FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
1-8979
(Commission File Number)
HONDO OIL & GAS COMPANY
(Exact name of registrant as specified in its charter)
Delaware 95-1998768
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
10375 Richmond Ave, Ste. 900, Houston, Texas 77042
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 954-4600
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
--- ---
The registrant has one class of common stock outstanding. As of May 19,
1997, 13,781,194 shares of registrant's $1 par value common stock were
outstanding.
1
HONDO OIL & GAS COMPANY
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE SIX MONTHS ENDED MARCH 31, 1997
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets as of
March 31, 1997 and September 30, 1996 3
Consolidated Statements of Operations for the three
months ended March 31, 1997 and 1996 4
Consolidated Statements of Operations for the six
months ended March 31, 1997 and 1996 5
Consolidated Statements of Cash Flows for the six
months ended March 31, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 23
Item 4 Submission of Matters to a Vote of Security Holders 23
Item 6 Exhibits and Reports on Form 8-K 24
SIGNATURES 24
2
PART I
Item 1 FINANCIAL STATEMENTS
HONDO OIL & GAS COMPANY
CONSOLIDATED BALANCE SHEETS
(In Thousands Except Share Information)
March 31, September 30,
1997 1996
------------- -------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $186 $374
Accounts receivable, net of allowances
of $205 and $332, respectively 300 317
Prepaid expenses and other 122 79
------------- -------------
Total current assets 608 770
Properties, net (Note 2) 31,302 21,248
Net assets of discontinued operations (Note 7) 2,393 2,202
Other assets 586 320
------------- -------------
$34,889 $24,540
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $2,574 $2,849
Current portion of long-term debt, including
$63,994 in 1997 due to a related party 64,765 738
Accrued expenses and other, including $2,048
in 1997 due to a related party (Note 3) 4,463 2,292
------------- -------------
Total current liabilities 71,802 5,879
Long-term debt, including $25,726 and $80,109,
respectively, due to a related party 28,686 83,334
Funding agreement (Note 4) 17,666 11,513
Other liabilities, including $775 and $2,411,
respectively, due to a related party (Note 5) 3,009 4,705
------------- -------------
121,163 105,431
Contingent liabilities (Note 7)
Shareholders' equity (deficit):
Common stock, $1 par value, 30,000,000 shares
authorized; shares issued and outstanding:
13,781,194 and 13,776,194, respectively 13,781 13,776
Additional paid-in capital 53,635 53,581
Accumulated deficit (153,690) (148,248)
------------- -------------
(86,274) (80,891)
------------- -------------
$34,889 $24,540
============= =============
The accompanying notes are an integral part of these financial statements.
3
HONDO OIL & GAS COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Thousands Except Share and Per Share Data)
For the three months ended
March 31,
----------------------------
1997 1996
------------- -------------
REVENUES
Sales and operating revenue $1 $1
Other income 4 75
------------- -------------
5 76
------------- -------------
COSTS AND EXPENSES
Operating costs 390 90
Depreciation, depletion, and amortization 57 38
Overhead, Colombian operations 511 439
General and administrative 598 577
Exploration costs 2 846
Interest on indebtedness including $1,450
and $1,187, respectively, to a
related party 1,456 1,247
------------- -------------
3,014 3,237
------------- -------------
Loss from continuing operations
before income taxes (3,009) (3,161)
Income tax expense (benefit) -- --
------------- -------------
Loss from continuing operations (3,009) (3,161)
Loss from discontinued operations (Note 7) -- --
------------- -------------
Net Loss $(3,009) $(3,161)
============= =============
Loss per share:
Continuing operations $(0.22) $(0.23)
Discontinued operations -- --
------------- -------------
Net loss per share $(0.22) $(0.23)
============= =============
Weighted average common shares outstanding 13,781,194 13,573,750
The accompanying notes are an integral part of these financial statements.
4
HONDO OIL & GAS COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Thousands Except Share and Per Share Data)
For the six months ended
March 31,
----------------------------
1997 1996
------------- -------------
REVENUES
Sales and operating revenue $1 $1
Other income 19 101
------------- -------------
20 102
------------- -------------
COSTS AND EXPENSES
Operating costs 335 97
Depreciation, depletion, and amortization 115 76
Overhead, Colombian operations 1,127 1,724
General and administrative 996 952
Exploration costs 13 1,717
Interest on indebtedness including $2,823
and $2,375, respectively, to a
related party 2,878 2,378
------------- -------------
5,464 6,944
------------- -------------
Loss from continuing operations
before income taxes (5,444) (6,842)
Income tax expense (benefit) (2) --
------------- -------------
Loss from continuing operations (5,442) (6,842)
Loss from discontinued operations (Note 7) -- --
------------- -------------
Net Loss $(5,442) $(6,842)
============= =============
Loss per share:
Continuing operations $(0.40) $(0.50)
Discontinued operations -- --
------------- -------------
Net loss per share $(0.40) $(0.50)
============= =============
Weighted average common shares outstanding 13,779,527 13,569,250
The accompanying notes are an integral part of these financial statements.
