SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 0-16487
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INLAND RESOURCES INC.
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(Exact name of Registrant as specified in its charter)
WASHINGTON 91-1307042
------------------------------- ---------------------------------
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
410 17TH STREET, SUITE 700, DENVER, COLORADO 80202
- -------------------------------------------- ------------
(Address of Principal Executive Offices) (ZIP Code)
Registrant's Telephone Number, Including Area Code: (303) 893-0102
--------------------
(Former name, address and fiscal year, if changed, since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 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 __XX__ No ______
Number of shares of common stock, par value $.001 per share, outstanding as
of November 10, 1999: 23,093,689
PART 1. FINANCIAL INFORMATION
INLAND RESOURCES INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(In thousands)
September 30, December 31,
1999 1998
------------------ ----------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 419 $1,627
Accounts receivable and accrued sales 4,184 5,682
Inventory 5,062 5,353
Other current assets 619 700
------------------ ----------------
Total current assets 10,284 13,362
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Property and equipment, at cost:
Oil and gas properties (successful efforts method) 167,199 180,538
Accumulated depletion, depreciation and amortization (26,091) (21,433)
------------------ ----------------
141,108 159,105
Other property and equipment, net 19,566 20,212
Other long-term assets 2,529 3,150
------------------ ----------------
Total assets $ 173,487 $ 195,829
================== ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 5,961 $ 14,282
Accrued expenses 2,824 2,408
Current portion of long-term debt 141,709
------------------ ----------------
Total current liabilities 8,785 158,399
------------------ ----------------
Long-term debt 75,910 17,114
Other long-term liabilities 850 875
Mandatorily redeemable Series C preferred stock, 100,000 shares
issued and outstanding 9,568
Accrued Series C preferred stock dividends 1,534
Warrants outstanding 1,300
Mandatorily redeemable Series D preferred stock, 10,757,747 shares
issued and outstanding, liquidation preference of $80,683,103 60,500
Mandatorily redeemable Series E preferred stock, 121,973 shares
issued and outstanding, liquidation preference of $12,197,300 8,000
Stockholders' equity:
Preferred Class A stock, par value $.001, 20,000,000 shares authorized
Series Z convertible preferred stock, 5,882,901 shares issued
and outstanding 7,280
Common stock, par value $.001; 25,000,000 shares authorized; issued
and outstanding 23,093,689 23 9
Additional paid-in capital 66,694 42,758
Accumulated deficit (54,555) (35,728)
------------------ ----------------
Total stockholders' equity 19,442 7,039
------------------ ----------------
Total liabilities and stockholders' equity $ 173,487 $ 195,829
================== ================
The accompanying notes are an integral part of
the consolidated financial statements
1
INLAND RESOURCES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
(In thousands except earnings per share)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
---------------------------------- ---------------------------------
1999 1998 1999 1998
--------------- ---------------- -------------- --------------
Revenues:
Sales of refined product $ 18,843 $ 17,740 $ 51,447 $ 52,978
Sales of crude oil and natural gas 1,448 3,005 6,328 11,507
Oil hedging gain (loss) (1,708) 100 (2,520) 194
--------------- ---------------- -------------- --------------
Total revenues 18,583 20,845 55,255 64,679
--------------- ---------------- -------------- --------------
Operating expenses:
Cost of refinery feedstock 11,439 11,850 33,453 39,455
Refinery operating expenses 2,297 3,014 7,210 6,968
Lease operating expenses 1,863 2,086 5,223 6,182
Production taxes 211 117 411 345
Exploration 67 37 131 128
Depletion, depreciation and amortization 2,491 3,299 8,638 8,617
General and administrative, net 2,022 901 3,843 2,690
--------------- ---------------- -------------- --------------
Total operating expenses 20,390 21,304 58,909 64,385
--------------- ---------------- -------------- --------------
Operating income (loss) (1,807) (459) (3,654) 294
Interest expense (5,146) (3,971) (14,150) (10,867)
Other income, net 24 206 197 343
--------------- ---------------- -------------- --------------
Net loss before extraordinary loss (6,929) (4,224) (17,607) (10,230)
Extraordinary loss on early extinguishment of debt (556) (556) (212)
--------------- ---------------- -------------- --------------
Net loss (7,485) (4,224) (18,163) (10,442)
Accrued Series C preferred stock dividend (153) (255) (663) (783)
--------------- ---------------- -------------- --------------
Net loss available to common stockholders $ (7,638) $ (4,479) $ (18,826) $ (11,225)
=============== ================ ============== ==============
Net loss per share - Basic and Diluted
Before extraordinary loss $ (0.66) $ (0.53) $ (1.97) $ (1.31)
Extraordinary loss $ (0.05) $ (0.06) $ (0.03)
--------------- ---------------- -------------- --------------
Total $ (0.71) $ (0.53) $ (2.03) $ (1.34)
=============== ================ ============== ==============
Weighted average common shares outstanding 10,752 8,378 9,279 8,369
=============== ================ ============== ==============
Dividends per common share NONE NONE NONE NONE
=============== ================ ============== ==============
The accompanying notes are an integral part of
the consolidated financial statements
2
INLAND RESOURCES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
(In thousands)
(Unaudited)
1999 1998
--------------- ---------------
Cash flows from operating activities:
Net loss $ (18,163) $ (10,442)
Adjustments to reconcile net loss to net cash
provided by (used by) operating activities:
Depletion, depreciation and amortization 8,638 8,617
Amortization of debt issue costs and debt discount 630 491
Noncash interest consideration 8,822
Loss on early extinguishment of debt 556 212
Effect of changes in current assets and liabilities:
Accounts receivable 1,498 5,716
Inventory 291 (1,423)
Other assets 217 304
Accounts payable and accrued expenses (7,931) 8,857
--------------- ---------------
Net cash provided by (used by) operating activities (5,442) 12,332
--------------- ---------------
Cash flows from investing activities:
Development expenditures and equipment purchases (990) (36,524)
--------------- ---------------
Net cash used by investing activities (990) (36,524)
--------------- ---------------
Cash flows from financing activities:
Proceeds from sale of common stock 37
Proceeds from issuance of long-term debt 6,250 39,800
Payments of long-term debt (32) (13,705)
Debt issue costs (494) (885)
Restructuring costs (500)
--------------- ---------------
Net cash provided by financing activities 5,224 25,247
--------------- ---------------
Net change in cash and cash equivalents (1,208) 1,055
Cash and cash equivalents at beginning of period 1,627 604
--------------- ---------------
Cash and cash equivalents at end of period $ 419 $ 1,659
=============== ===============
NONCASH FINANCING ACTIVITY:
The Company entered into a significant financial restructuring as described in
Note 6 to the financial statements whereby certain subordinated debt and
Preferred Stock of the Company was exchanged for Common Stock and new series of
Preferred Stock.
The accompanying notes are an integral part of
the consolidated financial statements
3
INLAND RESOURCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------
1. COMPANY ORGANIZATION:
Inland Resources Inc. (the "Company") is an independent energy company with
substantially all of its producing oil and gas property interests located
in the Monument Butte Field within the Uinta Basin of Northeastern Utah.
The Company also operates a crude oil refinery located in Woods Cross, Utah
(the "Woods Cross Refinery"). The refinery has a processing capacity of
approximately 10,000 barrels per day and tankage capacity of 485,000
barrels.
2. BASIS OF PRESENTATION:
The preceding financial information has been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC") and, in the opinion of the Company, includes all normal
and recurring adjustments necessary for a fair statement of the results of
each period shown. Certain information and footnote disclosures normally
included in the financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
SEC rules and regulations. Management believes the disclosures made are
adequate to ensure that the financial information is not misleading, and
suggests that these financial statements be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December 31, 1998.
