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, 1998
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 18, 1998,
13,798,424 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, 1998
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets as of
March 31, 1998 and September 30, 1997 3
Consolidated Statements of Operations for the three
months ended March 31, 1998 and 1997 4
Consolidated Statements of Operations for the six
months ended March 31, 1998 and 1997 5
Consolidated Statements of Cash Flows for the six
months ended March 31, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
PART II - OTHER INFORMATION
Item 4 Submission of Matters to a Vote of Security Holders 30
Item 6 Exhibits and Reports on Form 8-K 30
SIGNATURES 31
2
PART I
Item 1 FINANCIAL STATEMENTS
HONDO OIL & GAS COMPANY
CONSOLIDATED BALANCE SHEETS
(In Thousands Except Share Information)
March 31, September 30,
1998 1997
------------- -------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $717 $1,019
Accounts receivable 1,435 296
Prepaid expenses and other 127 1
------------- -------------
Total current assets 2,279 1,316
Properties, net (Notes 1 and 3) 40,728 40,612
Net assets of discontinued operations (Note 8) 2,280 2,137
Other assets 1,569 865
------------- -------------
$46,856 $44,930
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $7,751 $3,464
Accrued expenses and other, including $3,868
in 1998 due to a related party (Note 4) 9,866 3,421
Current portion of long-term debt, including
$101,217 in 1998 due to a related 101,497 265
party (Notes 1 and 5)
Funding agreement (Notes 1 and 6) 25,843 --
------------- -------------
Total current liabilities 144,957 7,150
Long-term debt, including $7,433 and $99,943,
respectively, due to a related party
(Notes 1 and 5) 10,113 102,903
Funding agreement (Notes 1 and 6) -- 22,788
Other liabilities, including $3,407 in 1997
due to a related party (Note 7) -- 5,262
------------- -------------
155,070 138,103
Contingencies (Notes 1 and 8)
Shareholders' equity (deficit):
Common stock, $1 par value, 30,000,000 shares
authorized; shares issued and outstanding:
13,798,424 and 13,788,424, respectively 13,798 13,788
Additional paid-in capital 53,737 53,675
Accumulated deficit (175,749) (160,636)
------------- -------------
(108,214) (93,173)
------------- -------------
$46,856 $44,930
============= =============
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,
----------------------------
1998 1997
------------- -------------
REVENUES
Sales and operating revenue $1,721 $1
Other income 4 4
------------- -------------
1,725 5
------------- -------------
COSTS AND EXPENSES
Operating costs 334 390
Depreciation, depletion, and amortization 559 57
Overhead, Colombian operations 501 511
General and administrative 769 598
Costs of exploration and dry holes 8,452 2
Interest on indebtedness including $1,947
and $1,450, respectively, to a
related party 3,010 1,456
------------- -------------
13,625 3,014
------------- -------------
Loss from continuing operations
before income tax expense (11,900) (3,009)
Income tax expense -- --
------------- -------------
Loss from continuing operations (11,900) (3,009)
Loss from discontinued operations (Note 8) -- --
------------- -------------
Net Loss $(11,900) $(3,009)
============= =============
Loss per share:
Continuing operations $(0.87) $(0.22)
Discontinued operations -- --
------------- -------------
Net loss per share $(0.87) $(0.22)
============= =============
Weighted average common shares outstanding 13,798,424 13,781,194
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,
----------------------------
1998 1997
------------- -------------
REVENUES
Sales and operating revenue $1,864 $1
Other income 8 19
------------- -------------
1,872 20
------------- -------------
COSTS AND EXPENSES
Operating costs 650 335
Depreciation, depletion, and amortization 655 115
Overhead, Colombian operations 976 1,127
General and administrative 1,233 996
Costs of exploration and dry holes 8,482 13
Interest on indebtedness including $3,868
and $2,823, respectively, to a
related party 4,989 2,878
------------- -------------
16,985 5,464
------------- -------------
Loss from continuing operations
before income tax expense (15,113) (5,444)
Income tax expense (benefit) -- (2)
------------- -------------
Loss from continuing operations (15,113) (5,442)
Loss from discontinued operations (Note 8) -- --
------------- -------------
Net Loss $(15,113) $(5,442)
============= =============
Loss per share:
Continuing operations $(1.10) $(0.40)
Discontinued operations -- --
------------- -------------
Net loss per share $(1.10) $(0.40)
============= =============
Weighted average common shares outstanding 13,793,424 13,779,527
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,
----------------------------
1998 1997
------------- -------------
Cash flows from operating activities:
Pretax loss from continuing operations $(15,113) $(5,444)
Adjustments to reconcile pretax loss from continuing
operations to net cash used by continuing operations:
Cost of dry holes 7,953 --
Depreciation, depletion and amortization 655 115
Capitalized interest (677) (300)
Accrued interest added to long-term debt 3,407 2,429
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable (1,139) 17
Prepaid expenses and other (126) (43)
Other assets (753) (359)
Increase (decrease) in:
Accounts payable 236 160
Accrued expenses and other 6,445 2,187
Funding agreement 2,248 936
Other liabilities (5,190) (1,637)
------------- -------------
Net cash used by continuing operations (2,054) (1,939)
Net cash used by discontinued operations (143) (207)
Income taxes (paid) received -- 2
------------- -------------
Net cash used by operating activities (2,197) (2,144)
------------- -------------
Cash flows from investing activities:
Sale of assets 2 --
Capital expenditures (3,142) (4,994)
------------- -------------
Net cash used by investing activities (3,140) (4,994)
------------- -------------
Cash flows from financing activities:
Proceeds from long-term borrowings 5,300 7,200
Principal payments on long-term debt (265) (250)
------------- -------------
Net cash provided by financing activities 5,035 6,950
------------- -------------
Net increase (decrease) in cash and cash equivalents (302) (188)
Cash and cash equivalents at the beginning of the period 1,019 374
------------- -------------
Cash and cash equivalents at the end of the period $717 $186
============= =============
Refer to Notes 3, 5 and 6 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, 1998
(All Dollar Amounts in Thousands)
1) Going Concern
-------------
The accompanying consolidated financial statements have been prepared on the
basis that the Company is a going-concern. During the quarter ended March
31, 1998, the Company encountered two important events whose consequences
may lead to the Company no longer being a going-concern:
- The Company's fourth well drilled at the Opon project, the Opon No. 14
well, was unsuccessful and did not discover significant quantities of
hydrocarbons.
- The Company began producing its two successful wells in December 1997.
Since production began, greater than expected decreases in the flowing
pressure of both wells have occurred.