5
HONDO OIL & GAS COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
For the six months ended
March 31,
----------------------------
1997 1996
------------- -------------
Cash flows from operating activities:
Pretax loss from continuing operations $(5,444) $(6,842)
Adjustments to reconcile pretax loss from continuing
operations to net cash used by continuing operations:
Depreciation, depletion and amortization 115 76
Capitalized interest (300) (120)
Accrued interest added to long-term debt 2,429 17
Accrued interest paid with common stock -- 2,367
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable 17 20
Prepaid expenses and other (43) (119)
Other assets (359) 9
Increase (decrease) in:
Accounts payable 160 195
Accrued expenses and other 2,187 1,554
Funding agreement 936 2,553
Other liabilities (1,637) (1,102)
------------- -------------
Net cash used by continuing operations (1,939) (1,392)
Net cash used by discontinued operations (207) (295)
Income taxes (paid) received 2 --
------------- -------------
Net cash used by operating activities (2,144) (1,687)
------------- -------------
Cash flows from investing activities:
Sale of assets -- --
Capital expenditures (4,994) (602)
------------- -------------
Net cash used by investing activities (4,994) (602)
------------- -------------
Cash flows from financing activities:
Proceeds from long-term borrowings 7,200 1,000
Principal payments on long-term debt (250) (235)
Issuance of stock -- 251
------------- -------------
Net cash provided by financing activities 6,950 1,016
------------- -------------
Net increase (decrease) in cash and cash equivalents (188) (1,273)
Cash and cash equivalents at the beginning of the period 374 1,771
------------- -------------
Cash and cash equivalents at the end of the period $186 $498
============= =============
Refer to Notes 2 and 4 for descriptions of non-cash transactions.
The accompanying notes are an integral part of these financial statements.
6
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997
(All Dollar Amounts in Thousands)
1) Summary of Significant Accounting Policies
------------------------------------------
(a) Basis of Consolidation and Presentation
---------------------------------------
Hondo Oil & Gas Company ("Hondo Oil" or "the Company") is an independent oil
and gas exploration and development company. The consolidated financial
statements of Hondo Oil include the accounts of all subsidiaries, all of
which are wholly owned. All significant intercompany transactions have been
eliminated. The Hondo Company owns 70.7% of Hondo Oil & Gas Company.
Lonrho Plc ("Lonrho"), a publicly-traded English company and the Company's
primary lender, controls The Hondo Company and owns an additional 5.7% of
the Company through another wholly-owned subsidiary. In total, Lonrho
controls 76.4% of the Company's outstanding shares.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements. There has not been any change in the
Company's significant accounting policies for the periods presented. There
have not been any significant developments or changes in contingent
liabilities and commitments since September 30, 1996, other than the
contingency described in Note 7. Certain reclassifications have been made
to the prior year's amounts to make them comparable to the current
presentation. These changes had no impact on previously reported results of
operations or shareholders' equity (deficit).
In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The results for these interim periods are not necessarily
indicative of results for the entire year. These statements should be read
in conjunction with the financial statements and notes thereto included in
the Company's Annual Report on Form 10-K for the fiscal year ended September
30, 1996.
(b) Earnings Per Share
------------------
Net income (loss) per share amounts are computed using the weighted average
number of common shares and dilutive common equivalent shares outstanding.
The effect of common stock equivalents is not included for periods with
losses. Fully diluted per share amounts are the same as primary per share
amounts and, accordingly, are not presented.
7
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997
(All Dollar Amounts in Thousands)
1) Summary of Significant Accounting Policies (continued)
------------------------------------------------------
(c) Income Taxes
------------
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting For Income Taxes". Under Statement 109, the liability method is
used in accounting for income taxes. Deferred tax assets and liabilities
are determined based on reversals of differences between financial reporting
and tax bases of assets and liabilities and are measured using the enacted
effective tax rates and laws that will be in effect when the differences are
expected to reverse.
The Company provides for income taxes in interim periods based on estimated
annual effective rates. The Company records current income tax expense to
the extent that federal, state or alternative minimum tax is projected to be
owed. The Company has investment tax credit carryforwards of $687 which
are accounted for by the flow-through method.
2) Properties
----------
Properties, at cost, consist of the following:
March 31, September 30,
1997 1996
------------- -------------
(Unaudited)
Oil and gas properties (Colombia):
Proved, undeveloped $11,863 $11,803
Accumulated depletion, depreciation
and amortization -- --
------------- -------------
11,863 11,803
------------- -------------
Other properties - Colombia:
Wellsite facilities (a) 3,671 2,039
Pipelines (a) 8,983 5,398
Drilling in progress 6,657 1,858
Other properties - domestic
Other fixed assets 311 311
Accumulated depreciation (183) (161)
------------- -------------
$31,302 $21,248
============= =============
(a) Under construction.
The balances of wellsite facilities and pipelines include non-cash increases
of $4,042 and $4,998 for the six months ended March 31, 1997 and 1996,
respectively, which were charged to the Funding Agreement (Note 4).
8
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997
(All Dollar Amounts in Thousands)
3) Accrued expenses
----------------
Accrued expenses consist of the following:
March 31, September 30,
1997 1996
------------- -------------
(Unaudited)
Refining and marketing costs (Note 7) $2,012 $2,028
Interest payable to Lonrho Plc (Note 5) 2,048 --
Other 403 264
------------- -------------
$4,463 $2,292
============= =============
4) Funding Agreement
-----------------
Effective July 26, 1995, the Company's wholly-owned subsidiary, Hondo
Magdalena Oil & Gas Limited ("Hondo Magdalena"), Amoco Colombia Petroleum
Company ("Amoco Colombia"), and Opon Development Company entered into a
Funding Agreement for Tier I Development Project costs (the "Funding
Agreement") for the interim financing of costs associated with the
construction of a pipeline from the Opon Contract area, certain wellsite
facilities, a geological and geophysical work program, and for related
overheads. The Funding Agreement provides that Hondo Magdalena may repay
the amounts financed by Amoco Colombia from prior to the date of first
production until 365 days thereafter, along with an equity premium computed
using a 22% annualized interest rate. The equity premium will be computed
monthly on Hondo Magdalena's share of expenditures (including any amounts to
be recouped from Ecopetrol after commerciality). Alternatively, from the
date of first production until 90 days thereafter, Hondo Magdalena may elect
to repay 125% of its share (excluding any amounts to be recouped from
Ecopetrol after commerciality) of the total costs accumulated up to the date
of repayment. If the financed amounts are not repaid within 365 days after
the date of first production, an additional penalty of 100% of the amount
then due would be recovered out of Hondo Magdalena's revenues. Hondo
Magdalena's revenues from production of the first 80 million cubic feet of
natural gas and related condensate and natural gas liquids are pledged to
secure its obligations under the Funding Agreement.