3. ACCOUNTING PRONOUNCEMENT:
The Financial Accounting Standards Board ("FASB") issued Statement No. 133
"Accounting for Derivative Instruments and Hedging Activities" originally
effective for fiscal years beginning after June 15, 1999. The Statement
requires companies to record derivative transactions on the balance sheet
as assets or liabilities, measured at fair value, and further defines
transactions that qualify for hedge accounting. The Company has not
assessed the impact this Statement may have on reported financial
information. In June 1999, the FASB issued Statement No. 137 "Accounting
for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - An Amendment of FASB No. 133".
Statement No. 137 delays the effective date of the requirements of
Statement No. 133 to all fiscal quarters of fiscal years beginning after
June 15, 2000.
4. INVENTORIES:
Inventories at September 30, 1999 and December 31, 1998 consist of the
following (in thousands):
September 30, December 31,
1999 1998
---------------- ---------------
Crude Oil $ 983 $ 827
Refined Product 2,687 2,910
Tubular goods 1,198 1,416
Materials and supplies 194 200
---------------- ---------------
Total $ 5,062 $ 5,353
================ ===============
4
5. SEGMENT AND RELATED INFORMATION:
The Company operates in two segments; oil and gas exploration, development
and production operations ("E&P") in the Monument Butte Field in Utah and
crude oil refining in Woods Cross, Utah. Segment disclosures for the
three-month and nine-month periods ended September 30, 1999 and 1998 are as
follows (in thousands).
Balance Sheet
--------------------------------------------------------------
E&P Refinery Eliminations Total
----------- ------------ -------------- -------------
Total assets at September 30, 1999 $162,951 $25,995 $ (15,459) $173,487
Total assets at December 31, 1998 $183,389 $27,222 $ (14,782) $195,829
Nine Months Ended September 30, 1999
---------------------------------------------------------------
E&P Refinery Eliminations Total
----------- ------------ -------------- -------------
Revenues from external customers $ 3,808 $ 51,447 $ - $ 55,255
Intercompany revenue transactions 8,966 - (8,966) -
Interest income and other 758 160 (721) 197
Interest expense 14,133 738 (721) 14,150
Lease operating and production taxes 5,223 - - 5,223
Depreciation, depletion and amort. 7,990 648 - 8,638
Net loss (17,541) (622) (18,163)
Capital additions 569 421 - 990
Nine Months Ended September 30, 1998
---------------------------------------------------------------
E&P Refinery Eliminations Total
----------- ------------ -------------- -------------
Revenues from external customers $ 11,701 $ 52,978 $ - $ 64,679
Intercompany revenue transactions 4,170 - (4,170) -
Interest income and other 380 259 (296) 343
Interest expense 10,477 686 (296) 10,867
Lease operating and production taxes 6,182 - - 6,182
Depreciation, depletion and amort. 7,987 630 - 8,617
Net loss (10,087) (355) (10,442)
Capital additions 34,554 1,970 - 36,524
Three Months Ended September 30, 1999
---------------------------------------------------------------
E&P Refinery Eliminations Total
----------- ------------ -------------- -------------
Revenues from external customers $ (260) $ 18,843 $ - $ 18,583
Intercompany revenue transactions 4,619 - (4,619) -
Interest income and other 255 15 (246) 24
Interest expense 5,137 255 (246) 5,146
Lease operating and production taxes 1,863 - - 1,863
Depreciation, depletion and amort. 2,275 216 - 2,491
Net loss (7,117) (368) (7,485)
Capital additions 116 226 - 342
Three Months Ended September 30, 1998
---------------------------------------------------------------
E&P Refinery Eliminations Total
----------- ------------ -------------- -------------
Revenues from external customers $ 3,105 $ 17,740 $ - $ 20,845
Intercompany revenue transactions 2,290 - (2,290) -
Interest income and other 244 179 (217) 206
Interest expense 3,966 222 (217) 3,971
Lease operating and production taxes 2,086 - - 2,086
Depreciation, depletion and amort. 3,029 270 - 3,299
Net loss (3,976) (248) (4,224)
Capital additions 13,565 696 - 14,261
5
6. FINANCIAL RESTRUCTURING:
On September 21, 1999, the Company entered into an Exchange Agreement (the
"Exchange Agreement") with Trust Company of the West and affiliated
entities ("TCW") and Joint Energy Development Investments II Limited
Partnership ("JEDI"), pursuant to which TCW agreed to exchange certain
indebtedness and warrants to purchase Common Stock, for shares of Common
Stock and two new series of Preferred Stock of the Company, and JEDI agreed
to exchange 100,000 shares of Series C Preferred Stock of the Company for
shares of Common Stock and a third new series of Preferred Stock of the
Company (the "Recapitalization").
Pursuant to the Exchange Agreement, TCW agreed to exchange $75 million of
subordinated indebtedness plus accrued interest of $5.7 million and
warrants to purchase 158,512 shares of Common Stock for the following
securities of the Company: (i) 10,757,747 shares of newly designated Series
D Redeemable Preferred Stock of the Company ("Series D Preferred Stock"),
(ii) 5,882,901 shares of newly designated Series Z Convertible Preferred
Stock of the Company ("Series Z Preferred Stock") and (iii) 11,642,949
shares of Common Stock; and JEDI agreed to exchange the 100,000 shares
($10.0 million par value) of the Company's Series C Cumulative Convertible
Preferred Stock ("Series C Preferred Stock") owned by JEDI, together with
$2.2 million of accumulated dividends thereon, for (i) 121,973 shares of
newly designated Series E Redeemable Preferred Stock of the Company
("Series E Preferred Stock") and (ii) 2,920,975 shares of Common Stock.
Upon closing the Exchange Agreement, TCW owns 11,642,949 shares of Common
Stock, representing approximately 50.4% of the outstanding shares of Common
Stock, and JEDI owns 2,920,975 shares of Common Stock, representing
approximately 12.6% of the outstanding shares of Common Stock. In
connection with the Exchange Agreement, the Articles of Incorporation (the
"Articles") of the Company were amended to designate the Series D Preferred
Stock, Series E Preferred Stock and Series Z Preferred Stock. The amended
Articles provide that the Common Stock, Series D Preferred Stock, Series E
Preferred Stock and Series Z Preferred Stock shall vote together as a
single class and not as a separate voting group or class, except as
mandated by law or as expressly set forth in the Articles. The Series D
Preferred Stock and the Series E Preferred Stock and Series Z Preferred
Stock vote with the Common Stock on a share-for-share basis. Pursuant to
the amended Articles, the total number of votes of the combined class of
Common Stock, Series D Preferred Stock, Series E Preferred Stock and Series
Z Preferred Stock presently outstanding is 39,856,310 votes, of which
28,283,597 votes (representing approximately 71% of the total) are owned by
TCW, and 3,042,948 votes (representing approximately 7.6% of the total) are
owned by JEDI.
Under the amended Articles, the Series D Preferred Stock accrues dividends
at a rate of $0.16875 per share per quarter (9% annual rate) if paid in
cash on a current basis or $0.2109375 per share per quarter (11.25% annual
rate compounded quarterly) if accumulated and not paid on a current basis.
No dividends may be paid on Common Stock or any other series of preferred
stock while there are any accrued and unpaid dividends on the Series D
Preferred Stock. The Series D Preferred Stock also has liquidation
preference over all other classes and series of stock, in an amount equal
to $7.50 per share ($80.7 million). The Series D Preferred Stock may be
redeemed at any time by the Company (subject to the senior credit facility
being repaid) for a redemption price of $7.50 per share and must be
redeemed upon the earlier of September 21, 2004 or the repayment in full of
the Company's existing senior credit facility. The difference between the
book value and the liquidation value of the Series D Preferred Stock
($20.2 million) is being accreted over the minimum redemption period and
will result in a charge against earnings available for common shareholders.
