UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-52263*
MICHAEL PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
Texas 76-0510239
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
13101 Northwest Freeway
Suite 320
Houston, Texas 77040
(Address of principal executive offices including zip code)
(713) 895-0909
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of May 15, 2000, there were 10,000 shares of the Registrant's Common Stock,
par value $0.10 per share, outstanding.
* The Commission File Number refers to a Form S-4 Registration Statement filed
by the Registrant under the Securities Act of 1933 which was declared effective
on July 22, 1998.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICHAEL PETROLEUM CORPORATION
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2000 1999
----------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 2,666 $ 855
Accounts receivable 8,848 8,742
Note receivable 135 135
Prepaid expenses and other 1,033 1,375
----------- ------------
Total current assets 12,682 11,107
Oil and gas properties, (successful efforts method) at cost 184,139 181,126
Less: accumulated depreciation, depletion and amortization (50,426) (46,769)
----------- ------------
133,713 134,357
Other assets 4,021 4,347
----------- ------------
TOTAL ASSETS $150,416 $149,811
=========== ============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Liabilities Not Subject to Compromise:
Current liabilities:
Accounts payable: $ 5,265 $ 3,023
Accrued liabilities 570 240
Credit Facility and other 24,386 24,348
----------- ------------
Total current liabilities not subject to compromise 30,221 27,611
Liabilities Subject to Compromise:
Accounts payable 2,526 6,029
Accrued liabilities 11,620 10,717
Senior Notes 133,119 133,053
----------- ------------
Total current liabilities subject to compromise 147,265 149,799
Commitments and contingencies
Stockholder's deficit:
Preferred stock ($.10 par value, 50,000,000 shares authorized,
no shares issued and outstanding) - -
Common stock ($.10 par value, 100,000,000 shares
authorized, 10,000 shares issued and outstanding) 1 1
Additional paid-in capital 610 610
Accumulated deficit (27,681) (28,210)
----------- ------------
Total stockholder's deficit (27,070) (27,599)
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDER'S DEFICIT $150,416 $149,811
=========== ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
2
MICHAEL PETROLEUM CORPORATION
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
------------------
2000 1999
------- -------
Revenues
Oil and natural gas sales $ 7,566 $ 7,019
Operating expenses:
Production costs 1,301 1,353
Exploration 17 48
Depreciation, depletion and
amortization 3,672 3,654
Reorganization costs 560 -
General and administrative 487 478
------- -------
6,037 5,533
------- -------
Operating income 1,529 1,486
------- -------
Other income (expense):
Interest income and other 16 73
Interest expense and other (1,016) (3,997)
------- -------
(1,000) (3,924)
------- -------
Income (loss) before income taxes 529 (2,438)
Income tax expense - -
------- -------
Net Income (loss) $ 529 $(2,438)
======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
3
MICHAEL PETROLEUM CORPORATION
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
------------------
2000 1999
------- -------
Cash flows from operating activities:
Net income (loss) $ 529 $(2,438)
Adjustments to reconcile net loss to
Net cash provided by operating activities:
Depreciation, depletion and amortization 3,672 3,654
Amortization of debt issuance costs 204 204
Amortization of deferred loss on early termination
of commodity swap agreements 897 175
Amortization of discount of debt 67 60
Changes in operating assets and liabilities:
Accounts receivable (106) 12
Prepaid expenses and other (388) 64
Accounts payable (865) (279)
Accrued liabilities 1,234 3,775
------- -------
Net cash provided by operating activities 5,244 5,227
------- -------
Cash flows from investing activities:
Additions to oil and natural gas properties (3,425) (8,435)
------- -------
Net cash used in investing activities (3,425) (8,435)
------- -------
Cash flows from financing activities:
Proceeds from long-term debt - 11,000
Payments on long-term debt (8) (39)
------- -------
Net cash (used in) provided by financing activities (8) 10,961
------- -------
Net increase in cash and cash equivalents 1,811 7,753
Cash and cash equivalents, beginning of period 855 430
------- -------
Cash and cash equivalents, end of period $ 2,666 $ 8,183
======= =======
Non-cash transactions:
Changes in accounts payable related to capital expenditures $ (398) $ 2,543
Issuance of short-term note payable for financing of
insurance costs 45 145
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
4
MICHAEL PETROLEUM CORPORATION
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Michael Petroleum Corporation, a Texas corporation (the "Company"), is a
wholly owned subsidiary of Michael Holdings, Inc. ("MHI"), a Texas
corporation. The consolidated financial statements included herein have
been prepared by the Company and are unaudited, and do not contain all
information required by generally accepted accounting principles. In the
opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary to present fairly the results
of operations have been included. Due to seasonal fluctuations, the results
of operations for the interim periods are not necessarily indicative of
operating results for the entire fiscal year. The consolidated financial
statements in this Form 10-Q should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
2. CHAPTER 11 BANKRUPTCY FILING AND LIQUIDITY
Effective December 10, 1999, the Company, MHI and certain of its
subsidiaries entered into a Voting Agreement with certain holders of the
Company's Senior Notes for a consensual joint plan of reorganization of the
Company. The terms of the Voting Agreement contemplated that the joint plan
of reorganization would provide for a sale of the Company or its assets in
court-supervised proceedings under the Bankruptcy Code. The Voting
Agreement also contemplated that the Company and its subsidiaries would
continue to operate as debtors-in-possession subject to the supervision of
the Bankruptcy Court, and that the joint plan of reorganization would
provide for the payment of all trade creditors' claims as and when they
come due in the ordinary course or in full on the effective date of the
joint plan of reorganization.