The balance of the Funding Agreement consists of the following:
March 31, September 30,
1997 1996
------------- -------------
(Unaudited)
Outstanding principal $14,417 $9,771
Equity premiums 3,249 1,742
------------- -------------
$17,666 $11,513
============= =============
9
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997
(All Dollar Amounts in Thousands)
4) Funding Agreement (continued)
-----------------------------
The Company has accrued equity premiums computed in accordance with the 22%
annualized interest rate option. Equity premiums of $1,174 and $411 related
to the financed pipeline costs and wellsite facilities have been capitalized
for the six months ended March 31, 1997 and 1996, respectively. The
remainder of the equity premiums accrued to date, relating to the financed
geological and geophysical work and overheads, have been expensed.
5) Other Liabilities
-----------------
Other liabilities consist of the following:
March 31, September 30,
1997 1996
------------- -------------
(Unaudited)
Interest payable to Lonrho Plc $775 $2,411
City of Long Beach 1,549 1,533
Deferred compensation contracts 535 610
Other 150 151
------------- -------------
$3,009 $4,705
============= =============
In accordance with the terms of the Company's debts to Lonrho Plc, accrued
interest is either added to the outstanding principal or paid by issuance of
the Company's common stock on the interest due date, at the option of Lonrho
Plc. Accrued interest of $2,823 (including $2,048 in accrued expenses, Note
3) for the six months ended March 31, 1997 was added to outstanding
principal on April 1, 1997. Accrued interest of $2,411 for the six-month
period ended September 30, 1996 was added to outstanding principal on
October 1, 1996. Accrued interest of $2,367 for the six-month period ended
September 30, 1995 was paid by the issuance of 121,372 shares of the
Company's common stock on October 1, 1995.
6) Cash Flow Information
---------------------
Cash interest expense, all of which arises from discontinued operations, was
$113 and $119 for the six months ended March 31, 1997 and 1996,
respectively.
7) Discontinued Operations
-----------------------
In 1991, the Company adopted plans of disposal for its refining and
marketing and real estate segments. In September 1993, the Company executed
an agreement for the sale of its Fletcher refinery and its asphalt terminal
in Hilo, Hawaii. These assets represented the material portion of the
Company's refining and marketing segment.
10
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997
(All Dollar Amounts in Thousands)
7) Discontinued Operations (continued)
-----------------------------------
Operating losses of discontinued operations for the quarters ended March 31,
1997 and 1996 were $79 and $114, respectively. Corresponding amounts for
the six-month periods were $191 and $229, respectively, and were charged
against loss provisions established in earlier periods. The Company
recorded no loss provisions for discontinued operations for the six months
ended March 31, 1997 or 1996.
In the agreement for the sale of the Fletcher refinery, the Company
indemnified the buyer as to liabilities in excess of $300 for certain
federal and state excise taxes arising from periods prior to the sale.
Fletcher notified the Company in July 1994 that an audit for California
Motor Vehicle Fuels Tax was underway and a preliminary review by Fletcher
employees indicated that a significant liability might exist. The Company
retained a consultant to evaluate the contingent liability. In September
1994, the Company accrued $1,400 as a result of the consultant's evaluation.
An additional $650 was accrued in September 1995, primarily because of
increases in the estimated amounts of penalties and interest which will be
due. The State of California issued a preliminary report in June 1996 which
concluded taxes and penalties of $10,820 were due as a result of the audit.
The State of California issued a revised preliminary report in January 1997
indicating taxes and penalties of $6,446 are due. The Company expects the
State of California to issue an assessment in late May 1997 which includes
further reductions to the amount due. Assessed amounts are subject to a
process of appeal and further adjustment. The State of California's audit
could result in a liability different from that accrued when concluded. The
Company has provided its consultant to Fletcher to assist in disputing the
audit findings. The buyer notified the Company that it claims indemnity in
this matter and in January 1997 filed suit in Superior Court, Los Angeles,
California for a declaratory judgment enforcing the indemnity and for other
relief. The Company believes the liability accrued is sufficient to provide
for the amount that will ultimately be paid based on the information
available.
The balance of net assets of discontinued operations is comprised solely of
two parcels of land in the real estate segment. Changes in this balance for
the six months ended March 31, 1997 are as follows:
Balance as of September 30, 1996 $2,202
Valuation provisions established --
Valuation provisions used 191
-------------
Balance at March 31, 1997 (Unaudited) $2,393
=============
Interest expense included in the losses from discontinued operations
pertains only to debt directly attributable to the discontinued segments.
Allocations of interest to the real estate operations were $62 and $65 for
the quarters ended March 31, 1997 and 1996, respectively. Corresponding
amounts for the six-month periods ended March 31, 1997 and 1996 were $125
and $131, respectively.
11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL DISCUSSION
Introduction
------------
Hondo Oil & Gas Company is an independent oil and gas company focusing
on international oil and gas exploration and development. The Company's
principal asset is its interest in the Opon Association Contract (the
"Opon Contract"), an exploration concession for an area in the Middle
Magdalena Valley of Colombia, South America. Significant reserves of
natural gas and condensate were shown to exist in the Opon Contract area
by two discovery wells drilled during 1994 and 1995. In accordance with
the terms of the Opon Contract, Empresa Colombiana de Petroleos
("Ecopetrol") declared a portion of the area as commercial in May 1996.
A pipeline and related wellsite facilities to deliver natural gas and
condensate to a market are substantially complete, and await the
completion of improvements to Ecopetrol's gas plant so that production
can commence. A third well, the Opon No. 6 well, has been drilled and
is being tested. As further described below, the Company will require
additional financing to continue development of the Opon project.