In addition to voting as a class with the Common Stock, Series E Preferred
Stock and Series Z Preferred Stock, as discussed above, holders of 75% of
the outstanding shares of Series D Preferred Stock, voting as a separate
voting group, must approve any modification to the dividend rates,
liquidation preferences or other privileges of the Series D Preferred
Stock, any merger or consolidation of the Company in which the Company
is not the surviving entity, any transaction which will result in the
holders of voting stock of the Company immediately prior to such
transaction owning less than 50% of the outstanding voting stock of the
Company after the transaction or the sale or other transfer of
substantially all of the assets of the Company. Further, a majority of
the outstanding shares of Series D Preferred Stock, voting as a separate
voting group, have the right to (i) elect four members of the Board for as
long as at least 37.5% of the original shares of
6
Series D Preferred Stock remain outstanding; (ii) three members of the
Board for as long as at least 25%, but less than 37.5% remain outstanding;
(iii) two members of the Board for as long as at least 12.5%, but less
than 25% remain outstanding; and (iv) one member of the Board for as long
as any shares of Series D Preferred Stock remain outstanding even though
they are less than 12.5% of the original shares issued. As the number of
members that may be elected by holders of Series D Preferred Stock decline,
the holders of Common Stock are entitled to elect those members to the
Board.
Under the amended Articles, the Series E Preferred Stock accrues dividends
at a rate of $2.3125 per share per quarter (9.25% annual rate) if paid in
cash on a current basis or $2.875 per share per quarter (11.5% annual rate
compounded quarterly) if accumulated and not paid on a current basis. No
dividends may be paid on Common Stock or the Series Z Preferred Stock while
there are any accrued and unpaid dividends on the Series E Preferred Stock.
The Series E Preferred Stock also has liquidation preference over all other
classes and series of stock, except the Series D Preferred Stock, in an
amount equal to $100.00 per share ($12.2 million). The Series E Preferred
Stock may be redeemed at any time by the Company (subject to the senior
credit facility being repaid and the Series D Preferred Stock having been
redeemed) for a redemption price of $100.00 per share and must be redeemed
upon the earlier of September 21, 2006 or the redemption of all outstanding
shares of Series D Preferred Stock. The difference between the book value
and the liquidation value of the Series E Preferred Stock ($4.2 million) is
being accreted over the minimum redemption period and will result in a
charge against earnings available for common shareholders. In addition to
voting as a class with Common Stock, Series D Preferred Stock and Series Z
Preferred Stock, as discussed above, holders of 75% of the outstanding
shares of Series E Preferred Stock, voting as a separate voting group, must
approve any modification to the dividend rates, liquidation preferences or
other privileges of the Series E Preferred Stock; any merger or
consolidation of the Company in which the Company is not the surviving
entity or any transaction which will result in the holders of voting stock
of the Company immediately prior to such transaction owning less than 50%
of the outstanding voting stock of the Company after the transaction,
unless, in either case, the holders of Series E Preferred Stock receives
shares with substantially the same rights and preferences as correspond to
the Series E Preferred Stock; any merger in which the holders of Common
Stock receive consideration in exchange for their Common Stock other than
Common Stock of the surviving corporation junior to the securities issued
to the holders of Series E Preferred Stock; or the sale or other transfer
of substantially all of the assets of the Company unless, so long as the
Series D Preferred Stock is outstanding, at least 60% of the Series E
Preferred Stock is redeemed or the holders of Series E Preferred Stock
receive an amount equal to 60% of 10/85ths of the total consideration
received by the holders of Series D Preferred Stock and Series E Preferred
Stock in the same form of consideration as that received by the holders of
Series D Preferred Stock. Further, a majority of the outstanding shares of
Series E Preferred Stock, voting as a separate voting group, have the right
to elect one member of the Board; although they have not yet exercised this
right.
The Series Z Preferred Stock ranks on an equivalent basis with the Common
Stock with respect to all matters, except the Series Z Preferred Stock has
a liquidation preference of $.002 per share which ranks ahead of the Common
Stock, and after receiving this liquidation preference, the Series Z
Preferred Stock will share in any remaining assets on liquidation pro rata
on an as-converted basis with the holders of Common Stock. Currently, the
Series Z Preferred Stock is convertible at a rate of one share of Common
Stock for each share of Series Z Preferred Stock and shall be deemed
automatically converted into that number of shares immediately upon the
Articles being further amended to increase the number of authorized shares
of Common Stock to such a number that will permit such conversion. The
Company has called a meeting of stockholders on December 10, 1999 to vote
on such amendment. Due to the similarities between the Series Z Preferred
Stock and Common Stock and the upcoming stockholders meeting during which
the conversion of the Series Z Preferred Stock into Common Stock will be
authorized, the Series Z Preferred Stock has been treated as if it were
Common Stock in the earnings per share calculation.
One of the conditions to closing the Exchange Agreement was that Inland's
senior lenders would enter into a restructuring of the senior credit
facility acceptable to TCW, JEDI and the Company. As a
7
result, effective as of September 21, 1999, the Company entered into the
Second Amended and Restated Credit Agreement (the "ING Credit Agreement")
with ING (U.S.) Capital Corporation, U.S. Bank National Association and
Meespierson Capital Corporation (the "Senior Lenders") pursuant to which
the Senior Lenders agreed to increase the borrowing base from $73.25
million to $83.5 million, inclusive of a sublimit for letters of credit of
$4.0 million. The Company borrowed $3.0 million at closing, bringing the
total outstanding principal balance to $73,915,000 at September 30, 1999.
The Company also had $2.8 million of outstanding letters of credit at
September 30, 1999. All borrowings under the ING Credit Agreement are due
on October 1, 2001, or potentially earlier if the borrowing base is
determined to be insufficient. The borrowing base is calculated as the
collateral value of proved reserves and will be redetermined on October 1,
2000 and April 1, 2001 and may be redetermined at the option of the Senior
Lenders one additional time after October 1, 2000. Upon redetermination,
if the borrowing base is lower than the outstanding principal balance then
drawn, the Company must immediately pay the difference. Interest accrues,
at the Company's option, at either (i) 2% above the prime rate or (ii) 3%
above the LIBOR rate. At September 30, 1999, all amounts were borrowed
under the LIBOR option at an effective rate of 8.52% through December 29,
1999. The Company paid a facility fee of $150,000 and an additional fee of
$208,000 to the Senior Lenders at closing. The Company must also pay a
facility fee equal to 0.50% of the borrowing base on April 1, 2001 and
again on September 30, 2001. The Senior Lenders will also receive a fee
equal to 1% of the borrowing base on October 1, 2000 if ING (U.S.) Capital
Corporation continues to be a member of the Senior Lenders at September 30,
2000. The ING Credit Agreement continues to contain standard affirmative,
negative and financial covenants and is secured by a first lien on
substantially all assets of the Company.
The Company also amended its Farmout Agreement with Smith Energy
Partnership ("Smith") in conjunction with the financial restructuring on
September 21, 1999. The Farmout Agreement was originally entered into
effective June 1, 1998. As of December 31, 1998 Smith had received 152,220
pre-split shares of Common Stock as payment of net proceeds through October
31, 1998 under the Farmout Agreement. Effective November 1, 1998, an
Amendment to the Farmout Agreement was executed that suspended future
drilling rights under the Farmout Agreement until such time as the Company,
Smith and the Company's senior lenders agreed to recommence such rights. In
addition, a provision was added that gave Smith the option to receive cash
rather than Common Stock if the average stock price was calculated at less
than $3.00 per share, such cash only to be paid if the Company's senior
lenders agreed to such payment. The amendment to the Farmout Agreement on
September 21, 1999 eliminated this option and provided for cash payments
only effective June 1, 1999. The amendment also allowed the Company to
retain all proceeds under the Farmout Agreement accrued from November 1,
1998 through May 31, 1999. As a result of this recent amendment, and the
fact that the Company has no further obligations in relation to these
properties, the production loan accounting previously followed by the
Company is no longer considered proper. As a result, the Company has
removed all previously recorded drilling costs, accumulated depletion, debt
issue costs, loans and accrued interest from its accounting records as of
September 21, 1999 and will no longer record revenue and costs from wells
drilled under the Farmout Agreement in its Consolidated Statement of
Operations or Consolidated Statement of Cash Flows. The $6.0 gain
recognized upon the removal of previously recorded account balances
was charged directly to equity due to the related-party nature of the
transaction. The Farmout Agreement continues to provide that Smith will
reconvey all drillsites to the Company once Smith has recovered from
production an amount equal to 100% of its expenditures, including
management fees and production taxes, plus an additional sum equal to 18%
per annum on such expended sums.