The associate parties to the Opon Contract have commenced a new analysis of
the Opon structure, reservoir, and reserves. Initially, the analysis will
focus on the drop in pressure and production of the producing wells and
should be completed by early June. The analysis of the entire Opon Contract
area should be completed by the end of July.
As more fully described in Note 5, the Company's debts to Lonrho Plc include
an event of default which is triggered if the Company does not increase its
reserves by October 1, 1998. The failure of the Opon No. 14 well to find
additional reserves makes it unlikely the Company will be able to avoid the
event of default on October 1, 1998. The failure of the Opon No. 14 well
makes it unlikely that the Company will be able to obtain third-party
financing of its obligations under the Funding Agreement (see Note 6). It is
reasonably possible that the Company will incur the Funding Agreement's 100%
penalty in January 1999. If incurred, management estimates the penalty
would be a minimum of $18,246 (the current principal balance) and would be
charged to income. The declines in pressure and production from the Opon
No. 3 and No. 4 wells cause uncertainty as to whether the Company's reported
proved reserves are accurate. If the results of the analysis described
above lead to the conclusion that the Company's proved reserve estimates
need to be revised downward, it is likely the Company will incur additional
charges to income as it writes down its assets. The magnitude of such
write-downs cannot presently be estimated.
As more fully described under the caption Liquidity and Capital Resources in
Item 2, the Company has made arrangements with its two primary creditors,
Lonrho Plc and Amoco Colombia, to prevent actions on their part which could
lead to the Company's bankruptcy or impairment of its rights under the Opon
Association Contract until at least October 15, 1998. This should allow the
Company to continue as a going concern until the value of the Opon project
has been determined and acted upon. Under the circumstances, there can be
no assurances if, or how long, the Company will remain a going concern.
7
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
2) 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 62.7% of Hondo Oil & Gas Company. Lonrho
Plc ("Lonrho"), a publicly-traded English company and the Company's primary
lender, owns 100% of The Hondo Company and owns an additional 5.7% of the
Company through another wholly-owned subsidiary. In total, Lonrho controls
68.4% 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, 1997. 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 this interim period 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, 1997.
(b) Earnings Per Share
------------------
The Company implemented SFAS No. 128, Earnings per Share, beginning with the
quarter ended December 31, 1997. The Company has incurred losses in each of
the periods presented in these financial statements, thereby making the
inclusion of stock options in the basic earnings per share computation
antidilutive. Accordingly, stock options have not been included in the
present, or previously reported, basic earnings per share computations and
restatement of previously reported amounts is not necessary. Diluted per
share amounts are the same as basic per share amounts and, accordingly,
are not presented.
(c) Use of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
8
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
2) Summary of Significant Accounting Policies (continued)
------------------------------------------------------
(d) 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 $428 which
are accounted for by the flow-through method.
3) Properties
----------
Properties, at cost, consist of the following:
March 31, September 30,
1998 1997
------------- -------------
(Unaudited)
Oil and gas properties - Colombia:
Proved $12,019 $11,923
Accumulated depletion, depreciation
and amortization (285) --
------------- -------------
11,734 11,923
------------- -------------
Other properties - Colombia:
Wellsite facilities 4,671 4,689
Pipelines 12,891 12,061
Accumulated depreciation (302) --
Drilling in progress 11,637 11,821
------------- -------------
28,897 28,571
------------- -------------
Other properties - domestic
Other fixed assets 309 323
Accumulated depreciation (212) (205)
------------- -------------
$40,728 $40,612
============= =============
The balances of wellsite facilities and pipelines include non-cash increases
of $184 and $4,042 for the six months ended March 31, 1998 and 1997,
respectively, which were charged to the Funding Agreement (Note 6).
Additions to drilling in progress of $5,800 and $929 for the six months
ended March 31, 1998 and 1997, respectively, were unpaid and
are reflected in the balance of accounts payable.
9
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
4) Accrued expenses
----------------
Accrued expenses consist of the following:
March 31, September 30,
1998 1997
------------- -------------
(Unaudited)
Refining and marketing costs (Note 8) $3,197 $3,198
Interest payable to Lonrho Plc (Note 5) 3,868 --
City of Long Beach 1,642 --
Accrued dry hole costs 500 --
Unearned tariff revenue 377 --
Other 282 223
------------- -------------
$9,866 $3,421
============= =============
5) Long-Term Debt
--------------
Long-term debt consists of the following:
March 31, September 30,
1998 1997
------------- -------------
Notes payable to Lonrho Plc (a),(b): (Unaudited)
Note A (c) $3,585 $3,479
Note B (c) 4,673 4,535
Note C (a),(d) 39,734 38,577
Note D (d) 34,137 33,126
Note E (e) 5,455 5,294
Note F (f) 21,066 14,932
Pollution Control Revenue Bonds (g) 1,960 2,225
Industrial Development Revenue Bonds (g) 1,000 1,000
------------- -------------
111,610 103,168
Less current maturities (101,497) (265)
------------- -------------
$10,113 $102,903
============= =============
Maturities are as follows for the years ending March 31:
1999 $101,497
2000 1,947
2001 1,967
2002 1,987
2003 2,007
Thereafter 2,205
-------------
$111,610
=============
10
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
5) Long-Term Debt (continued)
--------------------------
(a) As consideration for extensions and certain other financial
undertakings received from Lonrho in 1996, the Company granted to
Lonrho a security interest in all of the shares of Hondo Magdalena on
May 13, 1997. In 1997, as consideration for extension of the term of
Note F and the granting of $7,000 additional credit thereunder, the
Company gave Lonrho an option to convert $7,000 of Note C into the
Company's common stock at a rate of $7.70 per share. The debt is
convertible at Lonrho's option at any time prior to maturity. The
option to convert the debt into common stock given in 1997 was
approved at the Company's 1998 annual meeting.
(b) The following terms apply to Notes A through F:
(1) Interest is payable semiannually on October 1 and April 1 at a
rate of 6% (except Note F which is 13%).
(2) If management determines sufficient cash is not available to pay
interest, management may offer to issue the Company's unregistered
stock valued at the American Stock Exchange closing price on the
interest due date as payment in kind. Lonrho may choose to either add
the accrued interest to the balance of the debt outstanding or accept
the payment in kind. The Company has an obligation to register any
shares issued in connection with the above if so requested by Lonrho.
(3) Accrued interest of $3,868, $3,407, $2,823 and $2,411 has been
added to the outstanding debt as of April 1, 1998, October 1, 1997,
April 1, 1997, and October 1, 1996, respectively. Accrued interest
has not been paid by the issuance of common stock since fiscal 1996.