Cautionary Statements
---------------------
The Company believes that this report contains certain forward-looking
statements, as defined in the Private Securities Litigation Reform Act
of 1995, including, without limitation, statements containing the words
"believes," "anticipates," "estimates," "expects," "may" and words of
similar import, or statements of management's opinion. Such forward
looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or
achievements of the Company to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the
following:
Substantial Reliance on Single Investment. The Company's success
currently is dependent on its investment in the Opon project in
Colombia, South America. The Company has no operating assets which are
presently generating cash to fund its operating and capital
requirements. At March 31, 1997 the Company had a deficiency in net
assets of $86.3 million.
Role of Ecopetrol. As described below and in the Company's 1996 Annual
Report on Form 10-K, Ecopetrol is a quasi-governmental corporate
organization wholly-owned by the Colombian government, a party to the
Opon Contract and the purchaser of natural gas and liquid hydrocarbons
under contracts for the sale of production from the Opon field. At
present, the price of natural gas is set by law enacted by the
legislature of Colombia in 1983. The regulated price of natural gas
could be changed in the future by governmental action. The
participation of Ecopetrol, a government-owned company, in the Opon
project as a producer and as a purchaser, and the power of the
government of Colombia to set the price of natural gas creates the
potential for a conflict of interest in Ecopetrol and/or the government.
12
If such a conflict of interest materializes, the economic value of the
Company's interest in the Opon project could be diminished.
Marketing of Natural Gas. The Company must secure additional markets
and sales contracts for natural gas in Colombia in order to increase
production and cash flow from the Opon project. This will depend on the
continued development of gas markets and an infrastructure for the
delivery of natural gas in Colombia. Also, other producers of natural
gas in Colombia will compete for the natural gas market and for access
to limited pipeline transportation facilities.
Foreign Operations. The Company's operations in Colombia are subject to
political risks inherent in all foreign operations, including: (i) loss
of revenue, property, and equipment as a result of unforeseen events
such as expropriation, nationalization, war and insurrection, (ii) risks
of increases in taxes and governmental royalties, (iii) renegotiation of
contracts with governmental entities, as well as, (iv) changes in laws
and policies governing operations of foreign-based companies in
Colombia. Guerrilla activity in Colombia has disrupted the operation of
oil and gas projects, including those at the Opon Contract area.
Security in the area has been improved and the associate parties have
taken steps to enhance relations with the local population through a
community relations program. The government continues its efforts
through negotiation and legislation to reduce the problems and effects
of insurgent groups, including regulations containing sanctions such as
impairment or loss of contract rights on companies and contractors if
found to be giving aid to such groups.
Colombia is among several nations whose progress in stemming the
production and transit of illegal drugs is subject to annual
certification by the President of the United States. In February 1997,
the President of the United States announced that Colombia again would
neither be certified nor granted a national interest waiver. The
consequences of the failure to receive certification generally include
the following: all bilateral aid, except anti-narcotics and humanitarian
aid, has been or will be suspended; the Export-Import Bank of the United
States and the Overseas Private Investment Corporation will not approve
financing for new projects in Colombia; U. S. representatives at
multilateral lending institutions will be required to vote against all
loan requests from Colombia, although such votes will not constitute
vetoes; and the President of the United States and Congress retain the
right to apply future trade sanctions. Each of these consequences of
the failure to receive such certification could result in adverse
economic consequences in Colombia and could further heighten the
political and economic risks associated with the Company's operations in
Colombia.
Risks of Oil and Gas Exploration. Inherent to the oil and gas industry
is the risk that future wells will not find hydrocarbons where prior
wells and engineering and geological data indicate hydrocarbons should
be found. Further, existing wells can deplete faster than anticipated,
potentially causing revisions to reserve estimates and increasing costs
due to replacement wells. Operations in the Opon Contract area are
subject to the operating risks normally associated with exploration for,
and production of, oil and gas, including blowouts, cratering, and
fires, each of which could result in damage to, or destruction of, the
oil and gas wells, formations or production facilities or properties.
In addition, there are greater than normal mechanical drilling risks at
the Opon Contract area associated with high pressures in the La Paz and
13
other formations. These pressures may: cause collapse of the well bore,
impede the drill string while drilling, or cause difficulty in
completing a well with casing and cement. These potential problems were
substantially overcome in the drilling of the Opon No. 3, No. 4 and No.
6 wells by the use of a top-drive drilling rig, heavy-weight and oil-
based drilling fluids and other technical drilling enhancements.
Laws and Regulations. The Company may be adversely affected by new laws
or regulations in the United States or Colombia affecting its operations
and/or environmental compliance, or by existing laws and regulations.
For additional information, see Other Factors Affecting the Company's
Business in Item 1, Business of the Company's 1996 Annual Report on Form
10-K.
Limited Capital. The Company has no source of current income from its
operations. The Company's principal asset, its investment in the Opon
project, does not currently provide any income and will require
additional capital for exploitation. See Liquidity and Capital
Resources, below.
Losses from Operations. The Company experienced losses of $11,056,000,
$11,906,000 and $12,657,000 for the years ended September 30, 1994, 1995
and 1996, respectively. As discussed above under Limited Capital,
because the Company's principal asset does not currently provide any
income and requires additional capital for exploitation, the Company
anticipates continued losses through fiscal 1998.
Continuation of American Stock Exchange Listing. Because of continuing
losses and decreases in shareholders' equity, the Company does not fully
meet all of the guidelines of the American Stock Exchange for continued
listing of its shares. For additional information, see Item 5, Market
For Registrant's Equity and Related Shareholder Matters in the Company's
1996 Annual Report on Form 10-K. Management has kept the Exchange fully
informed regarding the Company's present status and future plans.
Although the Company does not or may not meet all of the guidelines, to
date, the American Stock Exchange has chosen to allow the Company's
shares to remain listed. However, no assurances can be given that the
Company's shares will remain listed on the Exchange in the future.
