UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended September 30, 1998 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-19118 ABRAXAS PETROLEUM CORPORATION ---------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Nevada 74-2584033 ------------------------------- ---------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 500 N. Loop 1604, East, Suite 100, San Antonio, Texas 78232 ------------------------------------------------------ --------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code(210) 490-4788 Not Applicable (Former name,former address and former fiscal year,if changed since last report) 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 such shorter period that the restraint was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X or No __ The number of shares of the issuer's common stock outstanding as of November 11, 1998, was: Class Shares Outstanding Common Stock, $.01 Par Value 6,259,363 1 of 21 ABRAXAS PETROLEUM CORPORATION AND SUBSIDIARIES FORM 10 - Q INDEX PART I FINANCIAL INFORMATION ITEM 1 - Financial Statements (Unaudited) Consolidated Balance Sheets - September 30, 1998 and December 31,1997.....................................3 Consolidated Statements of Operations - Three and Nine Months Ended September 30, 1998 and 1997..............................5 Consolidated Statement of Stockholders Equity September 30, 1998 and December 31, 1997.................6 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1998 and 1997............7 Notes to Consolidated Financial Statements......................9 PART II OTHER INFORMATION ITEM 1 - Legal proceedings..................................................21 ITEM 2 - Changes in Securities..............................................21 ITEM 3 - Defaults Upon Senior Securities....................................21 ITEM 4 - Submission of Matters to a Vote of Security Holders................21 ITEM 5 - Other Information..................................................21 ITEM 6 - Exhibits and Reports on Form 8-K...................................21 Signatures ........................................................22 2 Abraxas Petroleum Corporation and Subsidiaries Part 1- Financial Information Item 1 - Financial Statements Consolidated Balance Sheets September 30, December 31, 1998 1997 (Unaudited) ------------ ------------- (In Thousands) Assets Current assets: Cash ........................................... $ 11,268 $ 2,836 Accounts receivable, less allowances for doubtful accounts: Joint owners ........................... 2,266 2,149 Oil and gas production ................. 4,427 11,194 Affiliates, Officers, and Stockholders ......................... 18 42 Other .................................. 2,241 1,217 --------- -------- 8,952 14,602 Property held for sale ......................... 60,250 - Equipment inventory ............................ 493 367 Other current assets ........................... 185 508 --------- -------- Total current assets ............................. 81,148 18,313 Property and equipment ........................... 358,672 385,442 Less accumulated depreciation, depletion and amortization: .......................... 98,708 74,597 --------- -------- Net property and equipment based on the full cost method of accounting for oil and gas properties, of which $11,519 at December 31,1997 and September 30, 1998 were excluded from amortization ....................... 259,964 310,845 Deferred financing fees, net of accumulated Amortization of $1,540 and $2,453 at December 31, 1997 and September 30, 1998, respectively ............... 8,656 8,072 Restricted cash .................................. 40 40 Other assets ..................................... 1,222 1,258 --------- -------- Total assets ................................... $351,030 $338,528 ========= ========= See accompanying notes to consolidated financial statements 3 Abraxas Petroleum Corporation and Subsidiaries Part 1- Financial Information Item 1 - Financial Statements Consolidated Balance Sheets (continued) September 30, December 31, 1998 1997 (Unaudited) ------------ ------------- (In Thousands) Liabilities and Shareholder's Equity Current liabilities Accounts payable .............................. $ 9,450 $ 17,120 Oil and gas production payable ................ 3,285 2,819 Accrued interest .............................. 13,253 4,622 Income tax payable ............................ 162 164 Other accrued expenses ........................ 1,109 2,732 --------- --------- Total current liabilities ........... 27,259 27,457 Long-term debt: Senior notes ................................ 275,000 215,000 Credit facility ............................. 100 31,500 Other ....................................... 7,076 2,117 --------- --------- 282,176 248,617 Premium on Senior Notes ......................... 3,471 -- Deferred income taxes ........................... 21,976 27,751 Minority interest in foreign subsidiary ......... 9,392 4,813 Future site restoration ......................... 3,279 3,077 Shareholders' equity: Common Stock, par value $.01 per share- authorized 50,000,000 shares; issued, 6,430,378 and 6,422,540 shares at September 30, 1998 and December 31, 1997, respectively .......................... 63 63 Additional paid-in capital .................... 51,248 51,118 Accumulated deficit ........................... (35,657) (19,185) Treasury stock, at cost, 171,015 and 53,023 shares at September 30, 1998 and December 31, 1997, respectively ............. (1,167) (281) Accumulated other comprehensive income (loss) ... (11,010) (4,902) --------- --------- Total shareholders' equity ...................... 3,477 26,813 --------- --------- Total liabilities and shareholders' equity ...... $ 351,030 $ 338,528 ========= ========= See accompanying notes to consolidated financial statements 4 Abraxas Petroleum Corporation and Subsidiaries Consolidated Statements of Operations (Unaudited) Three Months Ended Nine Months Ended September 30 September 30 (In thousands except share and per share data) ============================================ 1998 1997 1998 1997 ======== ========= ========= ======== Revenue: Oil & gas production sales ................... $ 12,798 $ 14,376 $ 41,406 $ 46,920 Processing revenue ........................... 