(4) As consideration for past deferrals of interest and principal
payments due under the terms of the first four notes, the Company
granted Lonrho Plc a 5% share of the Company's net profits, as
defined, under the Opon Contract. Following repayment of these notes,
Lonrho's entitlement will be reduced by half.
(5) If the Company does not furnish to Lonrho by October 1, 1998 a
report that shows an increase in proved gas reserves of 13,000,000
mcf, then Lonrho has the right to declare Notes A through F in default
and demand payment.
(c) Notes A and B are secured by mortgages on the Company's real estate
included in discontinued operations. Absent repayment in full as a
result of the sale of the securing real estate, principal amortization
in ten equal semiannual installments will commence January 15, 1999.
Note A is secured by the Company's Via Verde Bluffs real estate. Note
B is secured by the Company's Valley Gateway real estate.
(d) Notes C and D are secured by the Company's Valley Gateway real estate.
Notes C and D are due January 15, 1999.
(e) In October 1994, the Company received $4,800, net of withholding
taxes, from Amoco Colombia under the terms of a Farmout Agreement.
Also in October 1994, the Company paid $5,000 to Lonrho Plc to reduce
the balance of Note D and the related interest expense. At the same
time, Lonrho Plc made available $5,000 in the form of a new facility
loan to be drawn as needed by the Company. The Company drew $3,175 of
this facility loan during 1995 and the remaining $1,825 during 1996.
Note E is due January 15, 1999.
11
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
5) Long-Term Debt (continued)
--------------------------
(f) In June 1996, Lonrho Plc agreed to provide the Company a facility loan
of $13,500 at a rate of 13%, payable semiannually. In July 1997, the
loan was amended to extend the maturity date to January 1, 1999 and
revise the amount available to $20,500. In December 1997, the loan
was again amended to revise the amount available to $27,500. The loan
is secured by free cash flow, as defined, from Hondo Magdalena's
operations. The Company drew $14,600 during fiscal 1997 and has drawn
$5,300 during the six months ended March 31, 1998.
(g) Both issues of these tax-exempt bonds were issued under the authority
of the California Pollution Control Financing Authority. The
Pollution Control Revenue bonds bear interest at an average rate of
6.15%, payable semiannually, and mature serially through November 1,
2003. The Industrial Development Revenue Bonds bear interest at a
rate of 7.5%, payable semiannually, and mature September 1, 2011.
Both bond issues are collateralized by certain refinery facilities and
equipment located at Valley Gateway and the Fletcher refinery. The
collateral at the Fletcher refinery is leased to the buyer for a
nominal annual fee. The trustee of the bonds was notified of changes
to the collateral in 1993 and the trustee has not taken any action to
declare a breach of covenant or a default. The Company routinely
communicates with the Trustee and has received no indication that the
Trustee is contemplating any such action.
According to the terms of the various credit agreements, the Company is
restricted in its ability to: (a) incur additional debt; and (b) pay
dividends on and/or redeem capital stock.
Cash interest expense, all of which arises from discontinued operations, was
$105 and $113 for the six months ended March 31, 1998 and 1997,
respectively.
6) Funding Agreement
-----------------
In May 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") to finance
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 up to 365 days after the date
of first production and sales, 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 and sales 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 and sales, an additional penalty of 100% of the
amount then due would be recovered out of Hondo Magdalena's revenues.
12
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
6) Funding Agreement (continued)
-----------------------------
The associate parties have agreed that the date of first production for
purposes of this agreement is January 30, 1998. Hondo Magdalena was not
able to avail itself of the 125% option. Subsequent to the end of the
365-day option period, 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,
1998 1997
------------- -------------
(Unaudited)
Outstanding principal $18,246 $17,566
Equity premiums 7,597 5,222
------------- -------------
$25,843 $22,788
============= =============
The Company has accrued equity premiums computed in accordance with the 22%
annualized interest rate option. Equity premiums related to the financed
pipeline and wellsite facilities costs were capitalized until the
commencement of production (December 1997), including $624 and $1,174 for
the six months ended March 31, 1998 and 1997, respectively. The remainder
of the equity premiums accrued, relating to the financed geological and
geophysical work, overheads, and pipeline and wellsite costs subsequent to
the commencement of production, have been expensed.
7) Other Liabilities
-----------------
Other liabilities consist of the following:
March 31, September 30,
1998 1997
------------- -------------
(Unaudited)
Interest payable to Lonrho Plc (Note 5) $-- $3,407
City of Long Beach -- 1,594
Other -- 261
------------- -------------
$-- $5,262
============= =============
13
HONDO OIL & GAS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(All Dollar Amounts in Thousands)
8) 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.
Operating losses of discontinued operations for the quarters ended March 31,
1998 and 1997 were $70 and $79, respectively. Corresponding amounts for
the six months ended March 31, 1998 and 1997 were $143 and $191,
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, 1998 and 1997.
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, 1998 are as follows:
Balance as of September 30, 1997 $2,137
Valuation provisions established --
Valuation provisions used 143
-------------
Balance at March 31, 1998 (Unaudited) $2,280
=============
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 $49 and $62 for
the quarters ended March 31, 1998 and 1997, respectively. Comparable
amounts for the six-month periods were $99 and $125, respectively.
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 then
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 could 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 Notice of
Determination in July 1997 reducing the taxes and penalties due to $5,740.
Assessed amounts are subject to a process of appeal and further adjustment,
which remedies are still being pursued. 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 trial is scheduled to commence on
August 26, 1998. The Company accrued an additional $1,200 in September
1997. The Company has accrued its best estimate of the ultimate liability
and believes this is sufficient to provide for the amount that will
ultimately be paid based on the information available.
14
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 commercial in May 1996. A
pipeline and related wellsite facilities to deliver natural gas and
condensate to a market are complete, and production began in December
1997. Deliveries of natural gas to a power plant located at the Opon
Contract area also began in December 1997, but were suspended at the end
of March 1998 due to unanticipated drops in pressure and corresponding
production from the Opon No. 3 and No. 4 wells. The Company continues
to supply gas and liquids to Ecopetrol at production levels less than
required under the contracts. The Company is not incurring any
penalties under the contracts. During 1997, the Opon No. 6 well
encountered mechanical problems during completion operations and was
temporarily suspended to evaluate information and develop plans for
further operations on the well.* The associate parties have deferred
commencing production of the Opon No. 6 well until they have completed a
review and analysis of the reservoir and reserves. Drilling of the Opon
No. 14 well began in October 1997 and has been completed and tested.