Given these uncertainties, prospective investors are cautioned not to
place undue reliance on such forward-looking statements. The Company
disclaims any obligation to update any such factors or to publicly
announce the result of any revisions to any of the forward-looking
statements contained herein to reflect future events or developments.
14
Opon Exploration
----------------
Hondo Magdalena Oil & Gas Limited ("Hondo Magdalena"), a wholly-owned
subsidiary, became involved in the Opon Contract through a farmout
agreement with Opon Development Company ("ODC") in 1991. In August
1993, Hondo Magdalena and ODC entered into a Farmout Agreement under
which Amoco Colombia Petroleum Company ("Amoco Colombia") earned a 60%
participating interest in the Opon Contract. To earn the interest,
Amoco Colombia paid $3.0 million in cash in 1993 and paid all of the
costs related to drilling the Opon No. 3 well in 1994. In addition,
Amoco Colombia paid Hondo Magdalena $5.0 million in October 1994 and
paid all but $2.0 million of Hondo Magdalena's costs for drilling the
Opon No. 4 well in 1995.
The Opon No. 3 well, completed in September 1994, was drilled to a depth
of 12,710 feet at a total cost of approximately $30.0 million. The well
tested at a daily rate of 45 million cubic feet of natural gas and 2,000
barrels of condensate. Downhole restrictions prevented the well from
testing at higher rates. The Opon No. 4 well, completed in September
1995, was drilled to a depth of 11,500 feet at a total cost of
approximately $28.5 million. The well tested at a daily rate of 58
million cubic feet of natural gas and 1,900 barrels of condensate.
These two wells have confirmed the existence of a significant natural
gas field and will supply gas for the contracts described below.
Presently, Amoco Colombia, Hondo Magdalena and ODC have interests in the
Opon Contract (outside the commercial area described below) of
approximately 60%, 30.9% and 9.1%, respectively. As provided in the
Opon Contract, upon the designation of an area or field as commercial,
Ecopetrol acquires a 50% interest in such area or field and will
reimburse the associate parties for 50% of the direct exploration costs
for each commercial discovery from its share of production. An
application for commerciality was submitted by Amoco Colombia in
February 1996. In May 1996, Ecopetrol approved a commercial field of
approximately 2,500 acres around the Opon No. 3 and No. 4 wells. The
interests in the commercial field are approximately: Ecopetrol, 50%,
Amoco Colombia, 30%, Hondo Magdalena, 15.4%, and ODC, 4.6%. The
commercial field is substantially smaller than that requested, but may
be enlarged by future drilling and/or additional technical information.
Ecopetrol will not pay for its share of expenditures to enlarge the
commercial field until the new areas are proven and declared commercial.
Ecopetrol will participate in further development costs of the existing
commercial field. As described below, Ecopetrol has agreed to reimburse
in cash certain costs related to the construction of pipeline and
wellhead facilities incurred before commerciality was declared.
The Opon Contract provides that the Opon Contract area will be reduced
after the end of the exploration period, or September 30, 1995. The
first acreage relinquishment of 50% was completed during 1996. The Opon
Contract area now covers 25,021.5 hectares (61,828 acres). On September
30, 1997, the Opon Contract area will be further reduced to 25% of the
original area. On September 30, 1999, the Opon Contract area will be
reduced to the area of the commercial field that is in production or
development, plus a reserve zone of five kilometers in width around the
productive limit of such field. The commercial field plus the zone
surrounding such field will become the area of exploitation. The
associate parties designate the acreage to be released. Additional
wells will be required to enlarge the commercial area and to increase
the size of the area of exploitation.
15
The Opon No. 6 well commenced drilling on October 24, 1996. This well
is slightly more than 1 kilometer north of the Opon No. 3 well and is
outside the presently designated commercial area. Hondo Magdalena is
paying 30.9% of the costs of this well presently estimated at $28.7
million. After the drilling was completed, several mechanical problems
in the completion and testing of the Opon No. 6 well have occurred. A
second set of perforating guns were fired after there was a failure of a
portion of the guns during the initial completion attempt in April 1997.
Cleanup and testing on the second set of perforations commenced on May
13, 1997 and, while all the guns fired, the well has not flowed as
anticipated. Based upon log indications, it appears the new
perforations in the lower zones of the well may have become blocked. As
of May 20, 1997, Amoco Colombia is using a different completion
procedure for perforating the lower zones. Two 20-foot sections of
perforating charges, conveyed by wireline, have been fired through the
tubing. The initial observations from these perforating attempts are
positive. However, a number of additional perforations and a full
evaluation will be necessary before the final test results of the well
are known.*
Hondo Magdalena, ODC, Amoco Colombia and Ecopetrol executed a Memorandum
of Understanding ("MOU") in July 1995 for the construction of a pipeline
and wellhead facilities (which were not contemplated in the Opon
Contract) and the sale of natural gas from the Opon Contract area. The
MOU provides that the parties will construct a 16-inch pipeline
approximately 88 kilometers in length from the Opon Contract area north
to Ecopetrol's gas processing plant at El Centro, and from there to
Barrancabermeja. The pipeline will have a capacity of 120 million cubic
feet per day and is now estimated to cost $53.1 million. Under the MOU,
Hondo Magdalena, ODC and Amoco Colombia each pay their respective share
of the costs incurred prior to July 1, 1995, up to a maximum of 10% of
the total pipeline costs. Ecopetrol will pay cash for its share of
pipeline costs incurred after July 1, 1995; the remainder of Ecopetrol's
share of costs (those incurred prior to July 1, 1995) will be recovered
out of production. The investment in pipeline costs will be recovered
through a pipeline tariff. In the MOU, Ecopetrol agreed to construct
improvements at its El Centro gas processing plant to handle incremental
production from the Opon Contract area. Ecopetrol will recover its
investment through a gas processing fee. The parties agreed in the MOU
to negotiate contracts necessary to carry out the agreements made in the
MOU. Ecopetrol agreed to fund 80% of its share of wellhead facilities
(total estimated cost of $29.3 million) in cash with 20% to be recovered
subsequently from production.