668 956 2,369 2,793 Rig revenues ................................. 112 144 350 250 Other ........................................ 221 227 1,884 728 -------- --------- --------- -------- 13,799 15,703 46,009 50,691 Operating costs and expenses: Lease operating and production taxes ......... 4,012 3,822 12,530 10,604 Gas processing costs ......................... 335 477 857 1,191 Depreciation, depletion and amortization ..... 8,826 6,385 26,049 19,780 General and administrative ................... 1,268 1,035 3,957 3,119 Rig Operations ............................... 123 82 381 214 -------- --------- --------- -------- 14,564 11,801 43,774 34,908 -------- --------- --------- -------- Operating Income ................................ (765) 3,902 2,235 15,783 Other (income) expense Interest income .............................. (110) (45) (418) (438) Interest expense ............................. 7,530 6,385 22,795 18,757 Amortization of deferred financing fees ...... 278 340 913 933 Other ........................................ -- (11) -- 115 -------- --------- --------- -------- 7,698 6,669 23,290 19,367 -------- --------- --------- -------- Income (loss) from operations before taxes ...... (8,463) (2,767) (21,055) (3,584) Income tax expense (benefit) Current ..................................... 124 41 208 156 Deferred .................................... (2,913) (724) (4,741) (1,227) Minority interest in income (loss) of consolidated foreign subsidiary .......... 121 (42) (50) 85 -------- --------- --------- -------- Net income (loss) ............................... (5,795) (2,042) (16,472) (2,598) Less dividend requirement on cumulative preferred stock ............................. -- -- -- (183) -------- --------- --------- -------- Net (loss) applicable to common stock ........... $ (5,795) $ (2,042) $(16,472) $ (2,781) ======== ========= ========= ======== Earnings (loss) per share: Net income (loss) per common share .......... $ (.92) $ (.33) $ (2.60) $ (.47) ======== ========= ========= ======== Net income (loss) per common share - assuming dilution ................. $ (.92) $ (.33) $ (2.60) $ (.47) ======== ========= ========= ======== See accompanying notes to consolidated financial statements 5 ABRAXAS PETROLEUM CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands except share amounts) Common Stock Treasury Stock Accumulated ------------------ -------- ---------Additional Other Paid-In Accumulated Comprehensive Shares Amount Shares Amount Capital Deficit Income(loss) Total --------- -------- -------- --------- --------- ------------ -------------- ----------- Balance at December 31, 1997 . 6,422,540 $ 63 53,023 $ 281 $ 51,118 $ (19,185) $ (4,902) $ 26,813 Comprehensive income (loss): Net Loss ................... (16,472) (16,472) Other comprehensive income: Foreign currency translation adjustment (6,108) (6,108) ----------- Comprehensive income (loss) (22,580) Issuance of common stock for Compensation ............... 4,838 (18,263) (94) 114 208 Stock options exercised ...... 3,000 16 Purchase of Treasury Stock ... 136,255 980 (980) ========== ===== ======== ======== ======= ========= ========== ========== Balance at September 30, 1998 6,430,378 $ 63 171,015 $ 1,167 $ 51,248 $ (35,657) $ (11,010) $ 3,477 ========== ===== ======== ======== ======= ========= ========== ========== See accompanying notes to consolidated financial statements 6 Abraxas Petroleum Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30 ===================== 1998 1997 ========= ========= (In Thousands) Operating Activities Net loss ............................................... $(16,472) $ (2,598) Adjustments to reconcile net income (loss) to net Cash provided by (used)by operating activities: Minority interest in income of foreign subsidiary .... (50) 85 Depreciation, depletion, and amortization ............ 26,049 19,780 Amortization of deferred financing fees .............. 913 933 Deferred income tax benefit .......................... (4,741) (1,227) Issuance of common stock for compensation ............ 207 310 Changes in operating assets and liabilities: Accounts receivable .................................. 3,254 3,404 Equipment inventory .................................. (126) 21 Other assets ......................................... 304 (18) Accounts payable and accrued expenses ................ 3,315 11,920 Oil and gas production payable ....................... (1,052) 32 -------- -------- Net cash provided by operating activities .............. 11,601 32,642 Investing Activities Capital expenditures, including purchases and development of properties .......................... (41,661) (44,604) Proceeds from sale of oil and gas producing properties ............................................. 272 8,978 -------- -------- Net cash used in investing activities .................. $(41,389) $(35,626) See accompanying notes to consolidated financial statements 7 Abraxas Petroleum Corporation and Subsidiaries Consolidated Statements of Cash Flows (continued) (Unaudited) Nine Months Ended September 30 ===================== 1998 1997 ========= ========= (In Thousands) Financing Activities Issuance of common stock ............................... $ 5,014 $ 11 Purchase of treasury stock ............................. (980) -- Dividends paid on preferred stock ...................... -- (182) Proceeds from long term borrowings ..................... 65,106 2,298 Premium from issuance of Senior Notes .................. 3,471 -- Payments on long-term borrowings ....................... (31,609) -- Increase in long term liabilities ...................... 202 156 Deferred financing fees ................................ (1,681) (30) -------- -------- Net cash provided (used) by financing activities ....... 39,523 2,253 Effect of exchange rate changes on cash ................ (1,303) -- -------- --------- Increase (decrease)in cash ............................. 8,432 (731) Cash at beginning of period ............................ 2,876 8,380 -------- --------- Cash at end of period, including restricted cash ....... $ 11,308 $ 7,649 ======== ========= Supplemental disclosures of cash flow information: Interest paid .......................................... $ 14,484 $ 12,594 =======- ========= See accompanying notes to consolidated financial statements 8 Abraxas Petroleum Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) September 30, 1998 Note 1. Basis of Presentation The accounting policies followed by Abraxas Petroleum Corporation and its subsidiaries (the "Company") are set forth in the notes to the Company's audited financial statements in the Annual Report on Form 10-K filed for the year ended December 31, 1997 which is incorporated herein by reference. Such policies have been continued without change. Also, refer to the notes to those financial statements for additional details of the Company's financial condition, results of operations, and cash flows. All the material items included in those notes have not changed except as a result of normal transactions in the interim, or as disclosed within this report. The consolidated financial statements have not been audited by independent accountants, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the financial position and results of operations. Any and all adjustments are of a normal and recurring nature. The consolidated financial statements include the accounts of the Company and its wholly owned foreign subsidiary Canadian Abraxas Petroleum Ltd. ("Canadian Abraxas"), and its 48% owned foreign subsidiary Grey Wolf Exploration, Inc. ("Grey Wolf"). Minority interest represents the minority shareholders' proportionate share of the equity and income of Grey Wolf. Canadian Abraxas and Grey Wolf assets and liabilities are translated to U.S. dollars at period-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the period. Translation adjustments are accumulated as a separate component of shareholders' equity. 9 Note 2. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 1998 1997 1998 1997 ------------ ------------ ------------ ------------ Numerator: Net income (loss) ....................... $ (5,795) $ (2,042) $ (16,472) $ (2,598) Preferred stock dividends ............... -- -- -- 183 ------------ ------------ ------------ ------------ Numerator for basic earnings per share-income(loss) available to common stockholders .................... (5,795) (2,042) (16,472) (2,781) Effect of dilutive securities: Preferred stock dividends ............. -- -- -- -- ------------ ------------ ------------ ------------ Numerator for diluted earnings per share-income available to common stockholders after assumed conversions . (5,795) (2,042) (16,472) (2,781) Denominator: Denominator for basic earnings per share - weighted-average shares ........... 6,322,370 6,271,707 6,323,361 5,920,135 Effect of dilutive securities: Stock options and warrants ............ -- -- -- -- Convertible preferred stock ........... -- -- -- -- ------------ ------------ ------------ ------------ -- -- -- -- ------------ ------------ ------------ ------------ Dilutive potential common shares Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions ........ 6,322,370 6,271,707 6,323,361 5,920,135 Basic earnings (loss) per share: Income (loss) ......................... $ (.92) $ (.33) $ (2.60) $ (.47) =========== ============ =========== ============ Diluted earnings (loss) per share: Income (loss) ......................... $ (.92) $ (.33) $ (2.60) $ (.47) ============ ============ =========== ============ For the three months and nine months ended September 30, 1998, none of the shares issuable in connection with stock options or warrants are included in diluted shares. For the three months and nine months ended September 30, 1997, shares issuable in connection with the conversion of preferred stock are also excluded from diluted shares. Inclusion of these shares would be antidilutive due to losses incurred. 10 Note 3. Summary Financial Information of Canadian Abraxas Petroleum Ltd. The following is summary financial information of Canadian Abraxas, a wholly owned subsidiary of the Company at September 30, 1998. Canadian Abraxas is jointly and severally liable with the Company for the entire balance of the Company's and Canadian Abraxas' 11.5% Senior Notes due 2004 (the "Notes") ($275,000,000), of which $84,612,000 was utilized by Canadian Abraxas in connection with the acquisition of Canadian Gas Gathering Systems, Inc ("CGGS"). The Company has not presented separate financial statements and other disclosures concerning Canadian Abraxas because management has determined that such information is not material to the holders of the Notes and the Company's Common Stock. Assets Liabilities and Shareholders Equity - - ------------------------------------ ---------------------------------------- (In Thousands) Total current assets $ 11,965 Total current liabilities $ 5,201 Oil and gas properties 91,548 11.5% Senior Notes due 2004 74,682 Other assets 3,522 Note payable to Abraxas -------- Petroleum Corporation 21,144 $ 107,035 Other liabilities 24,685 ======== Shareholder's equity (deficit) (18,677) --------- $ 107,035 ========= Three Months Nine Months September 30, September 30, 1998 1998 Revenues $ 3,806 $ 14,216 Operating costs & expenses 5,232 15,490 Interest expense 2,415 7,614 Income tax benefit (2,903) (4,544) -------- -------- Net loss $ (938) $ (4,344) ======== ======== Note 4. Contingencies In May 1995, certain plaintiffs filed a lawsuit against the Company alleging negligence and gross negligence, tortuous interference with contract, conversion and waste. In May 1998, a jury found against the