On December 10, 1999, the Company, MHI and one of its subsidiaries filed
petitions for relief under Chapter 11 of the Bankruptcy Code in the United
States Bankruptcy Court for the Southern District of Texas, Laredo Division
(the "Bankruptcy Court"). The bankruptcy petitions were filed in order to
give the Company an opportunity to conserve its cash and restructure its
debt. Since December 10, 1999, the Company, MHI and the filing subsidiary
have operated as debtors-in-possession under the Bankruptcy Code. The
Company has curtailed its developmental drilling program, and limited
expenditures to a one-rig drilling program. No trustee or examiner has been
appointed and the Company, MHI and these subsidiaries are paying their
post-petition obligations (except those subject to Bankruptcy Court
approval) as they become due.
The Voting Agreement provided that the obligations of the parties thereto
may terminate upon a "Termination Event," which included any failure under
the marketing process to timely achieve certain milestones, including the
receipt of at least one final bid by March 17, 2000 in an amount equal to
at least $120 million, as adjusted for certain costs and working capital
items. Although the Company received several bids, as of March 17, 2000,
the Company had not received a final bid in such an amount sufficient to
meet this requirement.
The Company filed a Joint Plan of Reorganization (the "Plan of
Reorganization") and related disclosure statement with the Bankruptcy Court
on April 26, 2000. The Plan of Reorganization, if approved by the
Bankruptcy Court, provides for the sale of the reorganized Company's stock
to a limited liability company.
The accompanying financial statements have been prepared on a going concern
basis which contemplates continuity of operations, realization of assets
and liquidation of liabilities in the ordinary course of business. As a
result of the bankruptcy filing and related events, there is no assurance
that the carrying amounts of assets will be realized or that liabilities
will be liquidated or settled for the amounts recorded. The Plan of
Reorganization, and any modification or rejection thereof, could change the
amounts reported in the financial statements. The ability of the Company to
continue as a going concern is dependent upon confirmation of the Plan of
Reorganization, adequate sources of capital and the ability to sustain
positive results of operations and cash flows sufficient to continue to
explore for and develop oil and gas reserves.
5
In the ordinary course of business, the Company makes substantial capital
expenditures for the exploration and development of oil and natural gas
reserves. Historically, the Company has financed its capital expenditures,
debt service and working capital requirements with cash flow from
operations, public offerings of debt and a senior credit facility. Cash
flow from operations is sensitive to the prices the Company receives for
its oil and natural gas. A reduction in planned capital spending or an
extended decline in oil and gas prices could result in less than
anticipated cash flow from operations, which would likely have a further
material adverse effect on the Company.
Management's plan is to continue based on the Plan of Reorganization filed
with the Bankruptcy Court on April 26, 2000. In addition to the approval of
the Bankruptcy Court, the consummation of the Plan of Reorganization will
be subject to the consent of the requisite number and amount of certain of
the Company's creditors. At this time, it is not possible to predict the
outcome of the bankruptcy proceedings, or the effect on the Company's
business or on the claims and interests of its creditors, royalty owners or
stockholders or whether certain executory contracts will be assumed or
rejected. As a result of the bankruptcy filing, certain of the Company's
liabilities are subject to compromise. Through March 31, 2000, the Company
has incurred reorganization expenses of approximately $1.3 million, of
which approximately $721,000 was incurred during the year ended December
31, 1999, consisting of legal, professional and other fees. At March 31,
2000, approximately $458,000 of reorganization costs were unpaid and
reflected in accrued liabilities (subject to compromise).
3. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which is effective for
fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. It also requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those items at fair value. If certain conditions are met, a
derivative may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency-dominated
forecasted transaction. For a derivative designated as hedging the exposure
to variable cash flows of a forecasted transaction (referenced to as a cash
flow hedge), the effective portion of the derivative gain or loss is
initially reported as a component of other comprehensive income (outside
earnings) and subsequently reclassified into earnings when the forecasted
transaction affects earnings. The ineffective portion of the gain or loss
is reported in earnings immediately. The extent of the impact of adopting
SFAS 133 on the Company's financial position, results of operations, or
cash flows will be a function of the open derivative contracts at the date
of adoption. As of March 31, 2000, the Company can not estimate the impact
of SFAS 133 on its future consolidated financial position, results of
operations or cash flows.