After new regulations were adopted in late 1995 by the Comision de
Regulacion de Energia y Gas (Commission for the Regulation of Energy and
Gas, "CREG"), an agency of the Ministry of Mines and Energy of the
Colombian government, the parties began to renegotiate certain terms of
the MOU. The regulations set a ceiling price for natural gas and a
maximum rate of return of 12.0% (after Colombian taxes, except for a 14%
Remittance Tax on foreign exchange returned to the United States) for
pipeline tariffs. The ceiling price has been interpreted to include
costs or fees for the processing of natural gas, thus processing costs
cannot be passed on to the buyer as contemplated in the MOU. Ecopetrol
was unwilling to provide the terms outlined in the MOU related to the
____________________
* This statement may be considered forward-looking. See Cautionary
Statements under General Discussion, above, for a description of
important risk factors that may affect actual results.
16
buyer's payment of gas processing fees and the 13.2% rate of return
(after Colombian taxes) included in the pipeline tariff because of these
new regulations.
After lengthy negotiations, contracts covering the sale of natural gas,
the sale of condensate and natural gas liquids, and the processing of
the gas stream have been completed. Management believes that the new
contracts achieve an arrangement that is an economic equivalent to the
terms of the MOU and comply with the new CREG regulations.* The
contracts provide for: (i) the sale of 100 million cubic feet of natural
gas per day for the life of the Opon Contract at the regulated price
determined semi-annually by a formula based upon the average price
received by Ecopetrol for exported fuel oil during the prior two six-
month periods (currently US$1.31 per million British Thermal Units);
(ii) the sale of condensate and natural gas liquids at market-related
and market-indexed prices; and (iii) the processing of the gas stream at
Ecopetrol's El Centro gas processing plant for a fee of US$0.20 per
thousand cubic feet of gas.
Preliminary work for the pipeline began in late 1994 and construction
began in July 1996. The pipeline is substantially complete.
Construction of wellsite facilities began in August 1996 and is also
substantially complete. Ecopetrol has begun the improvements to the El
Centro gas plant; completion is now estimated to occur in October 1997.*
Work on the El Centro gas plant improvements has been interrupted by
labor disputes. Production will commence after the El Centro
improvements are completed and the entire system has been tested. The
estimates of the completion dates of the projects are subject to delays
due to weather, labor interruptions, guerrilla activity, unanticipated
shortages of materials or equipment and other causes beyond the control
of the associate parties.
On March 3, 1997, Hondo Magdalena, ODC, Amoco Colombia and Ecopetrol, as
sellers, signed a contract with Termo Santander de Colombia E.S.P., as
purchaser ("Termo Santander"), to supply natural gas to an electric
generation plant being built at the Opon Contract area. The parties to
the Opon Contract will supply natural gas to the power plant which is
expected to begin commercial operations by the end of calendar 1997.*
The estimate of the completion date of the power plant is subject to
delays due to weather, labor interruptions, guerrilla activity,
unanticipated shortages of materials or equipment and other causes
beyond the control of Termo Santander. The sellers will supply
natural gas requested by the purchaser up to 60 million cubic feet per
day. The sellers will receive $4.2 million per year for making the gas
available for purchaser's call. Purchaser will pay 60% of the
government-regulated price (described above) for the natural gas it
takes. The sellers will also receive additional bonus payments when the
power plant achieves a price for its electrical power in excess of
target rates each month of the contract. Condensate associated with the
natural gas that is delivered to the purchaser will be separately sold
to Ecopetrol. The contract provides for substantial penalties,
decreasing over the life of the contract, to the sellers for the failure
to deliver gas as and when requested by the purchaser. The commencement
____________________
* This statement may be considered forward-looking. See Cautionary
Statements under General Discussion, above, for a description of
important risk factors that may affect actual results.
17
of the contract is contingent upon the completion of the electric
generation plant and a determination by the sellers that there are
sufficient reserves to supply natural gas to the purchaser for the
entire term of the agreement.
Amoco Colombia submitted a budget to Hondo Magdalena and ODC for
calendar 1996 in April 1996. Hondo Magdalena approved capital
expenditures for wells and the pipeline projects, and certain other
expenditures, but did not approve the proposed overhead. Similarly,
Amoco Colombia submitted a budget for calendar 1997 on November 5, 1996,
and Hondo Magdalena approved capital expenditures for wells and the
pipeline projects, and certain other expenditures, but did not approve
the proposed overhead. As of this date, no final budget has been
approved for calendar years 1996 and 1997. The parties continue to try
to resolve the dispute about overhead. Hondo Magdalena has paid
invoices from Amoco Colombia, including disputed overhead and has
charged the full overhead amount to expense. It is management's opinion
that the Company is not obligated to pay for overhead unless charged
pursuant to an approved budget; however the Company has paid Amoco
Colombia's invoices, under protest and subject to audit, in the hope of
resolving the dispute. If the dispute cannot be resolved, the joint
operating agreement among Amoco Colombia, Hondo Magdalena and ODC
provides for arbitration of disputes.
Discontinued Operations
-----------------------
Two of the Company's former business segments, refining and marketing
operations and real estate operations were discontinued in 1991. Except
as noted below, no change in the status of these discontinued operations
from that reported in the Company's 1996 Annual Report on Form 10-K
occurred during the current period. See Part II, Item 1, of the
Company's Quarterly Report on Form 10-Q for the quarter ended December
31, 1996, concerning a legal proceeding involving the sale of the
Fletcher refinery.
As more fully described in Note 7 to the Consolidated Financial
Statements in Item 1, the State of California issued a preliminary
report in June 1996 finding that the Fletcher refinery owed $10.8
million for certain state excise taxes (and related penalties and
interest) arising from periods when the Company owned the Fletcher
refinery. The State of California issued a revised preliminary report
in January 1997 reducing this amount to $6.4 million. The Company
expects the State of California to issue an assessment in late May 1997
which includes further reductions to the amount alleged to be due.* The
Company believes the liability it has accrued is sufficient to provide
for the amount ultimately found to be due.* The Company and the
Fletcher refinery intend to further contest the forthcoming assessment
through the appeals and hearing process.