Company in the amount of $1,332,000 plus attorney's fees and pre-judgment interest. On May 22, 1998 final judgment in the amount of $890,270 was entered. The Company has filed various post-judgment motions including a motion for judgment notwithstanding the verdict and a motion for new trial. Management believes, based on the advice of legal counsel, that the plaintiffs' claims are without merit and that damages should not be recoverable under this action; however, the ultimate effect on the Company's financial position and results of operations cannot be determined at this time. The Company has not established a reserve for this matter at September 30, 1998. Additionally, from time to time, the Company is involved in litigation relating to claims arising out of its operations in the normal course of business. At September 30, 1998, the Company was not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on the Company. 11 Note 5. Subsequent Event On November 12, 1998 the Company announced a definitive agreement to sell its natural gas producing properties in the Wamsutter area of southwestern Wyoming's Green River Basin. A partnership between a wholly-owned subsidiary of the Company and a third party will acquire the reserves for approximately $60.2 million cash. The Company will continue to operate the properties and retain an equity position in the partnership. The effective date of the transaction is October 1, 1998 and it is expected to close before November 30, 1998. Note 6. Reclassifications Certain balances for 1997 have been reclassified for comparative purposes. 12 ABRAXAS PETROLEUM CORPORATION AND SUBSIDIARIES PART I Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following is a discussion of the Company's financial condition, results of operations, liquidity and capital resources. This discussion should be read in conjunction with the consolidated financial statements of the Company and the notes thereto, included in the Company's Annual report on Form 10-K filed for the year ended December 31, 1997, which is incorporated herein by reference. Results of Operations The factors which most significantly affect the Company's results of operations are (1) the sales prices of crude oil and natural gas, (2) the level of total sales volumes of crude oil and natural gas, (3) the level of and interest rates on borrowings and (4) the level and success of exploration and development activity. Selected operating data. The following table sets forth certain operating data of the Company for the periods presented. Three Months Ended Nine Months Ended September 30 September 30 ----------------------------------------- 1998 1997 1998 1997 ------------------------------------------ Operating Revenue (in thousands): Crude Oil Sales ....................... $ 2,374 $ 4,282 $ 7,768 $ 13,383 Natural Gas Sales ..................... 9,082 7,709 28,699 25,557 Natural Gas Liquids Sales ............. 1,342 2,385 4,939 7,980 Processing Revenue .................... 668 956 2,370 2,793 Rig Operations ........................ 112 144 350 250 Other ................................. 221 227 1,883 728 -------- -------- -------- -------- $ 13,799 $ 15,703 $ 46,009 $ 50,691 ======== ======== ======== ======== Operating Income (loss) (in thousands) $ (765) $ 3,902 $ 2,235 $ 15,783 Crude Oil Production (MBBLS) .......... 178 242 565 712 Natural Gas Production (MMCFS) ........ 6,395 4,959 18,874 14,985 Natural Gas Liquids Production (MBBLS) 238 245 715 751 Average Crude Oil Sales Price ($/BBL) . $ 13.32 $ 17.69 $ 13.75 $ 18.79 Average Natural Gas Sales Price ($/MCF) $ 1.42 $ 1.55 $ 1.52 $ 1.71 Average Liquids Sales Price ($/BBL) ... $ 5.64 $ 9.73 $ 6.90 $ 10.63 Operating Revenue. During the first nine months of 1998, operating revenue from crude oil, natural gas and natural gas liquid sales decreased by 11.7% to $41.4 million as compared to $46.9 million for the same period of 1997. The decrease in revenue is due primarily to lower commodity prices. For the nine months ended September 30, 1998 the average sales prices were $13.75 per BBL of crude oil, $6.90 per BBL of natural gas liquid and $1.52 per MCF of natural gas compared to $18.79 per BBL of crude oil, $10.63 per BBL of natural gas liquid and $1.71 per MCF of natural gas in the same period of 1997. Lower prices negatively impacted revenue by $11.2 million for the nine month period, offset by $5.5 million, in increased revenue primarily as a result of increased natural gas volumes. Natural gas volumes increased 26% from 14,953 MMCFs for the first 13 nine months of 1997 to 18,874 MMCFs for the same period of 1998. The increased volumes are attributable to the Company's ongoing exploration and development program. Crude oil and natural gas liquids volumes declined 12.5% during the first nine months of 1998 to 1,280 MBBLs compared to 1,463 MBBLs for the same period of 1997. Crude oil volumes declined 20.15% to 565 MBBLs for the first nine months of 1998 from 712 MBBLs for the same period of 1997. The decline in crude oil volumes is the result of the de-emphasis of the Company's oil exploration and development, due to the dramatic decline in crude oil prices. Natural gas liquid volumes declined 4.7% to 715 MBBLs for the first nine months of 1998 compared to 751 MBBLs for the same period of 1997. The decline in natural gas liquids volumes is due to a decline in gas volumes in operating areas where the Company is processing gas. For the three months ended September 30, 1998, operating revenue from crude oil, natural gas and natural gas liquid sales decreased by 10.9% to $12.8 million compared to $14.4 million for the same period of 1997. The decrease in revenue is due primarily to lower commodity prices. For the three months ended September 30, 1998 the average sales prices were $13.32 per BBL of crude oil, $5.64 per BBL of natural gas liquid and $1.42 per MCF of natural gas compared to $17.69 per BBL of crude oil, $9.73 per BBL of natural gas liquid and $1.55 per MCF of