The Opon No. 14 well did not produce any hydrocarbons and has been
temporarily suspended. The Company will require additional financing to
continue development of the Opon project.*
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
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
15
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. 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 50%, 30%, 15.4%, and 4.6% for Ecopetrol, Amoco
Colombia, Hondo Magdalena, and ODC, respectively. The commercial field
is substantially smaller than that requested, but may be enlarged by
future drilling and/or additional technical information.* The associate
parties submitted an application to declare the area around the Opon No.
6 well commercial in August 1997. Ecopetrol responded in September 1997
that it considered the information presented to be insufficient to
evaluate the application for the extension of the commercial area. The
associate parties are evaluating Ecopetrol's response in light of the
terms of the Opon Contract and have approached Ecopetrol for
clarification of its response. At this date, the area around the Opon
No. 6 well is not a part of the commercial area. 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.
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 (61,827 acres). The second
acreage relinquishment was due on September 30, 1997. By agreement with
Ecopetrol, the second relinquishment has been postponed until September
30, 1998. As consideration, the associate parties agreed to perform,
for the full Opon Contract area, surface geological studies and
petrochemical analysis, and to undertake a study to determine the
economic and technical viability of putting the shallow oil producing
wells in the Opon Contract area into production. 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.*
The Opon No. 6 well commenced drilling in October 1996. This well is
slightly more than 1 kilometer north of the Opon No. 3 well and is
outside the current commercial area. The well is presently estimated to
cost $30.6 million, of which Hondo Magdalena's share is 30.9%.* After
the drilling was completed, several mechanical problems in the
completion and testing of the Opon No. 6 well occurred. After there was
a failure of a portion of the guns during the initial completion attempt
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
16
in April 1997, a second set of perforating guns were fired. Cleanup and
testing on the second set of perforations commenced in May 1997 and,
while all the guns fired, the well has not flowed as anticipated. The
associate parties recently decided to connect the well in its present
condition and commence production in hopes debris from past mechanical
problems will be evacuated. However, this decision has been suspended
and is under review pending completion of the analysis of the unexpected
drops in pressure and production from the Opon No. 3 and No. 4 wells.
Further workover alternatives will be evaluated after a production
history has been accumulated.*
The associate parties are attempting to negotiate a settlement of claims
against suppliers of services and equipment related to the problems
encountered during completion operations on the Opon No. 6 well, but no
settlement has been reached. The claims relate to the failure of
perforating guns, problems with the installation of the production
tubing and failure of a downhole safety valve provided by Colombian
branches of U.S. and multinational oil service companies. The claims
are based upon contract and purchase order terms providing for
warranties, adequate supervision of assembly of components and other
work, equipment to be in good working order, and work to be performed in
a workmanlike manner. The disputed charges aggregate approximately $4.9
million, of which Hondo Magdalena's share is approximately $1.5 million.
Consequential losses, depending on how measured, could make the claims
larger. If a settlement is not reached, the next step will be either
non-binding mediation or arbitration.* No prediction of the outcome of
these matters can be made at this time.
The Opon No. 14 well, approximately 4 kilometers south of the Opon No. 4
well, commenced drilling in October 1997. The total cost of the well is
estimated to be $26.3 million, of which Hondo Magdalena will bear
30.9%.* The well was planned and intended to confirm the existence of
the La Paz gas and condensate reservoir in the south of the Opon
Contract area.* The well has been drilled to a depth of 12,200 feet.
The associate parties have completed testing of both the La Paz
formation and the deeper Lisama formation. The results were
unsuccessful and the well did not flow any significant hydrocarbons and
has been plugged and temporarily suspended in such a manner that it may
be re-entered in the future. The adverse results of the Opon No. 14
well have caused Amoco Colombia and the other associate parties to
commence a new analysis of the Opon structure, reservoir, and reserves.
The initial part of the analysis will focus on the drop in pressure and
production of the producing wells and should be completed in early
June.* The analysis of the entire Opon Contract Area should be
completed by the end of July.* In the interim, the associate parties
have released the Parker 216 drilling rig and have not budgeted any
additional wells.*
In July 1995, Hondo Magdalena, ODC, Amoco Colombia and Ecopetrol agreed
to construct a pipeline and wellhead facilities (which were not
contemplated in the Opon Contract). The parties constructed 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 Ecopetrol's refinery at Barrancabermeja. The investment in the
pipeline is to be recovered through a pipeline tariff, but see the
discussion in the next paragraph concerning the action of the
governmental agency on the associate parties' tariff application.*
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
17
Ecopetrol has constructed 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 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, regulates natural gas
pipelines and the sale of natural gas in Colombia. CREG's regulations
provide the ceiling price for natural gas and the methodology for
establishing pipeline tariffs. Based upon these regulations, Amoco
Colombia, as operator, applied for a pipeline tariff of 60.4 cents per
thousand cubic feet of gas; CREG has responded by rejecting the proposed
tariff, instead approving a tariff of 25.0 cents per thousand cubic feet
of gas. Amoco Colombia has appealed this decision. In the interim, the
associate parties are charging (and through March production, Ecopetrol
has paid) the higher 60.4 cents tariff. The Company is recognizing
revenue using the 25.0 cent rate, the remainder of the cash being
received is recorded as a liability.
Contracts, covering the sale of natural gas, the sale of condensate and
natural gas liquids, the processing of the gas stream, and
transportation of natural gas and liquids are complete and have been
signed by all parties. 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$1.15 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 $0.159 per thousand cubic feet of gas. Ecopetrol, as
purchaser, pays the pipeline tariff for the natural gas sold by the
associate parties.
In March 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, subject to the conditions
noted below, natural gas to its electric generation plant at the Opon
Contract area. Under the contract, that is not yet in effect, 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 if the power plant achieves a price for its electrical power in
excess of certain target rates. 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. The commencement of the contract is conditioned upon a
determination by the sellers that there are sufficient reserves to
supply natural gas to the purchaser for the entire term of the
agreement. In order to begin deliveries before the condition concerning
the sufficiency of reserves is satisfied, an interim agreement for the
sale of gas to Termo Santander was signed on November 20, 1997. The
interim agreement will be effective until January 1, 1999. The gas
sales price under the interim agreement is equivalent to the price,
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
18
including pipeline tariff, that would have been received if the same gas
were sold under the contract with Ecopetrol described in the preceding
paragraph. The associate parties have not supplied gas to Termo
Santander since March 31, 1998. The power plant has not been able to
locate another supply of gas and has temporarily ceased operation. The
associate parties have no liability for failing to supply gas to the
power plant under the interim agreement.