7. NET LOSS PER SHARE:
Basic and diluted net loss per share is presented before the extraordinary
loss and after the extraordinary loss. All amounts can be computed based on
information on the face of the Consolidated Statements of Operations. Basic
earnings per share is computed by dividing net loss attributable to common
stockholders by the weighted-average number of common shares for the
period. The computation of diluted earnings per share is shown as equal to
the computation for basic earnings per share due to the antidilutive effect
of additional common shares that would have been outstanding if potentially
dilutive common shares had been issued.
8
INLAND RESOURCES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
---------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION:
RESULTS OF OPERATIONS:
THREE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998:
REFINED PRODUCTS SALES. The Company averaged refined product sales
of 8,100 barrels per day from the Woods Cross Refinery during the third
quarter of 1999, of which 46% represented gasoline and diesel products. This
is a decrease of 1,400 barrels per day when compared to the third quarter of
1998. The large decrease in volumes sold was attributable to the Company's
poor financial condition prior to the restructuring on September 21, 1999 and
its inability to secure certain crude oil for processing. This large volume
decrease was more than offset by a $5.00 increase in the average price
received by the Company for its refined products. The price increase was due
to general market conditions in the Salt Lake City region.
OIL AND GAS SALES. The Company eliminated in consolidation $4.6
million and $2.3 million of crude oil sales made between its production
operations and the Woods Cross Refinery during the third quarters of 1999 and
1998, respectively. Prior to considering intercompany eliminations, crude oil
and natural gas sales increased $772,000 between the third quarters of each
year. The change in gross revenues was the net effect of a 25% decline in the
Company's BOE sales offset by an increase in crude oil prices. Crude oil
prices increased 76% from an average of $9.81 per barrel during the third
quarter of 1998 to $17.22 during the third quarter of 1999. Approximately 75%
of the Company's oil and gas revenues are derived from crude oil sales.
OIL HEDGING GAIN (LOSS). As further discussed in "Liquidity and
Capital Resources" below, the Company has entered into price protection
agreements to hedge against volatility in crude oil prices. Although hedging
activities do not affect the Company's actual sales price for crude oil in
the field, the financial impact of hedging transactions is reported as an
adjustment to revenue in the period in which the related oil is sold. Oil
hedging activities resulted in a loss of $1.7 million and a gain of $100,000
during the third quarters of 1999 and 1998, respectively.
COST OF REFINERY FEEDSTOCK. The Company eliminated in consolidation
$4.6 million and $2.3 million of feedstock costs associated with sales
between its production operations and the Woods Cross Refinery during the
third quarters of 1999 and 1998, respectively. Without consideration of these
eliminations, refinery feedstock costs increased 11% between third quarters
due primarily to the increase in crude oil prices experienced during the
quarter.
REFINERY OPERATING EXPENSES. Refinery operating expense for the
quarter ended September 30, 1999 decreased 24%, or $717,000, from the third
quarter of 1998. The decrease was the result of lower variable costs due to
lower refinery throughput in conjunction with cost cutting measures to
increase refinery cash flow.
LEASE OPERATING EXPENSES. Lease operating expense for the third
quarter ended September 30, 1999 decreased 11%, or $223,000, from the third
quarter of 1998. Lease operating expense per BOE increased between quarters
from $3.90 to $4.65 as cost reductions and new efficiencies were offset by
lower production.
9
PRODUCTION TAXES. Production taxes as a percentage of oil and gas
sales were 3.5% and 2.2% in the third quarters of 1999 and 1998,
respectively. Production tax expense consists of estimates of the Company's
yearly effective tax rate for Utah state severance tax and production ad
valorem tax. Changes in sales prices, tax rates, tax exemptions and the
timing, location and results of drilling activities can all affect the
Company's actual tax rate.
EXPLORATION. Exploration expense represents the Company's cost to
retain unproved acreage.
DEPLETION, DEPRECIATION AND AMORTIZATION. Depletion, depreciation
and amortization for the quarter ended September 30, 1999 decreased 25%, or
$808,000, from the previous year. Depletion, which is based on the
units-of-production method, comprises the majority of the total charge. The
depletion charge decreased consistent with the 25% decrease in oil and gas
BOE sales. The depletion rate is a function of capitalized costs and related
underlying proved reserves in the periods presented. The Company's average
depletion rate decreased from $5.35 per BOE sold during the third quarter of
1998 to $5.15 per BOE sold during the third quarter of 1999.
GENERAL AND ADMINISTRATIVE, NET. General and administrative expense
for the quarter ended September 30, 1999 increased $1,121,000 from the
previous year. The third quarter of 1999 includes $1.2 million of charges
relating to the Company's financial restructuring. After removal of the
restructuring costs, general and administrative expense was consistent
between periods.
INTEREST EXPENSE. Interest expense for the third quarter of 1999
increased 30%, or $1.2 million compared to the third quarter of 1998. The
increase resulted from increased average borrowings outstanding as the
Company's debt balance increased $15 million during the twelve months prior
to the Company's financial restructuring on September 21, 1999. Interest cost
approximated 10.6% during the third quarters of 1999 and 1998. The financial
restructuring will have the effect of significantly lowering outstanding
borrowings and interest cost in future periods.
OTHER INCOME. Other income in 1999 and 1998 primarily represents
interest earned on the investment of surplus cash balances.
INCOME TAXES. In 1999 and 1998, no income tax provision or benefit
was recognized due to net operating losses incurred and the reversal and
recording of a full valuation allowance.
EXTRAORDINARY ITEM. Effective September 21, 1999, the Company
refinanced an existing obligation to TCW and amended the terms of its farmout
arrangement with Smith Energy Partnership. As a result of these transactions,
unamortized debt issue costs of $556,000 were written off as an extraordinary
loss.
ACCRUED SERIES C PREFERRED STOCK DIVIDENDS. Inland's Series C
preferred stock accrued dividends at 10%, compounded quarterly. No dividends
were paid in cash since the stock was issued on July 21, 1997. The amount
accrued represents those dividends earned during the respective period. On
September 21, 1999, JEDI exchanged their Series C Preferred Stock for Common
Stock and a new series of preferred stock as explained in Note 6 to the
financial statements.
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998:
REFINED PRODUCTS SALES. The Company averaged refined product sales
of 8,600 barrels per day from the Woods Cross Refinery during the initial
nine months of 1999, of which 52% represented gasoline and diesel products.
This is an decrease of 400 barrels per day when compared to the first nine
months of 1998 due to the Company's poor financial condition prior to the
restructuring on September 21, 1999 and its inability to secure certain crude
oil for processing. Sales revenue decreased $1.5 million due to a decline in
volumes offset by a higher average price received for the Company's refined
product slate. The price increase was due to general market conditions in the
Salt Lake City region.
10
OIL AND GAS SALES. The Company eliminated in consolidation $9.0
million and $4.2 million of crude oil sales made between its production
operations and the Woods Cross Refinery during the initial nine months 1999
and 1998, respectively. Prior to considering intercompany eliminations, crude
oil and natural gas sales decreased $771,000 or 4.8% between years. The
change in revenues was the effect of a 12% decline in the Company's BOE sales
offset by a 10% increase in the average price per BOE sold. Crude oil
approximates 75% of the Company's revenues. Crude oil prices increased from
an average of $10.10 per barrel during the first nine months of 1998 to
$12.71 during the first nine months of 1999.