natural gas in the same period of 1997. Lower prices negatively impacted revenue by $3.4 million for the three month period, offset by $1.8 million in increased revenue primarily as a result of increased natural gas volumes. Natural gas volumes increased 29% from 4,959 MMCFs for the first three months of 1997 to 6,395 MMCFs for the same period of 1998. The increased volumes are attributable to the Company's ongoing exploration and development program. Crude oil and natural gas liquids volumes declined 14.6% during the first three months of 1998 to 416 MBBLs compared to 487 MBBLs for the same period of 1997. Crude oil volumes declined 26.4% to 178 MBBLs for the first three months of 1998 from 242 MBBLs for the same period of 1997. The decline in crude oil volumes is the result of the de-emphasis of the Company's oil exploration and development program, due to the dramatic decline in crude oil prices. Natural gas liquid volumes declined 2.8% to 238 MBBLs for the first three months of 1998 compared to 245 MBBLs for the same period of 1997. The decline in natural gas liquids volumes is due to a decline in gas volumes in operating areas where the Company is processing gas. Lease Operating Expenses. Lease operating expenses ("LOE") and natural gas processing costs for the nine months ended September 30, 1998 increased to $13.4 million compared to $11.8 million for the same period in 1997. The Company's LOE on a per MCFE basis for the nine months ended September 30, 1998 was $0.47 compared to $0.45 for the same period of 1997. The increase in LOE was primarily due to the greater number of wells owned by the Company during the period ended September 30, 1998 compared to the same period of 1997. The increase on a per MCFE basis is due to a general increase in the cost of services from 1997 to 1998. For the three months ended September 30, 1998 LOE and natural gas processing cost remained constant at $4.3 million. For the three month period LOE on a per MCFE basis was $0.45 compared to $0.48 for the same period of 1997. The decrease on a MCFE basis for the three month period was primarily due to a general decrease in the cost of services from 1997 to 1998, as a result of decreased demand caused by the continued weakness in commodity prices. G&A Expenses. G&A expenses for the first nine months of 1998 increased to $3.9 million compared to $3.1 million for the same period of 1997. G&A expense on a per MCFE basis increased from $0.13 for the nine months September 30, 1997 to $0.15 for the same period of 1998 The increase was primarily due to the hiring of additional staff to manage and develop the Company's properties. For the three months ended September 30, 1998 G&A expense increased to $1.3 million compared to $1.0 million for the same period of 1997. G&A expense on a per MCFE basis remained constant at $0.13 for the quarter ended September 30, 1998 compared to the same period of 1997. Depreciation, Depletion and Amortization Expenses. Depreciation, depletion and amortization ("DD&A") expense increased by $6.3 million to $26.0 million for the first nine months of 1998 from $19.8 million in the same period of 1997. The Company's DD&A on a per MCFE basis for the nine months ended September 30, 1998 was $0.98 per MCFE compared to $0.83 in 1997. For the three months ended 14 September 30, 1998 DD&A increased $2.4 million to $8.8 million compared to $6.4 million for the same period of 1997. DD&A on a per MCFE basis for the three month period of 1998 was $0.99 compared to $0.81 for the same period of 1997. The per MCFE increase was due to higher finding costs added to the full cost pool in 1997 and the loss of liquids reserves at September 30, 1998 resulting from low commodity prices forcing some of the Company's oil properties to their economic limits much sooner. Interest Expense and Preferred Dividends. Interest expense and preferred dividends ("Interest and Dividends") increased to $22.8 million for the first nine months of 1998 from $18.9 million for the same period of 1997. For the three months ended September 30, 1998 interest expense increased from $6.4 million to $7.5 million. Long-term debt increased from $217.3 million at September 30, 1997 to $282.2 million at September 30, 1998, as a result of the Company's issuing an additional $60.0 million of its 11.5% Senior Notes due 2004, Series C ("Series C Notes") in January 1998. Preferred dividends were eliminated on July 1, 1997 as the result of the conversion of all outstanding preferred stock into Abraxas Common Stock. General . The Company's revenues, profitability and future rate of growth are substantially dependent upon prevailing prices for crude oil and natural gas and the volumes of crude oil, natural gas and natural gas liquids produced by the Company. The prices of natural gas, crude oil and natural gas liquids received by the Company declined during the first nine months of 1998. The average natural gas price realized by the Company declined to $1.52 per MCF during the first nine months of 1998 compared with $1.71 per MCF during the same period of 1997. Crude oil prices declined from a realized average of $18.79 per BBL during the first nine months of 1997, to a realized average of $13.75 per BBL for the same period of 1998. Natural gas liquids prices declined to a realized average of $6.90 per BBL compared to a realized average of $10.63 per BBL in the first nine months of 1997. In addition, the Company's proved reserves will decline as crude oil, natural gas and natural gas liquids are produced unless the Company is successful in acquiring properties containing proved reserves or conducts successful exploration and development activities. In the event crude oil, natural gas and natural gas liquids prices remain at depressed levels or decline further or if the Company's production levels decrease, the Company's revenues, cash flow from operations and profitability will be adversely affected. Liquidity and Capital Resources General: Capital expenditures