4. DEFERRED INCOME TAXES
Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes,
and (b) operating loss carryforwards. At December 31, 1999, the Company had
a net operating loss carryforward of approximately $30.6 million.
Realization of deferred tax assets associated with the net operating loss
carryforward is dependent upon generating sufficient taxable income prior
to their expiration. The status of the Company's current and future
drilling activities and uncertainty about the availability of capital
resulted in uncertainty as to whether sufficient taxable income will be
available to utilize the entire net operating loss carryforward. Therefore,
a valuation allowance totaling $7.2 million was established at December 31,
1999 to provide for the portion of the net operating loss carryforward
which may not be realized. As discussed in Note 2, the Company has filed
for bankruptcy under Chapter 11 of the Bankruptcy Code. A reorganization of
the Company may result in a significant stock ownership change which would
significantly affect the timing of the utilization of the net operating
loss carryforward. The valuation allowance related to tax assets could be
further adjusted in the future if such restructuring were to occur, as well
as changes in estimates of future taxable income.
6
At March 31, 2000, the net operating loss carryforward and related
valuation allowance were reduced by the deferred tax liabilities created
during the three months ended March 31, 2000 as a result of the tax effect
of the earnings generated by the Company which amounted to approximately
$180,000. This resulted in no income tax expense for the three months ended
March 31, 2000.
5. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On December 10, 1999, the Company, MHI, and one of its subsidiaries filed
petitions for relief under Chapter 11 of the Bankruptcy Code in order to
facilitate the restructuring of the Company's liabilities. The Company
continues to operate as a debtor-in-possession subject to the Bankruptcy
Court's supervision and orders. The filing was made in the U.S. Bankruptcy
Court for the Southern District of Texas, Laredo Division. On April 26,
2000, the Company and its affiliated debtors filed the Plan of
Reorganization which would effectuate a sale of stock of the Reorganized
Company to a limited liability company. A hearing on the Debtors' Joint
Disclosure Statement is set for May 31, 2000.
On March 27, 2000, the Company received a demand letter from counsel for
certain royalty owners under the Schwarz and Rottersman Leases, challenging
certain deductions made by the Company in calculating prices for royalty
payments and demanding that unless the alleged underpayments of royalties
be cured within sixty (60) days, the royalty owners could seek to have the
Bankruptcy Court declare the Leases terminated. The March 27, 2000 letter
specifically relates to alleged post-petition claims. The Company conducted
an investigation of the allegations contained in the letter and believes it
has substantial defenses to these claims.
On April 28, 2000, the Company received a second demand letter from counsel
for the royalty owners demanding and alleging that the Company (i)
commission an independent accounting to determine the alleged underpaid
royalty amounts; (ii) cease and desist paying to third parties the proceeds
attributable to the royalty owners' royalties; and (iii) pay royalties to
the royalty owners in accordance with the market value of the natural gas.
The royalty owners further threatened that if the Company did not cure
these alleged defaults under the Schwarz and Rottersmann Leases within 60
days following receipt of notice, the Company may forfeit the Schwarz and
Rottersmann Leases. The April 28, 2000 letter specifically relates to
alleged pre-petition claims.
On April 28, 2000, the royalty owners filed two proofs of claim in the
Bankruptcy cases in the amount of $30 million and $400,000, respectively.
The basis for each claim is the Company's alleged unauthorized deduction of
post-production costs from the royalties paid to the royalty owners prior
to the filing of the bankruptcy petitions.
The Company believes it has numerous defenses to the allegations contained
in the April 28, 2000 and March 27, 2000 letters, as well as certain claims
against the royalty owners. On April 27, 2000, the Company filed a
declaratory judgment adversary proceeding in the Bankruptcy Court seeking a
determination by the Bankruptcy Court that no additional royalty payments
are owed to the royalty owners. The Company plans to seek to protect itself
from any possible lease termination claim by (i) paying directly to the
royalty owners the post-petition amount claimed to be owed (approximately
$50,000), (ii) paying into the registry of the Court the liquidated amount
of the pre-petition claims in cash (approximately $500,000) which will
remain on deposit until the litigation is finally resolved, and (iii)
seeking to enjoin the royalty owners from attempting to send notice of
default on the pre-petition claim, thereby preventing the 60-day cure
period from running.
On May 10, 2000, the Company filed its First Amended Complaint in the
Declaratory Judgment Action adding two additional causes of action: (i) an
objection to both proofs of claim filed by the royalty owners, including a
claim for bad faith filing with respect to the $30 million claim, and (ii)
a cause of action for sanctions for violation of the automatic stay in
respect of the April 27, 2000 Notice. While the Company's investigation
into these claims is in the early phases, the Company currently believes
that the total liquidated amount of these claims will be significantly less
than the claims asserted by the royalty owners.