OIL HEDGING GAIN (LOSS). As further discussed in "Liquidity and
Capital Resources" below, the Company has entered into price protection
agreements to hedge against volatility in crude oil prices. Although hedging
activities do not affect the Company's actual sales price for crude oil in
the field, the financial impact of hedging transactions is reported as an
adjustment to revenue in the period in which the related oil is sold. Oil
hedging activities resulted in a loss of $2.5 million and a gain of $194,000
during the initial nine months of 1999 and 1998, respectively.
COST OF REFINERY FEEDSTOCK. The Company eliminated in consolidation
$9.0 million and $4.2 million of feedstock costs associated with sales
between its production operations and the Woods Cross Refinery during the
initial nine months of 1999 and 1998, respectively. Without consideration of
these eliminations, refinery feedstock costs decreased $1.2 million or 2.8%
consistent with the decline in refined product sales.
REFINERY OPERATING EXPENSES. Refinery operating expense during the
initial nine months of 1999 increased 3.5%, or $242,000, from the comparable
period in 1998. The increase was the result of a number of factors including
(1) increased transportation costs since the current crude oil slate and the
refined product sold had more volumes shipped via railcar or truck rather
than pipeline, (2) an increase in the number of operating employees and pay
rates, (3) less processing fees and maintenance credits associated with the
Company's MDDW unit, offset by (4) lower variable costs during the third
quarter of 1999 due to lower refinery throughput and cost cutting measures
during the third quarter of 1999 to increase refinery cash flow.
LEASE OPERATING EXPENSES. Lease operating expense for the first nine
months of 1999 decreased 16%, or $959,000, from the comparable period in
1998. Lease operating expense per BOE decreased from $4.14 per BOE sold in
1998 to $3.98 in 1999. The reduction on a BOE basis is due to cost reductions
during 1999 that were not present in the prior year offset by lower volumes
in 1999.
PRODUCTION TAXES. Production taxes as a percentage of oil and gas
sales were recorded at 2.7% and 2.2% during 1999 and 1998, respectively.
Production tax expense consists of estimates of the Company's yearly
effective tax rate for Utah state severance tax and production ad valorem
tax. Changes in sales prices, tax rates, tax exemptions and the timing,
location and results of drilling activities can all affect the Company's
actual tax rate.
EXPLORATION. Exploration expense represents the Company's cost to
retain unproved acreage.
DEPLETION, DEPRECIATION AND AMORTIZATION. Depletion, depreciation
and amortization for the initial nine months of 1999 increased 1%, or
$21,000, from the previous year. Depletion, which is based on the
units-of-production method, comprises the majority of the total charge. The
small increase is the result of the 12% decrease in oil and gas BOE sales
offset by an increase in the depletion rate. The depletion rate is a function
of capitalized costs and related underlying proved reserves in the periods
presented. The Company's average depletion rate increased from $5.06 per BOE
sold during the first nine months of 1998 to $5.71 per BOE sold during the
first nine months of 1999.
GENERAL AND ADMINISTRATIVE, NET. General and administrative expense
during the nine months ended September 30, 1999 increased 43%, or $1.15
million, from the previous year. After removal of $1.7 million of one-time
costs related to the Company's financial restructuring and to an unsuccessful
combination, net general and administrative costs decreased $450,000 or 17%
between periods.
11
INTEREST EXPENSE. Interest expense for the initial nine months of
1999 increased 30%, or $3.3 million, compared to the same period in 1998. The
increase resulted from increased average borrowings outstanding as the
Company's debt balance increased $15 million during the twelve months prior
to the Company's financial restructuring on September 21, 1999. Interest cost
approximated 10.6% during the initial nine months of 1999 and 1998. The
financial restructuring will have the effect of significantly lowering
outstanding borrowings and interest cost in future periods.
OTHER INCOME. Other income in 1999 and 1998 primarily represents
interest earned on the investment of surplus cash balances.
INCOME TAXES. In 1999 and 1998, no income tax provision or benefit
was recognized due to net operating losses incurred and the reversal and
recording of a full valuation allowance.
EXTRAORDINARY ITEM. Effective September 21, 1999, the Company
refinanced an existing obligation to TCW and amended the terms of its farmout
arrangement with Smith Energy Partnership. As a result of these transactions,
unamortized debt issue costs of $556,000 were written off as an extraordinary
loss.
ACCRUED SERIES C STOCK DIVIDENDS. Inland's Series C preferred stock
accrued dividends at 10%, compounded quarterly. No dividends were paid in
cash since the stock was issued on July 21, 1997. The amount accrued
represents those dividends earned during the respective period. On September
21, 1999, JEDI exchanged their Series C Preferred Stock for Common Stock and
a new series of preferred stock as explained in Note 6 to the financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL RESTRUCTURING
On September 21, 1999, the Company entered into an Exchange Agreement (the
"Exchange Agreement") with Trust Company of the West and affiliated entities
("TCW") and Joint Energy Development Investments II Limited Partnership
("JEDI"), pursuant to which TCW agreed to exchange certain indebtedness and
warrants to purchase Common Stock, for shares of Common Stock and two new series
of Preferred Stock of the Company, and JEDI agreed to exchange 100,000 shares of
Series C Preferred Stock of the Company for shares of Common Stock and a third
new series of Preferred Stock of the Company (the "Recapitalization").
Pursuant to the Exchange Agreement, TCW agreed to exchange $75 million of
subordinated indebtedness plus accrued interest of $5.7 million and warrants
to purchase 158,512 shares of Common Stock for the following securities of
the Company: (i) 10,757,747 shares of newly designated Series D Redeemable
Preferred Stock of the Company ("Series D Preferred Stock"), (ii) 5,882,901
shares of newly designated Series Z Convertible Preferred Stock of the
Company ("Series Z Preferred Stock") and (iii) 11,642,949 shares of Common
Stock; and JEDI agreed to exchange the 100,000 shares ($10.0 million par
value) of the Company's Series C Cumulative Convertible Preferred Stock
("Series C Preferred Stock") owned by JEDI, together with $2.2 million of
accumulated dividends thereon, for (i) 121,973 shares of newly designated
Series E Redeemable Preferred Stock of the Company ("Series E Preferred
Stock") and (ii) 2,920,975 shares of Common Stock.
Upon closing the Exchange Agreement, TCW owns 11,642,949 shares of Common
Stock, representing approximately 50.4% of the outstanding shares of Common
Stock, and JEDI owns 2,920,975 shares of Common Stock, representing
approximately 12.6% of the outstanding shares of Common Stock. In connection
with the Exchange Agreement, the Articles of Incorporation (the "Articles")
of the Company were amended to designate the Series D Preferred Stock, Series
E Preferred Stock and Series Z Preferred Stock. The amended Articles provide
that the Common Stock, Series D Preferred Stock, Series E Preferred Stock and
Series Z Preferred Stock shall vote together as a single class and not as a
separate voting group or class, except as mandated by law or as expressly set
forth in the Articles. The Series D Preferred Stock and the Series E
Preferred Stock and Series Z Preferred Stock vote with the Common Stock on a
share-for-share basis. Pursuant to the amended Articles, the total number of
votes of the combined class of Common
12
Stock, Series D Preferred Stock, Series E Preferred Stock and Series Z
Preferred Stock presently outstanding is 39,856,310 votes, of which
28,283,597 votes (representing approximately 71% of the total) are owned by
TCW, and 3,042,948 votes (representing approximately 7.6% of the total) are
owned by JEDI.