excluding property divestitures during the nine months ended September 30, 1998 were $41.6 million compared to $44.6 million during the same period of 1997. The table below sets forth the components of these capital expenditures on a historical basis for the nine months ended September 30, 1998 and 1997. Nine Months Ended September 30 --------------------------- 1998 1997 -------------- ------------ Expenditure category (in thousands): Acquisitions $ 2,400 $ 2,067 Development 35,475 41,980 Facilities and other 3,786 557 =========== =========== Total $ 41,661 $ 44,604 =========== =========== At September 30, 1998, the Company had current assets of $81.1 million and current liabilities of $27.3 million resulting in working capital of $53.8 million. This compares to a working capital deficit of $9.2 million at December 31, 1997 and working capital of $9.6 million at September 30, 1997. The material components of the Company's current assets are cash $11.3 million, accounts receivable of $9.0 million and property held for sale of $60.2 million. Property held for sale represents the reclassification of oil and gas properties that are subject to a definitive agreement to sell. The agreement to sell these properties was announced by the Company on November 12, 1998. The Company will receive $60.2 million for the properties upon closing of the transaction, expected to be before November 30, 1998. The material components of the Company's current liabilities at September 30, 1998 include trade accounts payable of $9.5 million, revenues due third parties of $3.3 million and accrued interest of $13.3 million. 15 Operating activities during the nine months ended September 30, 1998 provided $11.6 million cash to the Company compared to providing $14.9 million in the same period in 1997. Net income plus non-cash expense items during 1998 and net changes in operating assets and liabilities accounted for most of these funds. Investing activities required $41.3 million net during the first nine months of 1998, primarily utilized for the development of crude oil and natural gas properties and other facilities. This compares to $24.9 million required during the same period of 1997. $24.6 million was utilized for the development of crude oil and natural gas properties and other facilities. Financing activities provided $39.5 million for the first nine months of 1998 compared to $3.3 million for the same period of 1997. Financing activities include $60 million proceeds from the sale of the Series C Notes in January 1998 and the corresponding premium associated with the Series C Notes, the net proceeds from the sale of the Series C Notes were used in part to repay the outstanding indebtedness under the Company's Credit Facility ("Credit Facility"), except for $100,000 that remains outstanding. In August 1998, the Company's 48% owned Canadian subsidiary, Grey Wolf, completed a 50 million common share private placement offering raising $16 million CDN. The Company subscribed to 50% of the issue in order to maintain its ownership position in Grey Wolf. Proceeds from the offering, combined with Grey Wolf's existing bank line of credit were used to complete the acquisition of certain oil and gas properties from the Company's 100% owned Canadian subsidiary, Canadian Abraxas, for $21.75 million CDN. Upon completion of the offering and after all intercompany transactions the Company netted approximately $10 million US which will be used to partially fund budgeted capital expenditures for the balance of 1998. The Company's current budget for capital expenditures for the last three months of 1998 other than acquisition expenditures is approximately $12 million. Such expenditures will be made primarily for the development of existing properties. Additional capital expenditures may be made for acquisitions of producing properties if such opportunities arise, but the Company currently has no agreements, arrangements or undertakings regarding any material acquisitions. The Company has no material long-term capital commitments and is consequently able to adjust the level of its expenditures as circumstances dictate. Additionally, the level of capital expenditures will vary during future periods depending on market conditions and other related economic factors. Should commodity prices remain at depressed levels or decline further, reductions in the capital expenditure budget may be required. The Company will have three principal sources of liquidity during the next six months: (i) cash on hand, (ii) borrowing capacity under the Company's revolving credit facility and (iii) cash flow from operations. While the availability of capital resources cannot be predicted with certainty and is dependent upon a number of factors including factors outside of management's control, management believes that the net cash flow from operations plus availability under the Credit Facility will be adequate to fund operations and planned capital expenditures. The Company may also sell additional equity or debt securities or additional non-strategic assets in order to fund operations and planned capital expenditures as well as to finance future acquisitions. Long-Term Indebtedness: The Credit Facility has an availability of approximately $37.9 million. As of September 30, 1998 there was $100,000 outstanding under the Credit Facility. The Credit Facility contains a number of covenants that, among other things, restricts the ability of the Company to (I) incur certain indebtedness or guarantee obligations, (ii) prepay other indebtedness including the Notes, (iii) make investments, loans or advances, (iv) create certain liens, (v) make certain payments, dividends and distributions, (vi) merge with or sell assets to another person or liquidate, (vii) sell or discount receivables, (viii) engage in certain intercompany transactions and transactions with affiliates, (ix) change its business, (x) experience a change of control and (xi) make amendments to its charter, by-laws and other debt instruments. In addition, under the Credit Facility, the Company is required to comply with specified financial ratios and tests, including interest coverage ratios, maximum funded debt to EBITDA tests, minimum net worth tests and minimum working capital tests. As of September 30, 1998, the Company was in compliance with the requirements of the credit facility. 