The pipeline and wellsite facilities were completed in June 1997.
Ecopetrol completed the improvements to the El Centro gas processing
plant in November 1997. Production from the Opon field began on
December 1, 1997, with gas supplied to Termo Santander for testing the
first of two turbines at the power plant. The first shipment of gas
through the pipeline occurred on December 5, 1997.
The associate parties have submitted invoices to Ecopetrol under the gas
sales agreement for payments under the take-or-pay clause, which
provides that Ecopetrol will pay 200% of the gas price for the Company's
share of 100 million cubic feet per day if the gas pipeline is completed
and ready and the El Centro gas plant improvements have not been
completed. The associate parties believe the pipeline was complete on
June 25, 1997, and submitted invoices accordingly. Ecopetrol has
indicated that it will not pay these invoices. The Company has not
accrued its $5.2 million invoice in its financial statements. The
associate parties are reviewing their legal options to pursue the
collection of these invoices, which could include negotiation of a
settlement and arbitration in a Colombian forum.*
Amoco Colombia has submitted budgets to Hondo Magdalena and ODC for
calendar years 1996, 1997 and 1998. 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, 1997 or
1998. The parties are currently at an impasse in resolving the dispute
about overhead for 1998. Pursuant to a Stand-Still Agreement reached
with Amoco Colombia on May 19, 1998, and further described under
Liquidity and Capital Resources, Hondo Magdalena has agreed to approve
the original 1996 and 1997 budgets in their entirety at the next
scheduled operating committee meeting. Hondo Magdalena has paid
invoices from Amoco Colombia, including disputed overhead and has
charged the full overhead amount to expense for 1998. 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 for calendar year 1998, the joint operating agreement among
Amoco Colombia, Hondo Magdalena and ODC provides for arbitration of
disputes.
Hondo Magdalena, on behalf of itself and ODC, has conducted audits of
the joint account with Amoco Colombia for 1994, 1995, and 1996. Attempts
to resolve the audit exceptions for 1994 and 1995 have been ineffective.
In March 1998, the Company submitted audit exceptions of $1.9 million
(gross charges to the joint account) to arbitration. The report for the
1996 audit was submitted to Amoco Colombia in March 1998. The Company
has not accrued in its financial statements any potential recoveries
which may arise from these audits.
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
19
American Stock Exchange Listing
-------------------------------
The Company has been informed of a decision by the American Stock
Exchange to remove the Company's stock from listing on the Exchange.
The Exchange has advised the Company that this action is necessary
because the Company no longer satisfies all the guidelines of the
American Stock Exchange for continued listing. The Company is appealing
this decision and has been advised by the Exchange that during the
pendency of the appeal, which could take several months, the Exchange
will continue the current halt in trading. There can be no assurances
that the appeal will be successful. For additional information, see
Item 5, Market For Registrant's Equity and Related Shareholder Matters
in the Company's 1997 Annual Report on Form 10-K.
Discontinued Operations
-----------------------
Two of the Company's former business segments, refining and marketing
operations and real estate operations were discontinued in 1991. No
change in the status of these discontinued operations from that reported
in the Company's 1997 Annual Report on Form 10-K occurred during the
current period except that Via Verde Development Company, a wholly-owned
subsidiary of the Company, entered into a contract for sale of one of
the Company's two real estate tracts in May 1998. The contract for the
Via Verde property, consisting of 11.5 acres of undeveloped land, is for
$3.13 million and is expected to close in October 1998.
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
20
RESULTS OF OPERATIONS
Quarters Ended March 31, 1998 and 1997
--------------------------------------
Results of continuing operations for the quarter ended March 31, 1998
amounted to a net loss of $11.9 million, or 87 cents per share. The
Company reported a net loss from continuing operations of $3.0 million,
or 22 cents per share, for the quarter ended March 31, 1997. No losses
from discontinued operations were reported for either period.
In the current period, the Company reported a full quarter of operating
revenue for the first time since 1993. The Company's Colombian
operations began delivering gas to Ecopetrol in December 1997. The
Company's share of Opon production amounted to 913,131 mmbtu sold for an
average price of $1.16 per mmbtu and 34,211 barrels of condensate and
natural gas liquids sold for an average price of $12.66 per barrel. In
addition, the Company recorded tariff revenues on 880,689 mcf at an
average price of $28.5 cents per mcf. Due to an unexpected drop in
pressure and related production from the Opon No. 3 and No. 4 wells
during the second quarter, the revenue was considerably lower than
planned and anticipated.
Net operating profit (defined as operating revenue less operating
expenses, depreciation, depletion, and amortization, and overhead,
Colombian operations) improved by $1.3 million between the periods as a
result of the commencement of production this year.
The Company has charged its entire cost of $8.5 million for the
unsuccessful Opon No. 14 well to costs of exploration and dry holes
during the current period. No comparable expense was incurred in the
prior period.
The level of the Company's debts to Lonrho Plc and to Amoco Colombia
under the Funding Agreement have increased by approximately $27.1
million between March 31, 1997 and March 31, 1998. Interest expense
increased by $1.6 million between the quarters because of the increased
debt levels and because interest is no longer being capitalized for the
pipeline construction.
Six months ended March 31, 1998 and 1997
----------------------------------------
Results of continuing operations for the six months ended March 31, 1998
amounted to a net loss of $15.1 million, or $1.10 per share. The
Company reported a net loss from continuing operations of $5.4 million,
or 40 cents per share, for the six months ended March 31, 1997. No
losses from discontinued operations were reported for either period.
Net operating profit (defined as operating revenue less operating
expenses, depreciation, depletion, and amortization, and overhead,
Colombian operations) improved by $1.2 million between the periods as a
result of the commencement of production in December 1997.
The Company has charged its entire cost of $8.5 million for the
unsuccessful Opon No. 14 well to costs of exploration and dry holes
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
21
during the current period. No comparable expense was incurred in the
prior period.
The level of the Company's debts to Lonrho Plc and to Amoco Colombia
under the Funding Agreement have increased by approximately $27.1
million between March 31, 1997 and March 31, 1998. Interest expense
increased by $2.1 million between the six-month periods because of the
increased debt levels and because interest is no longer being
capitalized for the pipeline construction.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended March 31, 1998, cash inflows of $5.3 million
arose from borrowings from Lonrho Plc. The Company utilized cash of
$2.1 million and $0.1 million to finance continuing and discontinued
operations, respectively, $3.1 million for capital expenditures, and
made scheduled debt repayments of $0.3 million. At March 31, 1998, the
Company had cash balances of $0.7 million.
