares of Series A Preferred Stock from it affiliate, Hallwood Group for $303,426. The shares were repurchased for $6.925 per share which represented the average of the closing prices of the stock during the five days prior to February 18, 2000. NOTE 11 - STATEMENT OF CASH FLOWS In connection with the Consolidation, the purchase of the common stock of HCRC and the direct energy interests of Hallwood Group was recorded through the issuance of approximately 2,600,000 shares of HEC common stock to HCRC and 1,800,000 shares of HEC common stock to Hallwood Group based on the estimated fair value of the assets acquired and the liabilities assumed as of the date of purchase. This noncash investing activity is summarized as follows: Fair Value of Acquired Interest ----------------- (In thousands) Current assets $ 4,823 Oil and gas properties 81,348 Other assets 1,140 Current liabilities (2,606) Long-term debt (49,544) Other noncurrent liabilities (62) Cash paid during 1999, 1998 and 1997 for interest totaled $6,583,000, $2,700,000 and $2,775,000, respectively. Cash paid for income taxes during 1999 was $375,000. There was no cash paid for income taxes during 1998 and 1997 as HEC was not a tax paying entity. NOTE 12 - ARBITRATION In connection with the Demand for Arbitration filed by Arcadia Exploration and Production Company ("Arcadia") with the American Arbitration Association against Hallwood Energy Partners, L.P., Hallwood Consolidated Resources Corporation, E.M. Nominee Partnership Company and Hallwood Consolidated Partners, L.P. (collectively referred to as "Hallwood"), the arbitrators ruled that the original agreement entered into in August 1997 to purchase oil and gas properties for $16,400,000 should proceed, with a reduction in the total purchase price of approximately $2,500,000 for title defects. The arbitrators also ruled that Arcadia was not entitled to enforce its claim that Hallwood was required to purchase an additional $8,000,000 in properties and denied Arcadia's claim for attorneys fees. The arbitrators granted Arcadia prejudgment interest on the adjusted purchase price, in the amount of $904,000 of which HEC's share was $452,000. That amount was accrued in the December 31, 1998 financial statements of the Company and was paid during the second quarter of 1999. In October 1998, HEC closed the acquisition of oil and gas properties from Arcadia pursuant to the ruling which included interests in approximately 570 wells, numerous proven and unproven drilling locations, exploration acreage, and 3-D seismic data. HEC's share of the purchase price was $8,200,000. NOTE 13 - LEGAL SETTLEMENTS In connection with the Consolidation, HEC assumed the liability for two lawsuits filed against Hallwood Group and certain individuals and related to the direct energy interests acquired from Hallwood Group. These lawsuits, both filed in federal court in Denver, Colorado, have been settled. HEC was obligated to pay approximately $673,000 in connection with these lawsuits, and that amount was accrued as a liability on the Company's balance sheet in connection with the Consolidation. The court gave its final approval for the settlement during January 2000 and the settlement amount was paid by HEC during February 2000. Concise Oil and Gas Partnership ("Concise"), a wholly owned subsidiary of HEC was a defendant in a lawsuit styled Dr. Allen J. Ellender, Jr. et al. vs. Goldking Production Company, et al., filed in the Thirty-Second Judicial District Court, Terrebonne Parish, Louisiana on May 30, 1996. The portion of the lawsuit against Concise was settled in consideration of the payment by Concise of $600,000. This amount was recorded as litigation settlement expense in the second quarter of 1998. Concise has been dismissed with prejudice from the lawsuit. In addition to the litigation noted above, the Company and its subsidiaries are from time to time subject to routine litigation and claims incidental to their business, which the Company believes will be resolved without material effect on the Company's financial condition, cash flows or operations. NOTE 14 - COMMITMENTS The Company currently leases office facilities in Denver, Colorado for approximately $600,000 per year, under a lease which expires on December 31, 2006. HEC also sub-leases office space in Houston, Texas for approximately $42,000 per year, under a lease that expires on October 14, 2001. Remaining commitments under these leases mature as follows: Year Ending December 31, Annual Rentals (In thousands) 2000 $ 643 2001 636 2002 601 2003 601 2004 601 Thereafter 1,379 ----- $4,461 Rent expense for the years ended December 31, 1999, 1998 and 1997 was $421,000, $287,000 and $288,000, respectively. NOTE 15 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