Under the amended Articles, the Series D Preferred Stock accrues dividends at
a rate of $0.16875 per share per quarter (9% annual rate) if paid in cash on
a current basis or $0.2109375 per share per quarter (11.25% annual rate
compounded quarterly) if accumulated and not paid on a current basis. No
dividends may be paid on Common Stock or any other series of preferred stock
while there are any accrued and unpaid dividends on the Series D Preferred
Stock. The Series D Preferred Stock also has liquidation preference over all
other classes and series of stock, in an amount equal to $7.50 per share
($80.7 million). The Series D Preferred Stock may be redeemed at any time by
the Company (subject to the senior credit facility being repaid) for a
redemption price of $7.50 per share and must be redeemed upon the earlier of
September 21, 2004 or the repayment in full of the Company's existing senior
credit facility. The difference between the book value and the liquidation
value of the Series D Preferred Stock ($20.2 million) is being accreted over
the minimum redemption period and will result in a charge against earnings
available for common shareholders. In addition to voting as a class with the
Common Stock, Series E Preferred Stock and Series Z Preferred Stock, as
discussed above, holders of 75% of the outstanding shares of Series D
Preferred Stock, voting as a separate voting group, must approve any
modification to the dividend rates, liquidation preferences or other
privileges of the Series D Preferred Stock, any merger or consolidation of
the Company in which the Company is not the surviving entity, any transaction
which will result in the holders of voting stock of the Company immediately
prior to such transaction owning less than 50% of the outstanding voting
stock of the Company after the transaction or the sale or other transfer of
substantially all of the assets of the Company. Further, a majority of the
outstanding shares of Series D Preferred Stock, voting as a separate voting
group, have the right to (i) elect four members of the Board for as long as
at least 37.5% of the original shares of Series D Preferred Stock remain
outstanding; (ii) three members of the Board for as long as at least 25%, but
less than 37.5% remain outstanding; (iii) two members of the Board for as
long as at least 12.5%, but less than 25% remain outstanding; and (iv) one
member of the Board for as long as any shares of Series D Preferred Stock
remain outstanding even though they are less than 12.5% of the original
shares issued. As the number of members that may be elected by holders of
Series D Preferred Stock decline, the holders of Common Stock are entitled to
elect those members to the Board.
Under the amended Articles, the Series E Preferred Stock accrues dividends at
a rate of $2.3125 per share per quarter (9.25% annual rate) if paid in cash
on a current basis or $2.875 per share per quarter (11.5% annual rate
compounded quarterly) if accumulated and not paid on a current basis. No
dividends may be paid on Common Stock or the Series Z Preferred Stock while
there are any accrued and unpaid dividends on the Series E Preferred Stock.
The Series E Preferred Stock also has liquidation preference over all other
classes and series of stock, except the Series D Preferred Stock, in an
amount equal to $100.00 per share ($12.2 million). The Series E Preferred
Stock may be redeemed at any time by the Company (subject to the senior
credit facility being repaid and the Series D Preferred Stock having been
redeemed) for a redemption price of $100.00 per share and must be redeemed
upon the earlier of September 21, 2006 or the redemption of all outstanding
shares of Series D Preferred Stock. The difference between the book value and
the liquidation value of the Series E Preferred Stock ($4.2 million) is being
accreted over the minimum redemption period and will result in a charge
against earnings available for common shareholders. In addition to voting as
a class with Common Stock, Series D Preferred Stock and Series Z Preferred
Stock, as discussed above, holders of 75% of the outstanding shares of Series
E Preferred Stock, voting as a separate voting group, must approve any
modification to the dividend rates, liquidation preferences or other
privileges of the Series E Preferred Stock; any merger or consolidation of
the Company in which the Company is not the surviving entity or any
transaction which will result in the holders of voting stock of the Company
immediately prior to such transaction owning less than 50% of the outstanding
voting stock of the Company after the transaction, unless, in either case,
the holders of Series E Preferred Stock receives shares with substantially
the same rights and preferences as correspond to the Series E Preferred
Stock; any merger in which the holders of Common Stock receive consideration
in exchange for their Common Stock other than Common Stock of the surviving
corporation junior to the securities issued to the holders of Series E
Preferred Stock; or the sale or other transfer of substantially all of the
assets of the Company unless, so long as the Series D Preferred Stock is
outstanding, at least 60% of the Series E Preferred Stock
13
is redeemed or the holders of Series E Preferred Stock receive an amount
equal to 60% of 10/85ths of the total consideration received by the holders
of Series D Preferred Stock and Series E Preferred Stock in the same form of
consideration as that received by the holders of Series D Preferred Stock.
Further, a majority of the outstanding shares of Series E Preferred Stock,
voting as a separate voting group, have the right to elect one member of the
Board; although they have not yet exercised this right.
The Series Z Preferred Stock ranks on an equivalent basis with the Common
Stock with respect to all matters, except the Series Z Preferred Stock has a
liquidation preference of $.002 per share which ranks ahead of the Common
Stock, and after receiving this liquidation preference, the Series Z
Preferred Stock will share in any remaining assets on liquidation pro rata on
an as-converted basis with the holders of Common Stock. Currently, the Series
Z Preferred Stock is convertible at a rate of one share of Common Stock for
each share of Series Z Preferred Stock and shall be deemed automatically
converted into that number of shares immediately upon the Articles being
further amended to increase the number of authorized shares of Common Stock
to such a number that will permit such conversion. The Company has called a
meeting of stockholders on December 10, 1999 to vote on such amendment. Due
to the similarities between the Series Z Preferred Stock and Common Stock and
the upcoming stockholders meeting during which the conversion of the Series Z
Preferred Stock into Common Stock will be authorized, the Series Z Preferred
Stock has been treated as if it were Common Stock in the earnings per share
calculation.
One of the conditions to closing the Exchange Agreement was that Inland's
senior lenders would enter into a restructuring of the senior credit facility
acceptable to TCW, JEDI and the Company. As a result, effective as of
September 21, 1999, the Company entered into the Second Amended and Restated
Credit Agreement (the "ING Credit Agreement") with ING (U.S.) Capital
Corporation, U.S. Bank National Association and Meespierson Capital
Corporation (the "Senior Lenders") pursuant to which the Senior Lenders
agreed to increase the borrowing base from $73.25 million to $83.5 million,
inclusive of a sublimit for letters of credit of $4.0 million. The Company
borrowed $3.0 million at closing, bringing the total outstanding principal
balance to $73,915,000 at September 30, 1999. The Company also had $2.8
million of outstanding letters of credit at September 30, 1999. All
borrowings under the ING Credit Agreement are due on October 1, 2001, or
potentially earlier if the borrowing base is determined to be insufficient.
The borrowing base is calculated as the collateral value of proved reserves
and will be redetermined on October 1, 2000 and April 1, 2001 and may be
redetermined at the option of the Senior Lenders one additional time after
October 1, 2000. Upon redetermination, if the borrowing base is lower than
the outstanding principal balance then drawn, the Company must immediately
pay the difference. Interest accrues, at the Company's option, at either (i)
2% above the prime rate or (ii) 3% above the LIBOR rate. At September 30,
1999, all amounts were borrowed under the LIBOR option at an effective rate
of 8.52% through December 29, 1999. The Company paid a facility fee of
$150,000 and an additional fee of $208,000 to the Senior Lenders at closing.
The Company must also pay a facility fee equal to 0.50% of the borrowing base
on April 1, 2001 and again on September 30, 2001. The Senior Lenders will
also receive a fee equal to 1% of the borrowing base on October 1, 2000 if
ING (U.S.) Capital Corporation continues to be a member of the Senior Lenders
at September 30, 2000. The ING Credit Agreement continues to contain standard
affirmative, negative and financial covenants and is secured by a first lien
on substantially all assets of the Company.
The Company also amended its Farmout Agreement with Smith Energy Partnership
("Smith") in conjunction with the financial restructuring on September 21,
1999. The Farmout Agreement was originally entered into effective June 1,
1998. As of December 31, 1998 Smith had received 152,220 pre-split shares of
Common Stock as payment of net proceeds through October 31, 1998 under the
Farmout Agreement. Effective November 1, 1998, an Amendment to the Farmout
Agreement was executed that suspended future drilling rights under the
Farmout Agreement until such time as the Company, Smith and the Company's
senior lenders agreed to recommence such rights. In addition, a provision was
added that gave Smith the option to receive cash rather than Common Stock if
the average stock price was calculated at less than $3.00 per share, such
cash only to be paid if the Company's senior lenders agreed to such payment.