The Company has had an obligation to Phillips Petroleum arising from a
1992 decision to plug and abandon certain California offshore wells in
which the Company owns a working interest. In December 1997, the
Company entered into an agreement to settle the $1.1 million obligation
(included in accounts payable on the balance sheet) by issuing 178,848
shares of common stock valued at a price of $6.91 per share (the average
closing price for the ten days prior to filing of a registration
statement and provided for) a warrant to purchase 29,808 additional
shares from the Company at a price of $1.00 per share if the price of
the Company's common stock was below $5.415 per share for 20 consecutive
business days. A registration statement on Form S-3 was filed on
January 7, 1998, but has subsequently been withdrawn. This agreement
was terminated in May 1998 by mutual consent, the shares and warrants
were not issued, and the Company has acknowledged in writing its debt to
Phillips of $1.1 million with interest to be accrued at 10% per annum
from April 28, 1998.
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 a 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. Under a December 1996
letter agreement, as consideration for extension of maturities and
certain other financial undertakings, the Company granted to Lonrho a
security interest in all of the shares of Hondo Magdalena.
In July 1997, the Company and Thamesedge, Ltd. agreed to amend and
restate the June 1996 Revolving Credit Agreement. Under the Amended and
Restated Revolving Credit Agreement dated as of July 2, 1997, Thamesedge
agreed to make additional advances of $7.0 million to the Company,
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
22
making the total amount of the loan $20.5 million. The interest rate
remains 13%, due semi-annually; as provided in other debts to Thamesedge
and described above, the Company may make interest payments in shares of
its common stock. The loan now matures January 1, 1999. As additional
consideration for the loan, the Company agreed to give Lonrho an option
to convert $7.0 million of existing debt with an interest rate of 6%
into the Company's shares at $7.70 per share (110% of the closing price
on July 1, 1997). The option to convert was approved by the Company's
shareholders at its annual meeting in March 1998. As of March 31, 1998,
$19.9 million of this facility has been drawn.
In August 1997, Thamesedge Ltd. assigned all of its interest in the
Company's indebtedness to London Australian & General Property Company
Limited ("LAGP"), a subsidiary of Lonrho Plc. In December 1997, the
Company restructured the terms of certain debt to LAGP, and obtained an
additional funding commitment of $7.0 million for fiscal 1998, bringing
the total commitment under the Revolving Credit Agreement to $27.5
million. Also in December 1997, Lonrho Plc committed to provide $3.2
million to the Company in fiscal 1998 for payment of a contingent
liability arising from the 1993 sale of the Company's Fletcher refinery,
should the contingency become payable in fiscal 1998. The Company
extended all of the above described indebtedness due on January 1, 1998
to January 15, 1999 and amended the notes by adding a cross-default
provision and a new event of default. The new event of default requires
the Company to furnish to LAGP by October 1, 1998 a reserve report that
shows a minimum of 13 billion cubic feet of gas increase over the 1997
proved reserve figure. In the event of a default under this new
provision, LAGP has the right to declare all the loans in default and
demand payment. Based on advice of the Company's engineering
consultants given at the time the loan amendments were executed,
management believed the results of drilling the Opon No. 14 well would
be sufficient to meet this requirement.* Since the Opon No. 14 well was
unsuccessful and no additional well can be drilled before October 1,
1998, and because the analysis of the pressure and production declines
in the Opon No. 3 and No. 4 wells could reduce the 1997 proved reserve
figure, the Company is of the opinion that it will not meet the required
reserve increase by October 1, 1998 and it will not be able to avoid an
event of default.* The Company presently owes Lonrho Plc $108.7
million, of which $101.2 million is due by January 15, 1999.
In May 1995, Hondo Magdalena, ODC and Amoco Colombia entered into a
Funding Agreement for Tier I Development Project costs (the "Funding
Agreement") to finance 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 up to 365 days after the date of first production and
sales, along with an equity premium computed on a 22% annualized
interest rate. The equity premium is 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 and sales 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. The parties have agreed that
the date of first production for purposes of this agreement is January
30, 1998. The alternative repayment election expired on April 30, 1998,
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
23
unused by the Company. If the financed amounts are not repaid within
365 days after the date of first production and sales, 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 per day and corresponding
condensate and natural gas liquids subsequent to the end of the 365 day
option period are pledged to secure its obligations under the Funding
Agreement. The Company does not presently have commitments or funds to
repay the Funding Agreement within the 365 day period.* If the Company
does not secure financing to repay the Funding Agreement prior to 365
days after the date of first production and sales, it will incur the
100% penalty and will pay the increased amount out of production, as
described above.
The Company and Hondo Magdalena entered into a 150 day Stand-Still
Agreement with Amoco Colombia on May 19, 1998 whereby the Company's
obligation to pay cash calls and invoices is suspended from May 15, 1998
to October 15, 1998. The Company has agreed to assign all of its
revenue, net of processing costs and pipeline operating expenses, to
Amoco Colombia for the months of April, May, June, July and August 1998
and to assign the revenue due to Hondo Magdalena from Ecopetrol's
reimbursement of its share of pipeline and wellsite construction costs.
Hondo Magdalena will receive the net difference from Amoco Colombia at
any time the cumulative revenue exceeds the cumulative expenses during
this 150 day stand-still period. Lonrho, Plc has confirmed to Amoco
Colombia that it will not initiate any action to place the Company or
its subsidiary, Hondo Magdalena, into bankruptcy during this stand-still
period. The Company hopes to use the stand-still period to determine
the reasons for the decline in pressure and production from the
producing wells, and to review the analysis of Amoco Colombia and its
own technical advisor on the reservoir and reserve study currently in
progress.* The stand-still period should also allow the Company to
determine Amoco Colombia's future development plans for the Opon
project.*
Based upon the Company's budget and current information, management
believes existing cash, the Stand-Still Agreement, and available
facilities will be sufficient to finance the Company's known obligations
during fiscal 1998.* However, management believes the Company will need
additional cash to repay obligations to third parties whose debts may
become accelerated.*
If the Company becomes obligated for the drilling of an additional well
in subsequent years, the Company has the option to not participate in
the drilling of wells under the sole risk provisions of the joint
operating agreement among Amoco Colombia, Hondo Magdalena and ODC. These
provisions provide for penalties of 200% to 1000% (depending on the
nature of the well) of the costs attributable to the Company. These sole
risk provisions do not apply to other capital projects if the projects
are approved in accordance with the operating agreement. In
management's view, use of this sole risk election would be a last resort
to preserve the Company's existing interest in the Opon Contract area
because of the substantial penalties that would be incurred by not
participating.