December 31, 1999 December 31, 1998 ----------------- ----------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------ ---------- ------ ---------- (In thousands) Assets (Liabilities): Interest rate hedge contracts $ -- $ 2,156 $ -- $ 4,254 Oil and gas hedge contracts -- (4,558) -- (812) Long-term debt (109,357) (109,021) (49,700) (49,700)
The estimated fair value of the interest rate hedge contracts is computed by multiplying the difference between the quoted contract termination interest rate and the contract interest rate by the amounts under contract. This amount has been discounted using an interest rate that could be available to the Company. The estimated fair value of the oil and gas hedge contracts is determined by multiplying the difference between the quoted termination prices for oil and gas and the hedge contract prices by the quantities under contract. This amount has been discounted using an interest rate that could be available to the Company. The estimated fair value of long-term debt is computed using interest rates that could be available to the Company for similar instruments with similar terms. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1999. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively reevaluated for purposes of these financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein. HALLWOOD ENERGY CORPORATION SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION DECEMBER 31, 1999 (Unaudited) The following reserve quantity and future net cash flow information for HEC represents proved reserves which are located in the United States. The reserves have been estimated by the Company's in-house engineers. A majority of these reserves has been reviewed by independent petroleum engineers. The determination of oil and gas reserves is based on estimates which are highly complex and interpretive. The estimates are subject to continuing change as additional information becomes available. The standardized measure of discounted future net cash flows provides a comparison of HEC's proved oil and gas reserves from year to year. No consideration has been given to future income taxes as of December 31, 1999, because the tax basis of HEC's properties and net operating loss carryforwards exceed future net cash flows. No consideration was given to future income taxes as of December 31, 1998 and 1997 because HEC was not a tax paying entity during these years. Under the guidelines set forth by the Securities and Exchange Commission (SEC), the calculation is performed using year-end prices. The oil and gas prices used at December 31, 1999, 1998 and 1997 were $24.32 per bbl and $2.00 per mcf, $10.00 per bbl and $1.90 per mcf and $16.90 per bbl and $2.30 per mcf, respectively, for HEC, including the May Partnerships. Future production costs are based on year-end costs and include severance taxes. The present value of future cash inflows is based on a 10% discount rate. The reserve calculations using these December 31, 1999 prices result in 11.7 million bbls of oil, and 151.7 billion cubic feet of gas and a standardized measure of $208,000,000. The Mays are included on a consolidated basis, and 8,000 bbls of oil and .1 billion cubic feet of gas, representing a discounted present value of $352,000 are attributable to the minority ownership of these entities. This standardized measure is not necessarily representative of the market value of HEC's properties. HEC's standardized measure of future net cash flows has been decreased by $3,357,000 at December 31, 1999 for the effects of its hedge contracts. This amount represents the difference between year-end oil and gas prices and the hedge contract prices multiplied by the quantities subject to contract, discounted at 10%.