7
On March 31, 2000, the Company received correspondence from counsel to the
Official Committee of Unsecured Creditors requesting the Company to take
legal action on behalf of the Company's Estate against Glenn D. Hart,
Michael G. Farmar and the directors of Company, alleging certain
misstatements in connection with the issuance of the Senior Notes and
certain breaches of fiduciary duties to the creditors. The Company
investigated these allegations and determined there was no basis for their
assertion. The Company has responded to the Committee in writing indicating
that it found no basis for the allegations and would not be asserting such
claims at this time, but agreeing to reconsider the issues raised in the
event the Committee discovered additional facts which might support its
allegations.
EMPLOYEE RETENTION PLAN
On March 27, 2000, the Bankruptcy Court approved an Employee Retention
Bonus Plan. Under the terms of the Employee Retention Bonus Plan, eligible
employees are entitled to a bonus equal to three months salary if the
employee remains employed with the Company through the effective date of
the Plan of Reorganization. The estimated cost of the Employee Retention
Bonus Plan is approximately $400,000.
6. HEDGING ACTIVITIES
In January 2000, a third party terminated the Company's remaining open
hedge contracts as of December 31, 1999. The third party is seeking a claim
of approximately $450,000 as a result of the termination of these
contracts. The Company does not concur with the third party's calculation
of the amount of the claim.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain
significant factors that have affected certain aspects of the Company's
financial position and operating results during the periods included in the
accompanying unaudited condensed consolidated financial statements. For
supplemental information, it is suggested that this Item 2 be read in
conjunction with the corresponding section included in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999 (the "1999 Form
10-K") as filed with the Securities and Exchange Commission.
GENERAL
The Company is an independent energy company engaged in the
acquisition, development and production of oil and natural gas, principally in
the Lobo Trend of South Texas. The Company began operations in 1983, and, since
its inception, increased its reserve base and production as a result of
acquisitions and development of oil and natural gas properties. In March and
April 1998, the Company completed acquisitions adding approximately 51,000 gross
acres (48,400 net acres) in the Lobo Trend for an aggregate purchase price of
approximately $90.0 million. In December 1999, the Company, MHI, and one of its
subsidiaries filed petitions for relief under Chapter 11 of the Bankruptcy Code.
For the three months ended March 31, 2000, the Company participated in the
drilling of 3 gross (2 net) natural gas wells, 3 gross (2 net) of which were
completed as productive wells, compared to 8 gross (7 net) natural gas wells
drilled, and 5 gross (5 net) completed in the same period of 1999.
From April 1, 2000 through May 15, 2000, the Company participated in
the drilling of 4 gross (2 net) natural gas wells, of which one was completed,
one was in the process of being completed, and two were still drilling.
The Company utilizes the "successful efforts" method of accounting for
its oil and natural gas activities as described in Note 1 of the Notes to
Consolidated Financial Statements in the Company's 1999 Form 10-K.
RESULTS OF OPERATIONS
The following table summarizes production volumes, average sale prices
and operating revenues for the Company's oil and natural gas operations for the
three months ended March 31, 2000 and 1999:
8
THREE MONTHS
ENDED MARCH 31,
--------------------------
2000 1999
------------ ----------
Production volumes:
Oil and condensate (MBbls) 20 25
Natural gas (Mmcf) 3,030 3,349
Average sales prices:
Oil and condensate (per Bbl) $26.65 $10.92
Natural gas (per Mcf) 2.32 2.01
Operating revenues ($ 000's):
Oil and condensate $ 533 $ 278
Natural gas 7,033 6,741
------------ ----------
Total $7,566 $7,019
============ ==========
COMPARISON OF THREE MONTH PERIODS ENDED MARCH 31, 2000 AND 1999
Oil and natural gas revenues for the three months ended March 31, 2000
increased 8% to $7.6 million from $7.0 million for the three months ended March
31, 1999. Production volumes for oil and natural gas for the second quarter
ended March 31, 2000 decreased 10% to 3,150 MMcfe from 3,502 MMcfe for the first
quarter of 1999. Average oil and natural gas prices increased 20% to $2.40 per
Mcfe for 2000 from $2.00 per Mcfe for 1999. The decrease in oil and natural gas
production was a result of the reduction of the Company's drilling program due
to the Company's lack of sources of funds and the bankruptcy proceedings.
Oil and natural gas production costs for the three months ended March
31, 2000 decreased 7% to $1.3 million from $1.4 million for the three months
ended March 31, 1999. Production costs per equivalent unit for the three months
ended March 31, 2000 increased to $0.41 per Mcfe from $0.38 per Mcfe for the
same period in 1999 primarily due to lower production volumes.
Depreciation, depletion and amortization ("DD&A") expense remained
unchanged at $3.7 million for the three months ended March 31, 2000 compared to
the same period in 1999. The DD&A rate for the three months ended March 31, 2000
increased to $1.16 per Mcfe compared to $1.03 per Mcfe for the same period in
1999. The increase in the DD&A rate was the result of cost overruns and below
average reserves per well on certain wells.