16 The Credit Facility contains customary events of default, including nonpayment of principal, interest or fees, violation of covenants, inaccuracy of representations or warranties in any material respect, cross default and cross acceleration to certain other indebtedness, bankruptcy, material judgments and liabilities and change of control. The Indenture (as defined below) also contains a number of covenants and events of default including covenants restricting, among other things, the Company's and Canadian Abraxas' ability to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments, consummate certain asset sales, enter into certain transactions with affiliates, merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the assets of the Company and events of default including nonpayment of principal or interest on the Notes, violation of covenants, cross default on other indebtedness, bankruptcy and material judgments. Commitments available under the Credit Facility are subject to borrowing base redetermination to be performed semi-annually and, at the option of each of the Company and the lenders under the Credit Facility (the "Banks"), one additional time per year. Any outstanding principal balance in excess of the borrowing base will be due and payable in three equal monthly payments after a borrowing base redetermination. The borrowing base will be determined in the sole discretion of Bankers Trust Company ("BT"), subject to the approval of the Banks, based on the value of the Company's reserves as set forth in the reserve report of the Company's independent petroleum engineers, with consideration given to other assets and liabilities. The Credit Facility has an initial revolving term of two years (which expires in November 1998) and a reducing period of three years from the end of the initial two-year period. The commitment under the Credit Facility will be reduced during such reducing period by eleven equal quarterly reductions. Quarterly reductions will equal 8.2% per quarter with the remainder due at the end of the three-year reducing period. The applicable interest rate charged on the outstanding balance of the Credit Facility is based on a facility usage grid. If the borrowings under the Credit Facility represent an amount less than or equal to 33.3% of the available borrowing base, then the applicable interest rate charged on the outstanding balance will be either (a) an adjusted rate of the London Inter-Bank Offered Rate ("LIBOR") plus 1.25% or (b) the prime rate of BT (which is based on BT's published prime rate) plus 0.50%. If the borrowings under the Credit Facility represent an amount greater than or equal to 33.3% but less than 66.7% of the available borrowing base, then the applicable interest rate on the outstanding principal will be either (a) LIBOR plus 1.75% or (b) the prime rate of BT plus 0.50%. If the borrowings under the Credit Facility represent an amount greater than or equal to 66.7% of the available borrowing base, then the applicable interest rate on the outstanding principal will be either (a) LIBOR plus 2.00% or (b) the prime rate of BT plus 0.50%. LIBOR elections can be made for periods of one, three or six months. On November 14, 1996, the Company and Canadian Abraxas completed the sale of $215.0 million aggregate principal amount of Senior Notes due November 1, 2004, Series A which were exchanged for the Company's and Canadian Abraxas' 11.5% Senior Notes due 2004 Series B, (the "Series B Notes") in February 1997. In January 1998, the Company and Canadian Abraxas completed the sale of $60 million aggregate principal amount of Series C Notes. The Series B notes and the Series C Notes were exchanged for the Series D Notes ("the Notes") in June 1998. The Series D Notes are joint and several obligations of Abraxas and Canadian Abraxas. The indenture governing the Notes (the "Indenture") provides, among other things, that the Company may not, and may not cause or permit certain of its subsidiaries, including Canadian Abraxas, to, directly or indirectly, create or otherwise cause to permit to exist or become effective any encumbrance or restriction on the ability of such subsidiary to pay dividends or make distributions on or in respect of its capital stock, make loans or advances or pay debts owed to Abraxas, guarantee any indebtedness of Abraxas or transfer any of its assets to Abraxas except for such encumbrances or restrictions existing under or by reason of: (i) applicable law; (ii) the Indenture; (iii) the Credit Facility; (iv) customary non-assignment provisions of any contract or any lease governing leasehold interests of such subsidiaries; (v) any instrument governing indebtedness assumed by the Company in an acquisition, which encumbrance or 17 restriction is not applicable to such subsidiaries or the properties or assets of such subsidiaries other than the entity or the properties or assets of the entity so acquired; (vi) customary restrictions with respect to subsidiaries of the Company pursuant to an agreement that has been entered in to for the sale or disposition of capital stock or assets of such subsidiaries to be consummated in accordance with the terms of the Indenture solely in respect of the assets or capital stock to be sold or disposed of; (vii) any instrument governing certain liens permitted by the Indenture, to the extent and only to the extent such instrument restricts the transfer or other disposition of assets subject to such lien; or (viii) an agreement governing indebtedness incurred to refinance the indebtedness issued, assumed or incurred pursuant to an