HALLWOOD ENERGY CORPORATION RESERVE QUANTITIES (In thousands) (Unaudited) Gas Oil --- --- Mcf Bbls Proved Reserves: Balance, December 31, 1996 88,542 7,531 Extensions and discoveries 4,228 817 Revisions of previous estimates 11,578 (1,930) Sales of reserves in place (140) (9) Purchases of reserves in place 619 128 Production (11,774) (770) ------- -------- Balance, December 31, 1997 93,053 5,767 Extensions and discoveries 1,542 415 Revisions of previous estimates (9,369) (1,385) Sales of reserves in place (244) (35) Purchases of reserves in place 23,994 512 Production (14,037) (787) -------- -------- Balance, December 31, 1998 94,939 4,487 Extensions and discoveries 10,929 180 Revisions of previous estimates (10,730) 2,245 Sales of reserves in place (1,067) (185) Purchases of reserves in place 75,860 5,879 Production (18,263) (925) -------- -------- Balance, December 31, 1999 151,668 11,681 ======= ====== Proved Developed Reserves: Balance, December 31, 1997 89,816 5,181 ======== ======= Balance, December 31, 1998 90,915 3,577 ======== ======= Balance, December 31, 1999 139,839 10,301 ======= ======
HALLWOOD ENERGY CORPORATION STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (In thousands) (Unaudited) December 31, ----------------------------------------------------------- 1999 1998 1997 ---- ---- ---- Future cash flows $ 597,000 $ 245,000 $ 293,000 Future production and development costs (263,000) (102,000) (115,000) -------- ------- -------- Future net cash flows before discount 334,000 143,000 178,000 10% discount to present value (126,000) (42,000) (49,000) -------- --------- --------- Standardized measure of discounted future net cash flows $ 208,000 $ 101,000 $ 129,000 ========= ========= =========
HALLWOOD ENERGY CORPORATION CHANGES IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (In thousands) (Unaudited) For the Year Ended December 31, ------------------------------- 1999 1998 1997 ---- ---- ---- Standardized measure of discounted future net cash flows at beginning of year $101,000 $129,000 $206,000 Sales of oil and gas produced, net of production costs (32,919) (26,932) (30,209) Net changes in prices and production costs 12,454 (21,211) (78,965) Extensions and discoveries, net of future production and development costs 11,719 3,546 9,592 Changes in estimated future development costs (12,959) (9,738) (10,012) Development costs incurred 7,302 8,087 7,607 Revisions of previous quantity estimates 2,674 (15,547) (8) Purchases of reserves in place 108,449 23,802 1,457 Sales of reserves in place (2,124) (399) (204) Accretion of discount 10,136 12,936 20,600 Changes in production rates and other 2,268 (2,544) 3,142 -------- -------- -------- Standardized measure of discounted future net cash flows at end of year $208,000 $101,000 $129,000 ======= ======= =======
ITEM 9 - DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item will be included in the definitive proxy statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be filed with the SEC pursuant to Regulation 14A, which information is incorporated herein by reference. ITEM 11 - EXECUTIVE COMPENSATION The information required by this item will be included in the definitive proxy statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be filed with the SEC pursuant to Regulation 14A, which information is incorporated herein by reference. ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item will be included in the definitive proxy statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be filed with the SEC pursuant to Regulation 14A, which information is incorporated herein by reference. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will be included in the definitive proxy statement of HEC relating to HEC's 2000 Annual Meeting of Shareholders to be filed with the SEC pursuant to Regulation 14A, which information is incorporated herein by reference. PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Financial Statement Schedules. (See Index at Item 8). (b) Reports on Form 8-K. HEC filed no current reports on Form 8-K during the last quarter of the period covered by this report. (c) Exhibits. (1) 3.1 - Certificate of Incorporation of Hallwood Energy Corporation (1) 3.2 - Bylaws of Hallwood Energy Corporation (1) 4.1 - Certificate of Designations of the Series A Cumulative Preferred Stock of Hallwood Energy Corporation (2) 4.1.1 - Executed Rights Agreement dated as of June 8, 1999, between the Company and Registrar and Transfer Company (1) 4.2 - Form of Certificate of Designation of Series A Junior Participating Preferred Stock of Hallwood Energy Corporation (1) 10.1 - Form of Rights Agreement (1) 10.2* - 1999 Long-Term Incentive Plan of Hallwood Energy Corporation (1) 10.3* - 1999 Long-Term Incentive Plan Loan Program of Hallwood Energy Corporation (2) 10.5 - Registration Rights Agreement dated as of June 8, 1999, between the Company and The Prudential Insurance Company of America (2) 10.6* - Change of Control Agreement between the Company and Certain Executives, dated as of June 9, 1999 10.61* - Amended Schedule for Change of Control Contracts, dated as of December 13, 1999 (2) 10.7 - Amended and Restated Credit Agreement dated as of June 8, 1999, among the Company and certain of its subsidiaries and the Banks listed therein (2) 10.8 - Agreement Regarding Initial Exercise Price dated June 9, 1999, between the Company and The Prudential Insurance Company of America (2) 10.9* - Phantom Working Interest Incentive Plan of Hallwood Energy Corporation dated as of June 8, 1999 (2) 10.10 - Amended and Restated Subordinated Note and Warrant Purchase Agreement dated as of June 8, 1999, between Hallwood Consolidated Resources Corporation and The Prudential Insurance Company of America (2) 10.11 - Common Stock Purchase Warrant dated June 8, 1999 between the Company and The Prudential Insurance Company of America (3) 10.12 - Amendment No. 1 to Credit Agreement, dated as of October 15, 1999 (3) 10.13 - Letter Amendment No. 1 to Note Agreement, dated as of October 15, 1999 10.14 - Amendment No. 2 and Waiver to Credit Agreement, dated as of January 27, 2000 (1) 21 - Subsidiaries of the Registrant 27 - Financial Data Schedule --------------- (1) Incorporated by reference to the same Exhibit number filed with Registrant's Registration Statement No. 33-77409. (2) Incorporated by reference to the same exhibit number filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. (3) Incorporated by reference to the same exhibit number filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. *Designates management contracts or compensatory plans or arrangements. 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, thereunto duly authorized. HALLWOOD ENERGY CORPORATION Date: March 6, 2000 By: /s/William L.Guzzetti - ----------------------- --------------------- William L. Guzzetti President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Capacity Date /s/Anthony J. Gumbiner Chairman of the Board and March 6, 2000 - ---------------------- Anthony J. Gumbiner Director (Chief Executive Officer) /s/William L. Guzzetti President and Director March 6, 2000 - ---------------------- William L. Guzzetti /s/Hans-Peter Holinger Director March 6, 2000 - ---------------------- Hans-Peter Holinger /s/Rex A. Sebastian Director March 6, 2000 - --------------------- Rex A. Sebastian /s/Nathan C. Collins Director March 6, 2000 - --------------------- Nathan C. Collins /s/John R. Isaac, Jr. Director March 6, 2000 - --------------------- John R. Isaac, Jr. Director March 6, 2000 - --------------------- Jerry A. Lubliner /s/Hamilton P. Schrauff Director March 6, 2000 - ------------------------ Hamilton P. Schrauff Director March 6, 2000 - ------------------------ Bill M. Van Meter /s/William J. Baumgartner Vice President March 6, 2000 - ------------------------- William J. Baumgartner Chief Financial Officer (Principal Financial and Accounting Officer) EX-10.61 2 AMENDED SCHEDULE FOR CHANGE IN CONTROL CONTRACTS Amended Schedule for Change of Control Contracts Signing Executives Effective Date Severance Amount Anthony