General and administrative expenses for the three months ended March
31, 2000 increased 2% to $487,000 from $478,000 for the three months ended March
31, 1999. General and administrative expenses per equivalent unit increased to
$0.15 per Mcfe for the three months ended March 31, 2000 from $0.14 per Mcfe for
the three months ended March 31, 1999 primarily due to lower production volumes.
Reorganization costs (consisting of legal, professional and other fees)
of $560,000 were incurred for the three months ended March 31, 2000 as a result
of the bankruptcy filing. No reorganization costs were incurred for the same
period in 1999.
Interest expense, net of capitalized interest, and loan amortization
costs for the three months ended March 31, 2000 decreased 75% to $1.0 million
from $4.0 million for the same period in 1999. The decrease was due to the
discontinuation of interest on the Company's 11 1/2% Senior Notes due 2005 (the
"Senior Notes") due to the Bankruptcy Court filing on December 10, 1999. The
decrease in the interest incurred on the Senior Notes was partially offset by
the increase in the interest expense under the Company's senior secured credit
facility (the "Credit Facility") due to higher interest rates accrued and the
higher level of outstanding debt under the Credit Facility for the three months
ended March 31, 2000 compared to the same period of 1999. Because the Senior
Notes are unsecured obligations subject to compromise under the Bankruptcy
proceedings, beginning December 10, 1999, the Company discontinued accruing
interest under the Indenture which would have been approximately $936,000 from
December 10, 1999 through December 31, 1999 and $3.9 million from January 1,
2000 through March 31, 2000.
9
There was no income tax provisions for the three months ended March 31,
2000 and 1999. The Company's net operating loss carryforward was partially
reserved as of March 31, 2000 as the status of the current and future drilling
activities and uncertainty about the availability of capital resulted in
uncertainty as to whether sufficient taxable income will be available to utilize
the entire net operating loss carryforward. Any restructuring of the Company's
indebtedness may result in a significant stock ownership change which would
significantly affect the timing of the utilization of the net operating loss
carryforward. The valuation allowance related to tax assets could be adjusted in
the future if such restructuring were to occur, as well as for changes in
estimates of future taxable income. At March 31, 2000, the net operating loss
carryforward and related valuation allowance were reduced by the deferred tax
liabilities created during the three months ended March 31, 2000 as a result of
the tax effect of the earnings generated by the Company which amounted to
approximately $180,000. This resulted in no income tax expense for the three
months ended March 31, 2000.
The net income for the three months ended March 31, 2000 was $529,000
compared to a net loss of $2.4 million for the three months ended March 31,
1999, primarily as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2000, the Company had cash and cash equivalents of $2.7
million, consisting primarily of short-term money market investments, compared
to $855,000 at December 31, 1999. Cash increased primarily due to the bankruptcy
filing which enabled the Company to conserve cash, plus a reduction in capital
expenditures for the first quarter 2000 resulting from decreased drilling
activity.
Cash flows provided by operating activities from the Company's
operations was unchanged at $5.2 million for the three months ended March 31,
2000 and 1999.
Cash flows used in investing activities by the Company were $3.4
million and $8.4 million for the three months ended March 31, 2000 and 1999,
respectively. The decrease in capital expenditures for the three months ended
March 31, 2000 over the same period in 1999 was primarily due to a reduction in
the Company's drilling program caused by the liquidity factors described above.
Cash flows (used in) provided by financing activities were ($8,000) and
$11.0 million for the three months ended March 31, 2000 and 1999, respectively.
During the three months ended March 31, 1999, the Company borrowed an additional
$11.0 under the Credit Facility.
The Company's outstanding indebtedness (and the payment and other
defaults under the terms of the Senior Notes and Credit Facility) and the
Company's current lack of current funding available from other sources have
adversely affected the Company's results of operations and financial condition.
The Company filed a Plan of Reorganization and related disclosure
statement with the Bankruptcy Court on April 26, 2000. The Plan of
Reorganization, if approved by the Bankruptcy Court, provides for the sale of
the reorganized Company's stock to a limited liability company.
The Company's financial statements as of March 31, 2000 have been
prepared on a going concern basis which contemplates continuity of operations,
realization of assets and liquidation of liabilities in the ordinary course of
business. As a result of the bankruptcy filing and related events, there is no
assurance that the carrying amounts of assets will be realized or that
liabilities will be liquidated or settled for the amounts recorded. The Plan of
Reorganization, or any modification or rejection thereof, could change the
amounts reported in the financial statements. The ability of the Company to
continue as a going concern is dependent upon confirmation of the Plan of
Reorganization, adequate sources of capital and the ability to sustain positive
results of operations and cash flows sufficient to continue to explore for and
develop oil and gas reserves. In light of the above, the Independent
Accountants' Report pertaining to the Consolidated Financial Statements for the
year ended December 31, 1999 raised substantial doubt about the Company's
ability to continue as a going concern.