Cash flow from operations which commenced in December 1997 is not
expected to be a significant source of free funds in the near future
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
24
since, pursuant to the Stand-Still Agreement, Amoco Colombia receives
the proceeds from all revenue for the months of April, May, June, July
and August 1998.* Any additional free cash flow (as defined in the
Company's loan agreements with Lonrho Plc) is committed to existing loan
obligations. Management is reviewing several options for raising funds
including sale of the Company's 15.4% interest in the pipeline.*
However, this alternative is now very difficult in view of the declines
in tariff and throughput rates. Any proceeds realized from a sale of
the pipeline must be applied first to repayment of the Funding
Agreement. Management has discontinued discussions with a number of
financial institutions regarding debt or equity financing of the
Company's future obligations for the Opon project in view of the current
uncertainty about the future of the Opon project.* Additional
deliverability from additional yet to be proposed drilling projects and
adequate production capability through the pipeline infrastructure are
important factors in obtaining third party financing.* In the interim,
the Company must continue to rely on the financial support of Lonrho.*
Recently, in its annual report, Lonrho stated that it intends to sell
its investment in the Company. The Company has relied upon Lonrho to
provide funds for capital investment and operations when such funds have
not been available from third parties. If and when Lonrho sells its
investment in the Company, the Company will need to find another source
of financing, from outside sources or a new controlling shareholder.
The Company cannot predict the effect that a sale of Lonrho's interest
to a third party will have on the Company's ability to secure financing
nor can the Company predict the success of a sale in view of the
unsuccessful results of the Opon No. 14 well and the production declines
from the Opon No. 3 and No. 4 wells. While the Company may 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.* Furthermore, since the
success of the Opon No. 14 well was critical to obtaining third party
financing (either debt or equity) and for the decision by the associate
parties to continue the development of the Opon project, there can be no
assurances that the Opon project will be further developed or that Hondo
Oil will be a viable company.*
____________________
* This statement may be considered to be forward-looking. See
Cautionary Statements following Liquidity and Capital Resources.
25
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, a oil and
gas exploration concession in Colombia, South America. The Opon project
began producing natural gas and condensate in December 1997 and is the
Company's only source of operating revenue.
Ecopetrol's Inherent Conflict of Interest and Role. Ecopetrol is a
quasi-governmental corporate organization wholly-owned by the Colombian
government, a party to the Opon Contract and a 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 an
inherent conflict of interest in Ecopetrol and the government.
Disputes with Ecopetrol, including a recent disagreement about the
obligation to make take-or-pay payments under a gas sales agreement,
must be resolved in non-judicial or judicial proceedings in Colombia.
These conflicts may affect the value of the Company's interest in the
Opon project.
Under the terms of the Opon Contract, an application for commerciality
must be submitted to, and approved by, Ecopetrol before production of
the wells in that area can begin. Ecopetrol cannot prevent the other
contract parties from producing discovered hydrocarbons by disapproving
the application, but Ecopetrol can delay the commencement of production
for up to one year by requiring additional work (which can cost no more
than $1.0 million).
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
26
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 immediate 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 1998,
the President of the United States announced that Colombia again would
not be certified but was granted a national interest waiver.
Risks Of Oil And Gas Exploration. Inherent to the oil and gas industry
is the risk that future wells will not find hydrocarbons where
information from 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. Also,
because of the limited number of wells in the Opon Contract area (there
are presently two producing wells), the impact of the loss of a single
well would potentially affect the Company's production capability.
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 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, No. 6, and No. 14 wells by the
use of a top-drive drilling rig, heavy-weight and oil-based drilling
fluids and other technical drilling enhancements.
Acreage Relinquishments. The terms of the Opon Contract include
provisions which require the associate parties to relinquish portions of
the concession acreage which have not been found to contain hydrocarbons
in commercial quantities. Management believes the relinquishments of
acreage to date have not deprived the associate parties of significant
undiscovered reserves. Ecopetrol has agreed to extend contractual
relinquishment requirements in light of current exploration activity on
more than one occasion. Nonetheless, there can be no assurances that
Ecopetrol will agree to additional extensions in the future, or that
other factors (including for example: lack of capital, rig availability
or political unrest) will prevent the parties from completing assessment
of unproved acreage before the acreage must be released.
Laws And Regulations. The Company may be adversely affected by new laws
or regulations in the United States or Colombia regarding its operations
and/or environmental compliance, or by existing laws and regulations.
The Colombian governmental agency responsible for setting pipeline
tariffs has set a tariff substantially lower than that requested by the
Company. This action has been appealed, but no prediction can be made
27
about the outcome and the final determination of the tariff. A
reduction of the tariff will impair the Company's ability to recover its
investment in the pipeline through tariff revenue and/or sale of the
pipeline. For additional information, see Other Factors Affecting the
Company's Business in Item 1, Business of the Company's 1997 Annual
Report on Form 10-K.
Highly Leveraged. As of March 31, 1998, the Company owed debts to its
principal shareholder, Lonrho Plc, of $108.7 million, of which $101.2
million is due by January 15, 1999. The terms of this debt require the
Company to increase its September 30, 1997 proved reserves of 52.5
billion cubic of gas by 13.0 billion cubic feet of gas by October 1,
1998 to avoid an acceleration of the maturity of all of the debt to that
date. Acquisition of the additional reserves was dependent on the
results of drilling of the Opon No. 14 well and additional work to be
performed on the Opon No. 6 well, if any. As described above, the
Company does not believe it will discover the reserves necessary to
prevent the debts from being accelerated if Lonrho Plc declares an event
of default. The Company does not have the resources to repay the
indebtedness when it is due. Over the past five years, Lonrho Plc has
demonstrated a willingness to extend the repayment terms of the
Company's debts. However, there can be no assurances that Lonrho Plc
will continue to extend the maturity of the Company's debts in the
future. See Limited Capital and Change of Control and Financial Support
Shareholder, below.
Limited Capital. At March 31, 1998, the Company had a deficiency in net
assets of $108.2 million. The Company's principal asset, its investment
in the Opon project, will require additional capital for further
exploration works (additional exploratory wells and the related surface
facilities to put newly discovered hydrocarbons into production) if the
associate parties elect to proceed with further development of the Opon
project. The Opon project commenced production in December 1997.