J. Gumbiner June 9, 1999 three times compensation William L. Guzzetti June 9, 1999 three times compensation Russell P. Meduna June 9, 1999 two and one-half times compensation Cathleen M. Osborn June 9, 1999 two and one-half times compensation George L. Brinkworth June 9, 1999 two times compensation Betty J. Dieter June 9, 1999 two times compensation William H. Marble June 9, 1999 two times compensation Thomas J. Jung June 9, 1999 two times compensation William J. Baumgartner December 13, 1999 two and one-half times compensation EX-10.14 3 AMENDMENT NO. 2 AND WAIVER TO CREDIT AGREEMENT [CONFORMED COPY] AMENDMENT NO. 2 AND WAIVER TO CREDIT AGREEMENT AMENDMENT AND WAIVER dated as of January 27, 2000 to the Amended and Restated Credit Agreement dated as of June 8, 1999, as amended by Amendment No. 1 dated as of October 15, 1999 (as so amended, the "Credit Agreement"), among HALLWOOD ENERGY CORPORATION, HALLWOOD ENERGY PARTNERS, L.P. and HALLWOOD CONSOLIDATED RESOURCES CORPORATION (collectively, the "Borrowers"), the BANKS party thereto (the "Banks"), FIRST UNION NATIONAL BANK, as Collateral Agent and MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent (the "Agent"). W I T N E S S E T H : WHEREAS, the parties hereto desire to amend the Credit Agreement as set forth herein and the Banks have agreed to grant a waiver of certain provisions thereof as set forth herein; NOW, THEREFORE, the parties hereto agree as follows: SECTION 1. Defined Terms; References. Unless otherwise specifically defined herein, each term used herein which is defined in the Credit Agreement has the meaning assigned to such term in the Credit Agreement. Each reference to "hereof", "hereunder", "herein" and "hereby" and each other similar reference and each reference to "this Agreement" and each other similar reference contained in the Credit Agreement shall, after this Amendment and Waiver becomes effective, refer to the Credit Agreement as amended hereby. SECTION 2. Resetting of the Availability Limit and the Debt Limit. (a) The definition of "Availability Limit" set forth in Section 1.01 of the Credit Agreement is amended by to read in its entirety as follows: "Availability Limit" means, on any date, an amount equal to the lesser of (i) the aggregate amount of the Commitments at such date and (ii) $85,000,000. The Availability Limit may be increased only by an amendment in accordance with Section 8.05, which the Banks may agree to or not agree to in their sole discretion. (NY) 27008/757/AMEND/amend00.2.conf (b) Effective on and as of the date hereof, the "Debt Limit", as determined in accordance with subsection (b) of Section 4.17 of the Credit Agreement, shall be $85,000,000. SECTION 3. Amendment to Section 4.17(c)(ii). Section 4.17(c)(ii) of the Credit Agreement is hereby amended in its entirety as set forth below: "(ii) Upon any sale by the Borrowers or the Property Base Subsidiaries of Petroleum Property having, together with all previous such sales not taken into account in previous adjustments or redeterminations of the Debt Limit pursuant to this Section 4.17(c), an aggregate fair market value of $1,000,000 or more, under circumstances when subparagraph (iv) is not applicable, or, if subparagraph (iv) is applicable, until the Debt Limit is redetermined pursuant to subparagraph (iv), the Debt Limit shall be reduced, effective on the date of consummation of such sale, by an amount equal to 50% of the aggregate net proceeds to the Borrowers and the Property Base Subsidiaries of (x) such sale and (y) all previous such sales not taken into account in previous adjustments or rederminations of the Debt Limit pursuant to this Section 4.17(c)." SECTION 4. Waiver of the Asset Sale Covenant. The Banks hereby waive compliance by the Borrowers with the requirement in subsection (b) of Section 4.27 of the Credit Agreement that the net proceeds of all sales of Property by HEC and its Subsidiaries not exceed $5,000,000 during any period of six consecutive calendar months, such waiver being granted for the limited purpose of