10
CAPITAL EXPENDITURES
Capital expenditures for the three months ended March 31, 2000 totaled
$3.0 million compared to $11.0 million for the first quarter in 1999.
The Company expects to continue to experience working capital
requirements due to the Company's current development program and the bankruptcy
proceedings. Currently, the Company's estimated capital expenditure budget for
2000 is $15.0 million, substantially all of which is planned to be devoted to
drilling activities, lease acquisitions and 3-D seismic surveys in the Company's
project areas including the drilling of approximately 20 gross (14 net) wells in
2000. The Company currently believes that it will be able to fund the capital
expenditures from internally generated cash flows during the year 2000. However,
no assurances can be made that these cash flows will be sufficient. Furthermore,
no additional sources of funds are currently available to the Company.
FINANCING ARRANGEMENTS
CREDIT FACILITY
In May 1998, the Company entered into its Credit Facility with
Christiania Bank og KreditKasse (Christiania") as lender and administrative
agent. The Credit Facility provided for loans in an outstanding principal amount
not to exceed $50.0 million at any one time, subject to a borrowing base to be
determined semi-annually (each April and October) by the administrative agent
(the initial borrowing base was $30.0 million), and the issuance of letters of
credit in an outstanding face amount not to exceed $6.0 million at any one time
with the face amount of all outstanding letters of credit reducing,
dollar-for-dollar, the availability of loans under the Credit Facility.
The Credit Facility borrowing base was to be redetermined semiannually
by Christiania based on the Company's proved oil and natural gas reserves.
Effective April 1, 1999, the borrowing base was reduced to $23 million. The
Company and Christiania entered into two amendments and executed two waivers of
debt covenant violations to the Credit Agreement during 1999, including an
amendment requiring the principal amount outstanding to be decreased by monthly
mandatory reductions in the borrowing base of $1.5 million per month effective
October 31, 1999. Effective September 20, 1999, Christiania resumed charging the
default rate of interest, increasing the interest rate an additional 2% per
annum on the outstanding balance. The Company did not pay the principal
reduction amount due October 31, 1999, and is in default under the terms of
the Credit Facility.
On January 11, 2000, the Company and Christiania entered into a cash
collateral agreement, which contains certain financial covenants and provides
for weekly payments of interest by the Company. The cash collateral agreement
modified the previous financial covenants which were in violation at December
31, 1999, but did not modify the administrative covenants which the Company had
violated. On May 15, 2000, the Court entered its Third Motion of Debtors for
Order Authorizing Use of Cash Collateral and Granting Adequate Protection. This
Order was entered with the agreement of Christiania, who consented to the
Company's continued use of Christiania's cash collateral in accordance with the
terms and conditions set forth in the Order until June 30, 2000, unless extended
by the parties or further order of the Court after notice and a hearing. Among
other things, the Order provides Christiania new, first priority and senior
security interests in the Company's assets and requires the Company to make
weekly adequate protection payments to Christiania during the term of the Order.
The Order also imposes certain reporting requirements and cash collateral
operating requirements on the Company.
SENIOR NOTES
On April 2, 1998, the Company issued $135 million of Senior Notes at a
discount of 1.751%. The Senior Notes are scheduled to mature in April 2005 and
bear interest at a rate of 11.5% per annum, payable semi-annually in April and
October of each year, commencing October 1998. The Senior Notes are redeemable
at the option of the Company, in whole or in part, at any time after April 2003,
at specified redemption prices plus accrued and unpaid interest and liquidated
damages, as defined in the Indenture governing the terms of the Senior Notes. In
the event of certain asset dispositions, the Company is required under certain
circumstances to use the excess proceeds from such a disposition to offer to
repurchase the Senior Notes (and other Senior Indebtedness for which an offer to
repurchase is required to be concurrently made). The Company is required to
comply with certain covenants, which limit, among other things, the ability of
the Company to incur additional indebtedness, pay dividends, repurchase equity
11
interests, sell assets or enter into mergers and consolidations. An interest
payment on the Senior Notes of approximately $7.8 million was due on October 1,
1999, but was not paid by the Company. A 30-day grace period under the Indenture
governing the Senior Notes expired on October 31, 1999 without payment of
interest on the Senior Notes, and, as a result, an event of default occurred
under the Indenture. Because the Senior Notes are unsecured obligations subject
to compromise under the Bankruptcy proceedings, beginning December 10, 1999, the
Company discontinued accruing interest under the Indenture which would have been
approximately $936,000 from December 10, 1999 through December 31, 1999 and $3.9
million from January 1, 2000 through March 31, 2000.
Under the cross default provisions contained in the Indenture governing
the Senior Notes and in the Credit Facility, a default under either the
Senior Notes or the Credit Facility constituted a default under the other
instrument (see Note 2 discussing the Bankruptcy proceedings). Consequently,
balances outstanding under the Senior Notes and the Credit Facility have been
classified as current liabilities as of March 31, 2000.