The amendment to the Farmout Agreement on September 21, 1999 eliminated this
option and provided for cash payments only effective June 1, 1999. The
amendment also allowed the Company to retain all proceeds under the Farmout
Agreement accrued from November 1, 1998 through May 31, 1999. As a result of
this recent amendment, and the fact that the Company has no further
obligations in relation to these properties, the production loan accounting
previously followed by the Company is no longer considered proper. As a
result, the Company has removed all previously recorded
14
drilling costs, accumulated depletion, debt issue costs, loans and accrued
interest from its accounting records as of September 21, 1999 and will no
longer record revenue and costs from wells drilled under the Farmout
Agreement in its Consolidated Statement of Operations or Consolidated
Statement of Cash Flows. The $6.0 gain recognized upon the removal of
previously recorded account balances was charged directly to equity due to
the related-party nature of the transaction. The Farmout Agreement continues
to provide that Smith will reconvey all drillsites to the Company once Smith
has recovered from production an amount equal to 100% of its expenditures,
including management fees and production taxes, plus an additional sum equal
to 18% per annum on such expended sums.
EFFECT OF FINANCIAL RESTRUCTURING ON LIQUIDITY AND CAPITAL RESOURCES
As a result of the financial restructuring, the Company has significantly
improved its financial flexibility. As of November 10, 1999, the Company
borrowed an additional $4.0 million of its $10.25 million borrowing base
availability and used the proceeds to pay closing costs and reduce outstanding
accounts payable. The increase in the sublimit for letter of credit obligations
will permit the Company's refining operations to secure additional feedstock
allowing for more efficient operations. The exchange of subordinated debt for
equity securities has significantly decreased the Company's debt service
requirements thereby increasing discretionary cash flow available for capital
projects. Finally, the restructuring of the senior credit facility principal
repayment terms beyond calendar year 2000 allows the Company to reinvest its
operating cash flow for further development of the Monument Butte Field.
The Company reinitiated its drilling program in October 1999 based on
liquidity generated from the financial restructuring. The Company intends on
drilling 10 wells in 1999 and as many as 40 wells in 2000 depending on
commodity prices, operating cash flows and development results, among other
items. The level of these and other capital expenditures is largely
discretionary, and the amount of funds devoted to any particular activity may
increase or decrease significantly depending on available opportunities and
market conditions.
During the first nine months of 1999, the Company focused its efforts on
pressurizing the Monument Butte Field by converting 12 wells to water
injection. Due to its financial condition, the Company incurred only $990,000
of net capital expenditures year to date, down from $36.5 million in the
prior year. During the first nine months of 1999, the Company borrowed $6.25
million from its lenders and generated $5.0 million of cash from operations
which it primarily used to service debt and reduce outstanding accounts
payable to $6.0 million; a 58% decrease from the January 1, 1999 accounts
payable balance of $14.3 million. Although there can be no assurance, the
Company believes that cash on hand along with future cash to be generated
from operations will be sufficient to service its debt for the next year
while using the excess cash to implement its development projects.
DELISTING OF COMMON STOCK
Effective with the close of business July 28, 1999, the Company's Common Stock
was delisted from the Nasdaq SmallCap Market. The Company was no longer able to
satisfy the net tangible asset maintenance standard for continued listing. The
Company's Common Stock is now traded on the NASD over-the-counter bulletin board
under the same symbol "INLN".
INFLATION AND CHANGES IN PRICES The Company's revenues and the value of its
oil and gas properties have been and will be affected by changes in oil and
gas prices. The Company's ability to borrow from traditional lending sources
and to obtain additional capital on attractive terms is also substantially
dependent on oil and gas prices. Oil and gas prices are subject to
significant seasonal and other fluctuations that are beyond the Company's
ability to control or predict. Although certain of the Company's costs and
expenses are affected by the level of inflation, inflation did not have a
significant effect on the Company's result of operations during 1999 or 1998.
15
YEAR 2000 ISSUES
The Company is aware of the issues associated with the programming code in many
existing computer systems as the millennium approaches. The "Year 2000" problem
is pervasive; virtually every computer operation may be affected in some way by
the rollover of the digit value to 00. The risk is that computer systems will
not properly recognize sensitive information when the year changes to 2000.
Systems that do not properly recognize such information could generate erroneous
data or cause a system to fail, resulting in business interruption.
The Company has conducted a review of its computer systems and is taking
steps to correct Year 2000 compliance issues. The Company benefits from
having relatively new computer systems in most locations. The Company
believes its critical computer hardware and software is Year 2000 compliant.
Although the Company's operations are not extremely dependent on vendor
compliance with Year 2000 issues, the Company has discussed Year 2000 issues
with critical vendors and suppliers and is confident there will not be a
disruption of operations due to Year 2000 issues, although there can be no
complete assurance. In summary, management believes that Year 2000 issues can
be mitigated without a significant effect on the Company's financial
position. However, given the complexity of the Year 2000 issue, there can be
no assurance that the Company has identified and solved all Year 2000 issues
or that it will not incur future costs related to the Year 2000 issue which
are material to financial results or financial condition.
FORWARD LOOKING STATEMENTS
Certain statements in this report, including statements of the Company's and
management's expectation, intentions, plans and beliefs, including those
contained in or implied by "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Notes to Consolidated Financial
Statements, are "forward-looking statements", within the meaning of Section 21E
of the Securities Exchange Act of 1934, that are subject to certain events, risk
and uncertainties that may be outside the Company's control. These
forward-looking statements include statements of management's plans and
objectives for the Company's future operations and statements of future economic
performance, information regarding drilling schedules, expected or planned
production or transportation capacity, future production levels of fields,
marketing of crude oil and natural gas, sources of crude oil for refining,
marketing of refined products, refinery maintenance, operations and upgrades,
the Company's capital budget and future capital requirements, the Company's
meeting its future capital needs, the Company's realization of its deferred tax
assets, the level of future expenditures for environmental costs and the outcome
of regulatory and litigation matters, and the assumptions described in this
report underlying such forward-looking statements. Actual results and
developments could differ materially from those expressed in or implied by such
statements due to a number of factors, including, without limitation, those
described in the context of such forward-looking statements, fluctuations in the
price of crude oil and natural gas, the success rate of exploration efforts,
timeliness of development activities, risk incident to the drilling and
completion for oil and gas wells, future production and development costs, the
strength and financial resources of the Company's competitors, the Company's
ability to find and retain skilled personnel, climatic conditions, the results
of financing efforts, the political and economic climate in which the Company
conducts operations and the risk factors described from time to time in the
Company's other documents and reports filed with the Securities and Exchange
Commission.
16
PART 1. FINANCIAL INFORMATION (CONTINUED)
INLAND RESOURCES INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK:
Market risk generally represents the risk that losses may occur in
the value of financial instruments as a result of movements in interest
rates, foreign currency exchange rates and commodity prices.
INTEREST RATE RISK. Inland is exposed to some market risk due to the
floating interest rate under the ING Credit Agreement. See Item 2.