permitting HEC and its Subsidiaries to sell the Properties described in Schedules A-1 and A- 2 hereto for an aggregate purchase price of approximately $3,950,000 and $2,000,000, respectively, in each case substantially on the terms described by HEC to the Banks prior to the date hereof. SECTION 5. No Other Waivers. Other than as specifically provided herein, this Amendment and Waiver shall not operate as a waiver of any right, remedy, power or privilege of the Agent, the Collateral Agent or the Banks under the Credit Agreement or any other Financing Document or of any other term or condition thereof. SECTION 6. Representations of Borrowers. The Borrowers represent and warrant that (i) the representations and warranties of the Borrowers set forth in Article 3 of the Credit Agreement are true on and as of the date hereof and (ii) no Default has occurred and is continuing. SECTION 7. Governing Law. This Amendment and Waiver shall be governed by and construed in accordance with the laws of the State of New York. (NY) 27008/757/AMEND/amend00.2.conf SECTION 8. Counterparts. This Amendment and Waiver may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. SECTION 9. Effectiveness. This Amendment and Waiver shall become effective as of the date hereof on the date on which the Agent shall have received from the Borrowers and the Banks a counterpart hereof signed by such party or facsimile or other written confirmation (in form satisfactory to the Agent) that such party has signed a counterpart hereof. (NY) 27008/757/AMEND/amend00.2.conf IN WITNESS WHEREOF, the parties hereto have caused this Amendment and Waiver to be duly executed as of the date first above written. HALLWOOD ENERGY CORPORATION By: /s/ William J. Baumgartner Title: Vice President HALLWOOD CONSOLIDATED RESOURCES CORPORATION By: /s/ William J. Baumgartner Title: Vice President HALLWOOD ENERGY PARTNERS, L.P. By: HEC Acquisition Corp., its General Partner By/s/ William J. Baumgartner Title: Vice President (NY) 27008/757/AMEND/amend00.2.conf MORGAN GUARANTY TRUST COMPANY OF NEW YORK By: /s/ John Kowalczuk Title: Vice President FIRST UNION NATIONAL BANK By: /s/ Robert Wetteroff Title: Senior Vice President BANK OF AMERICA, N.A., formerly NATIONSBANK, N.A. By: /s/ Tracey S. Barclay Title: Principal (NY) 27008/757/AMEND/amend00.2.conf Acknowledged by: HALLWOOD LA PLATA, LLC LA PLATA ASSOCIATES, LLC By: HALLWOOD PETROLEUM, INC. By:/s/ Cathleen M. Osborn Title: Vice President The Manager of Hallwood La Plata LLC and La Plata Associates LLC CONCISE OIL AND GAS PARTNERSHIP EM NOMINEE PARTNERSHIP COMPANY MAY ENERGY PARTNERS OPERATING PARTNERSHIP LTD. By: HEC ACQUISITION CORP. By:/s/ Cathleen M. Osborn Title: Vice President The General Partner of Concise Oil and Gas Partnership, EM Nominee Partnership Company, May Energy Partners Operating Partnership LTD. HALLWOOD CONSOLIDATED PARTNERS, L.P. By: HALLWOOD CONSOLIDATED RESOURCES CORPORATION By:/s/ Cathleen M. Osborn Title: Vice President The General Partner of Hallwood Consolidated Partners, L.P. (NY) 27008/757/AMEND/amend00.2.conf SCHEDULE A-1 The Properties marked by an asterisk in this Schedule A-1 are the Properties referred to in Section 4 of the Amendment and Waiver to which this Schedule A-1 is attached. (NY) 27008/757/AMEND/amend00.2.conf SCHEDULE A-2 The Properties marked by an asterisk in this Schedule A-2 are the Properties referred to in Section 4 of the Amendment and Waiver to which this Schedule A-2 is attached. (NY) 27008/757/AMEND/amend00.2.conf EX-27 4 FDS HALLWOOD ENERGY CORPORATION
5 This schedule contains summary financial information extracted from Form 10-K for the year ended December 31, 1999 for Hallwood Energy Corporation and is qualified in its entirety by reference to such Form 10-K. 0000319019 Hallwood Energy Corporation 1,000 12-MOS DEC-31-1999 DEC-31-1999 10,480 0 18,064 0 0 29,753 766,957 585,336 212,774 26,382 0 0 21,386 100 53,091 212,774 56,523 56,881 0 17,726 0 0 6,815 3,218 338 2,880 0 0 0 2,880 .06 .06
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