CAUTIONARY STATEMENT FOR PURPOSES OF FORWARD LOOKING STATEMENTS
Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations" of Part I of this Quarterly Report on Form 10-Q
contains projections and other forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. These statements can be
identified by the use of forward-looking terminology, such as "believes,"
"expects," "may," "should" or "anticipates" or the negative thereof or
comparable terminology, or by discussions of strategy that involve risks and
uncertainties. In addition, all statements other than statements of historical
facts included in this Quarterly Report, including, without limitation,
statements regarding the results of any debt restructuring or other alternatives
for the Company, the possible outcome of litigation and other adversarial
proceedings, possible outcomes of the Company's negotiations with its creditors,
achievement of the Company's drilling and development program objectives,
amendment of or waiver under the Company's credit facilities, availability of
additional sources of capital funding, future governmental regulation, oil and
natural gas reserves, future drilling and development opportunities and
operations, future acquisitions, future production of oil and natural gas (and
the prices thereof and the costs therefor), anticipated results of hedging
activities, the need for and availability of additional capital, future capital
expenditures, Year 2000 compliance issues, and future net cash flows, are
forward-looking statements and may contain certain information concerning
financial results, economic conditions, trends and known uncertainties. Such
statements reflect the Company's current views with respect to future events and
financial performance, and involve risks and uncertainties. Actual results could
differ materially from those projected in the forward-looking statements as a
result of these various risks and uncertainties, including, without limitation,
(i) risks associated with the Company's substantial leverage, (ii) factors such
as natural gas price fluctuations and markets, uncertainties of estimates of
reserves and future net revenues, competition in the oil and natural gas
industry, risks associated with oil and natural gas operations, risks associated
with future acquisitions, risks associated with the Company's future capital
requirements and the availability of sources of capital and regulatory and
environmental risks, (iii) adverse changes to the properties and leases acquired
in 1998 or the failure of the Company to achieve the anticipated benefits of
such acquisitions, (iv) the inherent difficulty of predicting the outcome of
adversarial proceedings, and (v) adverse changes in the market for the Company's
oil and natural gas production. For a more detailed description of these and
certain other risks associated with the Company's operations, see "Risk Factors"
in the 1998 Form 10-K and 1999 Form 10-K.
EFFECTS OF INFLATION AND CHANGES IN PRICE
The Company's results of operations and cash flows are affected by
changes in oil and natural gas prices. If the price of oil and natural gas
increases (decreases), there could be a corresponding increase (decrease) in the
operating costs that the Company is required to bear for operations, as well as
an increase (decrease) in revenues. Inflation has had only a minimal effect on
the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HEDGING ACTIVITIES
In an effort to achieve more predictable cash flows and earnings and
reduce the effects of volatility of the price of oil and natural gas on the
Company's operations, the Company has hedged in the past, and in the future
expects to hedge oil and natural gas prices through the use of swap contracts,
put options and costless collars. While
12
the use of these hedging arrangements limits the downside-risk of adverse
price movements, it also limits future gains from favorable movements. The
Company accounts for these transactions as hedging activities and,
accordingly, gains and losses are included in oil and natural gas revenues in
the periods in which the related production occurs. The Company does not
engage in hedging arrangements in which the production amounts are in excess
of the Company's actual production.
In October 1999, Christiania terminated its two costless collar
contracts with the Company. Under the terms of the termination agreement, the
Company is required to pay Christiania approximately $1.3 million. In January
2000, a third party terminated the remaining hedge contracts open as of December
31, 1999. The third party is seeking a claim of $450,000 as a result of the
termination of these contracts. The loss on the terminated hedge contracts has
been deferred and recognized in the consolidated statement of operations as the
underlying physical transaction occurs.
The fair value of the hedge contracts in effect at March 31, 1999 was
approximately $1.1 million. After giving effect to the termination of these
contracts, none of the Company's future oil or natural gas production is hedged
as of March 31, 2000.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On December 10, 1999, the Company, MHI, and one of its subsidiaries
filed petitions for relief under Chapter 11 of the Bankruptcy Code in
order to facilitate the restructuring of the Company's liabilities. The
Company continues to operate as a debtor-in-possession subject to the
Bankruptcy Court's supervision and orders. The filing was made in the
U.S. Bankruptcy Court for the Southern District of Texas, Laredo
Division. On April 26, 2000, the Company and its affiliated debtors
filed their Plan of Reorganization which would effectuate a sale of
stock of the Reorganized Company to a limited liability company. A
hearing on the Debtors' Joint Disclosure Statement is set for May 31,
2000.
On March 27, 2000, the Company received a demand letter from counsel
for certain royalty owners under the Schwarz and Rottersman Leases,
challenging certain deductions made by the Company in calculating
prices for royalty payments and demanding that unless the alleged
underpayments of royalties be cured within sixty (60) days, the royalty
owners could seek to have the Bankruptcy Court declare the Leases
terminated. The March 27, 2000 letter specifically relates to alleged
post-petition claims. The Company conducted an investigation of the
allegations contained in the letter and believes it has substantial
defenses to these claims.