____________________
* This statement may be considered forward-looking. See Cautionary
Statements under General Discussion, above, for a description of
important risk factors that may affect actual results.
18
RESULTS OF OPERATIONS
Quarters Ended March 31, 1997 and 1996
--------------------------------------
Results of continuing operations for the quarter ended March 31, 1997
amounted to a net loss of $3.0 million, or 22 cents per share. The
Company reported a net loss from continuing operations of $3.2 million,
or 23 cents per share, for the quarter ended March 31, 1996. No losses
from discontinued operations were reported for either period.
Operating costs for the quarter ended March 31, 1997 include an accrual
of $0.4 million for revisions to estimated plugging and abandonment
costs of an offshore unit in California. No comparable costs were
incurred in the quarter ended March 31, 1996.
The Company's Colombian operations undertook a seismic exploration
program during fiscal 1996. The decrease of $0.8 million in exploration
costs between the quarters arises because there were no comparable
expenses incurred in fiscal 1997.
The level of the Company's debts to Lonrho Plc and to Amoco Colombia
under the Funding Agreement have increased by approximately $19.0
million between March 31, 1996 and March 31, 1997. Interest expense
increased by only $0.2 million between the quarters ended March 31, 1997
and 1996 because the majority of the charges from the Funding Agreement
are capitalized.
Six Months Ended March 31, 1997 and 1996
----------------------------------------
Results of continuing operations for the six months ended March 31, 1997
amounted to a net loss of $5.4 million, or 40 cents per share. The
Company reported a net loss from continuing operations of $6.8 million,
or 50 cents per share, for the six months ended March 31, 1996. No
losses from discontinued operations were reported for either period.
Operating costs for the six months ended March 31, 1997 include an
accrual of $0.4 million for revisions to estimated plugging and
abandonment costs of an offshore unit in California. No comparable
costs were incurred in the six months ended March 31, 1996.
Overhead, Colombian operations decreased $0.6 million between the six
months ended March 31, 1997 and 1996 primarily because:(i) year end
adjustments recorded by Amoco Colombia increasing the figure in December
1995 did not reoccur in December 1996 and (ii) Ecopetrol participated in
overhead expenses pertaining to the commercial operations for the six
months ended March 31, 1997.
The Company's Colombian operations undertook a seismic exploration
program during fiscal 1996. The decrease of $1.7 million in exploration
costs between the six-month periods arises because there were no
comparable expenses incurred in fiscal 1997.
19
The level of the Company's debts to Lonrho Plc and to Amoco Colombia
under the Funding Agreement have increased by approximately $19.0
million between March 31, 1996 and March 31, 1997. Interest expense
increased by only $0.5 million between the six months ended March 31,
1997 and 1996 because the majority of the charges from the Funding
Agreement are capitalized.
Management expects losses from continuing operations to continue through
fiscal 1998.*
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended March 31, 1997, cash inflows of $7.2 million
arose from borrowings from Lonrho Plc under existing loan agreements.
The Company utilized cash of $1.9 million and $0.2 million to finance
continuing and discontinued operations, respectively, $5.0 million for
capital expenditures, and made scheduled debt repayments of $0.3
million. At March 31, 1997, the Company had cash balances of $0.2
million.
In December 1993, the Company restructured the terms of its debts to
Lonrho Plc. The revised terms included reduction of interest rates to a
fixed rate of 6% and provisions allowing the Company to offer payment of
future interest in shares of its common stock, and allowing Lonrho Plc
to either accept such payment in kind or add the amount of the interest
due to principal. The ability to pay interest in kind or capitalize
interest allows the Company to service its debt while cash resources are
scarce.
The Company obtained an additional facility loan of $13.5 million in a
Revolving Credit Agreement dated as of June 28, 1996, between the
Company and Thamesedge, Ltd., a subsidiary of Lonrho Plc. The facility
is to be used for Hondo Magdalena's requirements for the Opon project
and for general corporate expenses. The interest rate is 13%, due
semiannually; as provided in other debts to Thamesedge and described
above, the Company may make payment of interest in shares of its common
stock. As of March 31, 1997, $7.2 million of this facility has been
drawn.
In December 1996, the Company obtained extensions of the maturity of its
debts to Lonrho Plc. The maturity of the loans from Lonrho Plc maturing
on October 1, 1997 was extended to not earlier than January 1, 1998. As
consideration for the extensions and certain other financial
undertakings, the Company has granted to Lonrho a security interest in
all of the shares of Hondo Magdalena and agreed to give Lonrho an option
to convert $13.5 million of existing loans with an interest rate of 6%
into the Company's common stock. The debt will be convertible at
Lonrho's option at any time prior to maturity (January 1, 1998) at a
rate of $12.375 per share. The portion of the debt that may be
converted into common stock will not be secured by the pledge of the
Hondo Magdalena shares. The option to convert the debt into common
stock was approved by the Company's shareholders at the 1997 Annual
Meeting on March 12, 1997.
____________________
* This statement may be considered forward-looking. See Cautionary
Statements under General Discussion, above, for a description of
important risk factors that may affect actual results.