However, net revenue from the sale of the first 80 million cubic feet of
natural gas per day and associated condensate (estimated to be in excess
of the Company's net revenue) is pledged to repayment of amounts
advanced by the operator under a Funding Agreement. Cash from
operations after Funding Agreement repayments will not be sufficient to
fund Colombian operating costs and capital expenditures, and U.S.
overhead, during fiscal 1998. The Company has been unable to secure
financing from sources other than its principal shareholder. Management
believed successful completion of the Opon No. 14 well was critical to
obtaining third party financing and such efforts have now been suspended
pending the analysis and review of the Opon project described above.
See Highly Leveraged, above, and Change of Control and Financial Support
Shareholder, below.
Change of Control and Financial Support of Shareholder. In a Schedule
13D amendment filed October 15, 1997 by Lonrho Plc and its affiliates,
the filing parties said that Lonrho Plc had retained Morgan Stanley &
Co. Incorporated to assess and implement strategic alternatives with
respect to Lonrho's direct and indirect investment in the Company.
Lonrho Plc said such strategic alternatives could include, without
limitation, a possible recapitalization of the Company or a sale or
business combination involving the Company or Lonrho's direct and
indirect equity interest in the Company (including the sale or
assumption of the debt obligations of the Company to affiliates of
Lonrho). Recently, in its annual report, Lonrho stated that it
intends to sell its investment in the Company. The Company has relied
28
upon Lonrho to provide funds for capital investment and operations when
such funds have not been available from third parties, and at March 31,
1998, was indebted to Lonrho in the amount of $108.2 million. If and
when Lonrho sells its investment in the Company, the Company will need
to find another source of financing, from outside sources or a new
controlling shareholder. The Company cannot predict the effect that a
sale of Lonrho's interest to a third party will have on the Company's
ability to secure financing. See Highly Leveraged and Limited Capital,
above.
Limited Revenues and Losses From Operations. The Opon Project commenced
production in December 1997. The Company reported its first full
quarter operating revenue of $1.7 million for the quarter ended March
31, 1998. This is the only full quarter of operating revenue the
Company has had since it sold its domestic operations in 1992. The
Company experienced losses of $12,388,000, $12,657,000 and $11,906,000
for the years ended September 30, 1997, 1996 and 1995, respectively.
The Company anticipates continued losses through fiscal 1998.
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.
29
Part II
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Shareholders on March 10, 1998,
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 six 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 12,701,414 627,069
DOUGLAS G. MCNAIR 13,245,714 117,359
NICHOLAS J. MORRELL 13,244,694 118,379
JOHN F. PRICE 13,245,694 117,379
ROBERT K. STEER 13,245,714 117,359
R.E. WHITTEN 13,238,594 124,479
There were no abstentions or broker non-votes recorded in the election
of directors.
The other proposals were (1) approval of an option for London Australian
& General Property Company Limited to convert $7.0 million of the
Company's debt into shares of the Company's common stock; (2) approval
of grant, cancellation and regrant of stock options to certain directors
and employees during fiscal year 1997; and (3) approval of the
appointment of Ernst & Young LLP as independent auditors for fiscal year
1998. These proposals were approved by the following vote:
FOR AGAINST ABSTENTIONS
---------- --------- -----------
LAGP Conversion 7,485,502 4,300,647 15,917
Option Regrants 12,171,229 1,109,058 11,984
Ernst & Young LLP 13,335,426 12,597 6,050
There were no broker non-votes recorded in the above voting.
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) One report on Form 8-K was filed during the quarter ended March 31,
1998:
1) Form 8-K filed March 25, 1998 to report that preliminary results
from drilling of the Opon No. 14 well were disappointing.
SIGNATURES
30
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, 1998 /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
------- --------------------------------------------
10.1 Amendment to Note Purchase Agreement dated December 18,
1997 between the Company and London Australian &
General Property Company Limited, amending Note
Purchase Agreement dated November 28, 1988, excluding
exhibits.
10.2 Amended and Restated $75,000,000 6% Senior Note due
January 15, 1999 dated December 18, 1997 between the
Company and London Australian & General Property
Company Limited, executed in conjunction with the
amendment in Exhibit 10.1.
10.3 Consolidated, Amended and Restated $40,000,000
Promissory Note dated December 18, 1997 between the
Company and London Australian & General Property
Company Limited, which replaces Promissory Notes
previously issued in conjunction with a loan agreement
dated December 20, 1991.
10.4 Amended and Restated $4,500,000 Promissory Note dated
December 18,1997 between Via Verde Development Company
and London Australian & General Property Company
Limited, which replaces a $3,000,000 note dated April
30, 1993.
10.5 First Guaranty Amendment dated December 18, 1997
between the Company and London Australian & General
Property Company Limited, in regard to Exhibit 10.4,
above.
10.6 Amended and Restated $5,500,000 Promissory Note dated
December 18,1997 between Newhall Refining Co., Inc. and
London Australian & General Property Company Limited,
which replaces a $4,000,000 note dated June 25,1993.
31
EXHIBIT INDEX (continued)
Exhibit
Number Subject
------- --------------------------------------------
10.7 Letter agreement dated December 18, 1997 between the
Company and London Australian & General Property
Company Limited, amending a letter agreement dated
December 17, 1993.
10.8 Amended and Restated $7,500,000 Promissory Note dated
December 18, 1997 between the Company and London
Australian & General Property Company Limited which
replaces a $5,000,000 note dated October 31, 1994.
10.9 First Amendment to Security Interest Agreement dated
March 18, 1998 between the Company, Folio Trust Company
Ltd., Folio Nominees Limited and London Australian &
General Property Company Limited, amending
Security Interest Agreement dated May 13, 1997.
10.10 First Amendment to Amended and Restated $35,000,000
Revolving Credit Agreement dated December 18, 1997
between the Company and London Australian & General
Property Company Limited, amending a revolving credit
agreement dated July 2, 1997.
10.11 First Guaranty Amendment dated December 18, 1997
between Hondo Magdalena Oil & Gas Limited and London
Australian & General Property Company Limited amending
a guaranty dated July 2, 1997.
10.12 Stand-Still Letter Agreement dated May 15, 1998 among
the Company (Hondo together with all of its
direct and indirect subsidiaries, which include
without limitation, Hondo Magdalena Oil and Gas
Limited, Newhall Refining Company, Inc., and Via
Verde Development Company), Lonrho Plc, Thamesedge,
Ltd., London Australian & General Property Company
Limited (collectively, together with any of their
respective affiliates, parent corporations and direct
and indirect subsidiaries that assert claims against
Hondo), and Amoco Colombia Petroleum Company.
27 Financial Data Schedule
32