On April 28, 2000, the Company received a second demand letter from
counsel for the royalty owners demanding and alleging that the Company
(i) commission an independent accounting to determine the alleged
underpaid royalty amounts; (ii) cease and desist paying to third
parties the proceeds attributable to the royalty owners' royalties; and
(iii) pay royalties to the royalty owners in accordance with the market
value of the natural gas. The royalty owners further threatened that if
the Company did not cure these alleged defaults under the Schwarz and
Rottersmann Leases within 60 days following receipt of notice, the
Company may forfeit the Schwarz and Rottersmann Leases. The April 28,
2000 letter specifically relates to alleged pre-petition claims.
On April 28, 2000, the royalty owners filed two proofs of claim in the
Bankruptcy cases in the amount of $30 million and $400,000,
respectively. The basis for each claim is the Company's alleged
unauthorized deduction of post-production costs from the royalties paid
to the royalty owners prior to the filing of the bankruptcy petitions.
The Company believes it has numerous defenses to the allegations
contained in the April 28, 2000 and March 27, 2000 letters, as well as
certain claims against the royalty owners. On April 27, 2000, the
Company filed a declaratory judgment adversary proceeding in the
Bankruptcy Court seeking a determination by the Bankruptcy Court that
no additional royalty payments are owed to the royalty owners. The
Company plans to seek to protect itself from any possible lease
termination claim by (i) paying directly
13
to the royalty owners the post-petition amount claimed to be owed
(approximately $50,000), (ii) paying into the registry of the Court
the liquidated amount of the pre-petition claims in cash (approximately
$500,000) which will remain on deposit until the litigation is
finally resolved, and (iii) seeking to enjoin the royalty owners
from attempting to send notice of default on the pre-petition claim,
thereby preventing the 60-day cure period from running.
On May 10, 2000, the Company filed its First Amended Complaint in the
Declaratory Judgment Action adding two additional causes of action: (i)
an objection to both proofs of claim filed by the royalty owners,
including a claim for bad faith filing with respect to the $30 million
claim, and (ii) a cause of action for sanctions for violation of the
automatic stay in respect of the April 27, 2000 Notice. While the
Company's investigation into these claims is in the early phases, the
Company currently believes that the total liquidated amount of these
claims will be significantly less than the claims asserted by the
royalty owners.
On March 31, 2000, the Company received correspondence from counsel to
the Official Committee of Unsecured Creditors requesting the Company to
take legal action on behalf of the Company's Estate against Glenn D.
Hart, Michael G. Farmar and the directors of Company, alleging certain
misstatements in connection with the issuance of the Senior Notes and
certain breaches of fiduciary duties to the creditors. The Company
investigated these allegations and determined there was no basis for
their assertion. The Company has responded to the Committee in writing
indicating that it found no basis for the allegations and would not be
asserting such claims at this time, but agreeing to reconsider the
issues raised in the event the Committee discovered additional facts
which might support its allegations.
Item 2. Changes in Securities and Use of Proceeds...................................... Not Applicable
Item 3. Defaults upon Senior Securities
The Company's Senior Notes and Credit Facility are currently in
default. See Part I, Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Financial
Arrangements."
Item 4. Submission of Matters to a Vote of Security Holders............................ Not Applicable
Item 5. Other Information.............................................................. Not Applicable
Item 6. Exhibits and Reports on Form 8-K:
(a) The following exhibits are filed as part of this report:
27.1* Financial Data Schedule.
* Filed herewith
(b) Reports on Form 8-K filed during the quarter ended March 31, 2000
and thereafter:
On March 24, 2000, the Company filed a Form 8-K reporting that a
"Qualifying Bid" of least $120 million, net of certain fees and working
capital adjustments, had not been received as of March 17, 2000.
On May 1, 2000, the Company filed a Form 8-K reporting that Michael
Petroleum Corporation, its parent corporation and one of its
subsidiaries filed a Joint Plan of Reorganization and a related
Disclosure Statement with the Bankruptcy Court.
14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
MICHAEL PETROLEUM CORPORATION
(REGISTRANT)
Date May 19, 2000 By /s/ Glenn D. Hart
---------------- -------------------------------------
Glenn D. Hart
Chief Executive Officer and Chairman
of the Board
Date May 19, 2000 By /s/ Michael G. Farmar
---------------- -------------------------------------
Michael G. Farmar
President and Chief Operating Officer
Date May 19, 2000 By /s/ Robert L. Swanson
--------------- -------------------------------------
Robert L. Swanson
Vice President, Finance
Date May 19, 2000 By /s/ Scott R. Sampsell
--------------- ----------------------------------------
Scott R. Sampsell
Vice President, Controller and Treasurer
15