20
The Company presently owes Lonrho Plc $89.7 million, of which $64.0
million is due January 1, 1998. The Company does not have the resources
to pay the amounts due in less than twelve months. Lonrho has
demonstrated its willingness to work with the Company on this matter in
the past, as evidenced by several prior modifications of the debts'
maturity terms. Management believes that the Company will be able to
obtain further extensions of the maturity of the Company's debts to
Lonrho Plc.*
On May 5, 1995, Hondo Magdalena, ODC and Amoco Colombia entered into a
Funding Agreement for Tier I Development Project costs (the "Funding
Agreement") for the interim financing of costs associated with the
construction of a pipeline from the Opon Contract area (see Note 4 to
the Consolidated Financial Statements in Item 1, above) and certain
other costs related to the Opon Contract. The Funding Agreement became
effective on July 26, 1995 with the execution of the MOU. Hondo
Magdalena may finance its share of the costs (including overhead) for
the pipeline and an approved geological and geophysical work program for
up to 365 days after the date that production from the Opon Contract
area begins. The Funding Agreement provides that Hondo Magdalena may
repay the amounts financed from prior to the date of first production
until 365 days thereafter, along with an equity premium computed on a
22% annualized interest rate. The equity premium will be computed
monthly on Hondo Magdalena's share of expenditures (including any
amounts to be later recouped from Ecopetrol after commerciality).
Alternatively, from the date of first production until 90 days
thereafter, Hondo Magdalena may elect to repay 125% of its share
(excluding any amounts to be later recouped from Ecopetrol after
commerciality) of the total costs accumulated up to the date of
repayment. If the financed amounts are not repaid within 365 days after
the date of first production, an additional penalty of 100% of the amount
then due would be recovered out of Hondo Magdalena's revenues. Hondo
Magdalena's revenues from production of the first 80 million cubic feet
of natural gas and corresponding condensate and natural gas liquids are
pledged to secure its obligations under the Funding Agreement.
____________________
* This statement may be considered forward-looking. See Cautionary
Statements under General Discussion, above, for a description of
important risk factors that may affect actual results.
21
Based upon the Company's budget and current information, management
believes existing cash, available facilities, Lonrho commitments, and
the interim Funding Agreement will be sufficient to finance the
Company's known obligations (the pipeline and related facilities,
unanticipated increased drilling and completion expenses of the Opon No.
6 well, overhead obligations unrelated to capital projects and other
business activities) during fiscal 1997.* However, management believes
the Company will need additional cash to participate in the drilling of
additional wells in Colombia and to fund its corporate overheads, or to
participate in other capital projects which may be proposed in
Colombia.* In addition, funds are required to retire the Funding
Agreement since a significant portion of the anticipated cash flow is
dedicated to servicing the Funding Agreement. There is a financial
incentive to prepay the Funding Agreement within 90 days after
production begins. If the Company becomes obligated for the drilling of
an additional well, or other capital projects, the Company has the
option to not participate in some or all of the capital projects.* In
management's view, use of this election would be a last resort to
preserve the Company's existing interest in the Opon Contract area
because substantial penalties would be incurred by not participating.
Cash from operations are not expected to be a source of funds until the
Opon Project begins commercial production, estimated in fall 1997.*
Management is reviewing several options for raising funds including
sale of the Company's 15.4 % interest in the pipeline.* Management
continues to pursue discussions with a number of financial institutions
regarding debt or equity financing of the Company's future obligations
for the Opon project but has received no commitments.* Favorable
results from Opon 6 and demonstrated production from Opon through the
pipeline infrastructure will be important factors in obtaining third
party financing.* In the interim, the Company must continue to rely on
the financial support of Lonrho.* While the Company will continue to
seek permanent financing in the near-term, there can be no assurance
that the Opon Project will be successfully developed or that additional
debt or equity funds will become available.
_____________________
* This statement may be considered forward-looking. See Cautionary
Statements under General Discussion, above, for a description of
important risk factors that may affect actual results.
22
Part II
Item 1. LEGAL PROCEEDINGS
Refer to Item 1 of Part II of the Company's Form 10-Q for the period
ended December 31, 1996 for a description of a legal proceeding
involving the sale of the Fletcher refinery that arose in that quarter.
No significant developments in this legal proceeding occurred during the
quarter ended March 31, 1997.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Shareholders on March 12,1997,
during which the shareholders of the Company voted on and approved the
following proposals by the votes indicated.
The first proposal was the election of seven directors to serve until
the next annual meeting of shareholders or until their respective
successors have been duly elected and qualified. The directors elected
and the votes cast for or withheld were as follows:
NAME FOR WITHHELD
---- --- --------
JOHN J. HOEY 12,929,597 373,363
C.B. MCDANIEL 13,170,335 132,625
DOUGLAS G. MCNAIR 13,183,435 119,525
NICHOLAS J. MORRELL 13,182,415 120,545
JOHN F. PRICE 13,182,315 120,645
ROBERT K. STEER 13,182,435 120,525
R.E. WHITTEN 13,183,415 119,545
There were no abstentions or broker nonvotes recorded in the election of
directors.
The other proposals were (1) approval of amendments to the Company's
1993 Stock Incentive Plan; (2) approval of an option for Thamesedge Ltd.
to convert $13.5 million of the Company's debt into shares of the
Company's common stock; and (3) approval of the appointment of Ernst &
Young LLP as independent auditors for fiscal year 1997. These proposals
were approved by the following vote:
FOR AGAINST ABSTENTIONS
--- ------- -----------
1993 Stock Incentive Plan 12,839,258 422,840 40,862
Thamesedge option 7,732,316 4,218,765 25,622
Ernst & Young LLP 13,265,038 32,973 4,949
There were no broker nonvotes recorded in the above voting.
23
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulations S-K are incorporated
by reference. Refer to Exhibit Index below.
(b) No reports on Form 8-K were filed during the quarter ended March
31, 1997.
SIGNATURES
Pursuant to the requirements 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.
HONDO OIL & GAS COMPANY
(Registrant)
Date: May 20, 1997 /s/ Stanton J. Urquhart
------------- -----------------------
Stanton J. Urquhart
Vice President and
Controller
The above officer of the registrant has signed this report as its duly
authorized representative and as its chief accounting officer.
EXHIBIT INDEX
Exhibit
Number Subject
------- -----------------------
27 Financial Data Schedule
24