agreement referred to in clause (ii), (iii) or (v) above; provided, however, that the provisions relating to such encumbrance or restriction contained in any such refinancing indebtedness are no less favorable to the holders of the Notes in any material respect as determined by the Board of Directors of the Company in their reasonable and good faith judgment than the provisions relating to such encumbrance or restriction contained in the applicable agreement referred to in such clause (ii), (iii) or (v). Hedging Activities: In August 1995, the Company entered into a rate swap agreement with a previous lender relating to $25.0 million of principal amount of outstanding indebtedness. This agreement was assumed by the Banks in connection with a Bridge Facility that was subsequently paid off. Under the agreement, the Company pays a fixed rate of 6.15% while the Banks will pay a floating rate equal to the USD-LIBOR-BBA rate for one month maturities, quoted on the eighteenth day of each month, to the Company. Settlements are due monthly. The agreement terminated in August 1998. In March 1998 the Company entered into a costless collar relating to 2,000 barrels a day of oil sales for the period April 1, 1998 through March 31, 1999. The agreement is tied to NYMEX prices. The Company is paid the difference between the average NYMEX price and $14.00 per barrel, when the average NYMEX price for the month is less than $14.00 per barrel. The Company must remit to the counterparty to the agreement the difference in the average NYMEX price during the month and $22.30 per barrel when the average NYMEX price exceeds $22.30 per barrel. Net Operating Loss Carryforwards. At December 31, 1997, the Company had, subject to the limitations discussed below, $25.1 million of net operating loss carryforwards for U.S. tax purposes, of which approximately $22.4 million may be utilized before it expires. These loss carryforwards will expire from 2002 through 2010 if not utilized. At December 31, 1997, the company had approximately $2.9 million of net operating loss carryforwards for Canadian tax purposes which expire in 2003 and 2004. As a result of the acquisition of certain partnership interests and crude oil and natural gas properties in 1990 and 1991, an ownership change under Section 382 of the Internal Revenue Code 1986, as amended (Section 382), occurred in December 1991. Accordingly, it is expected that the use of net operating loss carryforwards generated prior to December 31, 1991 of $4.9 million will be limited to approximately $235,000 per year. As a result of the issuance of additional shares of Common Stock for acquisitions and sales of stock, an additional ownership change under Section 382 occurred in October 1993. Accordingly, it is expected that the use of all U.S. net operating loss carryforwards generated through October 1993 or $8.2 million will be limited to approximately $1 million per year subject to the lower limitations described above. Of the $8.2 million net operating loss carryforwards, it is anticipated that the maximum net operating loss that may be utilized before it expires is $5.7 million. Future changes in ownership may further limit the use of the Company's carryforwards. In addition to the Section 382 limitations, uncertainties exist as to the future utilization of the operating loss carryforwards under the criteria set forth under FASB Statement No. 109. Therefore, the Company has established a valuation allowance of $5.7 million and $5.9 million for deferred tax assets at December 31, 1996 and 1997, respectively. Based upon the current level of operations, the Company believes that cash on hand, cash flow from operations and the Company's credit facility, will be adequate to meet its anticipated requirements for working capital, capital expenditures and scheduled interest payments through 1998. Continued depressed 18 prices for natural gas, crude oil or natural gas liquids will have a material adverse effect on the Company's cash flow from operations and anticipated levels of working capital, and could force the Company to revise its planned capital expenditures. Year 2000. The Company is assessing the impact of the Year 2000 issue on its operations, including the development and implementation of project plans and cost estimates required to make its information system infrastructure Year 2000 compliant. Based on existing information, the Company believes that anticipated spending necessary to become Year 2000 compliant will not have a material effect on the financial position, cash flows or results of operations of the Company, nor will the Year 2000 issues cause any material adverse effect on the future business operations of the Company. There can be no assurance, however, as to the ultimate effect of the Year 2000 issue on the Company. 19 Disclosure Regarding Forward-Looking Information This report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical facts included in this report regarding the Company's financial position, business strategy, budgets and plans and objectives of management for future operations are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Company's expectations ("Cautionary Statements") are disclosed under "Risk Factors" in the Company's Annual Report on Form 10-K which is incorporated by reference herein and this report. All subsequent written and oral forward-looking statements attributable to the Company, or persons acting on its behalf, are expressly qualified in their entirety by the Cautionary Statements Cautionary 20 ABRAXAS PETROLEUM CORPORATION AND SUBSIDIARIES PART II OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K None 21 ABRAXAS PETROLEUM CORPORATION AND SUBSIDIARIES 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. ABRAXAS PETROLEUM CORPORATION (Registrant) Date: 11/16/98 By:/s/ ROBERT L.G. WATSON, President and Chief Executive Officer Date: 11/16/98 By:/s/ CHRIS WILLIFORD, Executive Vice President and Principal Accounting Officer 22