- -"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources." All borrowings under the ING
Credit Agreement are due and payable October 1, 2001. As of September 30,
1999, the ING Credit Facility had a principal balance of $73.9 million at an
average floating interest rate of 8.52% per annum and $2.8 million of letters
of credit obligations outstanding. Assuming no hedge, and assuming the
principal is paid according to the terms of the loan, an increase in interest
rates could result in an increase in interest expense on the existing
principal balance for the remaining term of the loan, as shown by the
following chart:
-----------------------------------------------------------
Increase in Interest Expense Without Hedge
-----------------------------------------------------------
October 1, 1999 January 1, 2000 January 1, 2001
through through through
December 31, 1999 December 31, 2000 October 1, 2001
- -----------------------------------------------------------------------------
1% increase in $185,000 $739,000 $554,000
Interest Rates
- -----------------------------------------------------------------------------
2% increase in $370,000 $1,478,000 $1,108,000
Interest Rates
- -----------------------------------------------------------------------------
On April 30, 1998, as required by the ING Credit Agreement, Inland
entered into an interest rate hedge covering the ING Credit Agreement at a
cost of $140,000. This interest rate cap agreement with Enron Capital and
Trade Resources Corp. covers the period June 12, 1998 through December 12,
2000 and provides a 6.75% LIBOR rate, the net effect of which is to cap the
interest rate at 9.75% on $35.0 million of borrowings. Pursuant to the ING
Credit Agreement, this hedge must be renewed or replaced through the
remaining term of the loan. Assuming the renewal of the terms of the interest
rate cap agreement, the effect of the hedge through October 1, 2001 will be
to limit hypothetical increases in interest expenses under the ING Credit
Agreement, as shown by the following chart:
------------------------------------------------------------
Increase in Interest Expense with Hedge
------------------------------------------------------------
October 1, 1999 January 1, 2000 January 1, 2001
through through through
December 31, 1999 December 31, 2000 October1, 2001
- -----------------------------------------------------------------------------
1% increase in $185,000 $739,000 $554,000
Interest Rates
- -----------------------------------------------------------------------------
2% increase in $301,000 $1,208,000 $906,000
Interest Rates
- -----------------------------------------------------------------------------
17
COMMODITY RISKS. Inland hedges a portion of its oil production to
reduce its exposure to fluctuations in the market prices thereof. Inland uses
various financial instruments whereby monthly settlements are based on
differences between the prices specified in the instruments and the
settlement prices of certain futures contracts quoted on the NYMEX or certain
other indices. Gains or losses on hedging activities are recognized as an
adjustment to revenue in the period in which the hedged production is sold.
On March 10, 1999 Inland entered into two swap agreements with Enron
Capital and Trade Resources Corp. ("Enron"), each of which cover 40,000
barrels per month of crude oil production during the period April 1, 1999
through December 31, 1999. The swap price on the first contract is $14.02 and
the swap price on the second contract is $14.54, based on NYMEX Light Sweet
Crude Oil Futures Contracts. The potential losses on these contracts based on
a hypothetical average market price of equivalent product for the period from
October 1, 1999 to December 31, 1999 are as follows:
-------------------------------------------------------------------------------------------------
Average NYMEX Per Barrel Market Price for the Contract Period
-------------------------------------------------------------------------------------------------
$20.00 $21.00 $22.00 $23.00 $24.00 $25.00 $26.00
- --------------------------------------------------------------------------------------------------------------------
$14.02 Contract $717,000 $837,000 $957,000 $1,077,000 $1,197,000 $1,317,000 $1,437,000
- --------------------------------------------------------------------------------------------------------------------
$14.54 Contract 655,000 $775,000 $895,000 $1,015,000 $1,135,000 $1,255,000 $1,375,000
- --------------------------------------------------------------------------------------------------------------------
The Company's hedging activities resulted in a loss of $2.5
million and a gain of $194,000 during the initial nine months of 1999 and
1998, respectively.
The Company has also entered into the following hedge contracts
covering periods in year 2000. All contracts are with Enron and structured as
collars whereby if the average monthly price, based on NYMEX Light Sweet
Crude Oil Futures Contracts, is between the floor and ceiling, no payment is
exchanged between the parties. If the average price is above the ceiling,
then the Company pays the excess multiplied by the number of barrels hedged.
If the average price is below the ceiling, the Company receives the shortage
multiplied by the number of barrels hedged. The Company did not pay any fees
to enter into these contracts.
Monthly Barrels
Period Covered Hedged Floor Ceiling
-------------- ------ ----- -------
January 2000 through June 2000 60,000 $20.00 $22.45
July 2000 through December 2000 10,000 $19.00 $19.70
July 2000 through December 2000 10,000 $19.25 $19.75
July 2000 through December 2000 10,000 $19.25 $20.20
The potential losses on these year 2000 contracts based on a
hypothetical average market price of equivalent product for the period from
January 1, 2000 to December 31, 2000 are as follows:
-------------------------------------------------------------------------------------------
Average NYMEX Per Barrel Market Price for the Contract Period
-------------------------------------------------------------------------------------------
$20.00 $21.00 $22.00 $23.00 $24.00 $25.00 $26.00
- ---------------------------------------------------------------------------------------------------------------------
All Year 2000 Contracts $150,000 $690,000 $1,230,000 $1,770,000 $2,310,000 $2,850,000 $3,390,000
- ---------------------------------------------------------------------------------------------------------------------
PART II. OTHER INFORMATION
INLAND RESOURCES INC.
Items 1, 4 and 5 are omitted from this report as inapplicable.
ITEM 2. CHANGES IN SECURITIES. As discussed throughout this quarterly
report, the Company was involved in a financial restructuring that closed on
September 21, 1999 and resulted in the following securities being issued:
- 10,757,747 shares of newly designated Series D Redeemable Preferred
Stock issued to TCW
- 5,882,901 shares of newly designated Series Z Convertible Preferred
Stock issued to TCW
- 11,642,949 shares of Common Stock issued to TCW
- 121,973 shares of newly designated Series E Redeemable Preferred
Stock issued to JEDI
- 2,920,975 shares of Common Stock issued to JEDI
The Series Z Convertible Preferred Stock automatically converts (currently on
a one to one basis) to Common Stock upon the Company's Articles of
Incorporation being amended to increase the number of authorized shares of
Common Stock to such a number that will permit such conversion. The Company
has called a meeting of stockholders on December 10, 1999 to vote on such
amendment to the Articles of Incorporation.
The Company relied on the exemption provided by Section 4 (2) of the
Securities Act of 1933, as amended, with regard to these issuances of Common
Stock and Preferred Stock.
ITEM 3. DEFAULT UPON SENIOR SECURITIES. As discussed in the "Liquidity and
Capital Resources" section of "Management's Discussion and Analysis of
Financial Condition and Results of Operation" before the financial
restructuring on September 21, 1999, the Company was in default of certain
provisions of its credit agreements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. The following documents are filed
as part of this Quarterly Report on Form 10-Q.
Exhibit
Number Description of Exhibits
- ------ -----------------------
3.1 Amended and Restated Articles of Incorporation, as amended
through September 21, 1999 (filed as exhibit 3.1 to the
Company's Form 8-K dated September 21, 1999, and incorporated
herein by reference).
3.2 Bylaws of the Company (filed as Exhibit 3.2 to the Company's
Registration Statement of Form S-18, Registration No.
33-11870-F, and incorporated herein by reference).
3.2.1 Amendment to Article IV, Section 1 of the Bylaws of the
Company adopted February 23, 1993 (filed as Exhibit 3.2.1 to
the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1992, and incorporated herein by
reference).
3.2.2 Amendment to the Bylaws of the Company adopted April 8, 1994
(filed as Exhibit 3.2.2 to the Company's Registration
Statement of Form S-4, Registration No. 33-80392, and
incorporated herein by reference).
19
Exhibit
Number Description of Exhibits
- ------ -----------------------
3.2.3 Amendment to the Bylaws of the Company adopted April 27, 1994
(filed as Exhibit 3.2.3 to the Company's Registration
Statement of Form S-4, Registration No. 33-80392, and
incorporated herein by reference).
10.1 Employment Agreement between the Company and Bill I.
Pennington effective as of October 1, 1999.*
10.2 Employment Agreement between the Company and Michael J.
Stevens effective as of October 1, 1999.*
27.1 Financial Data Schedule.*
- ---------------------
* Filed herewith.
(b) Reports on Form 8-K:
Form 8-K was filed on August 20, 1999 under Item 5 reporting the press
release issued on the Company's restructuring plans.
Form 8-K was filed on September 21, 1999 under Item 1 reporting the
change in control of the Company and under Item 5 reporting the new
terms of the Company's credit agreement with its senior lenders.
20
INLAND RESOURCES INC.
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.
INLAND RESOURCES INC.
(Registrant)
Date: November 12, 1999 By: /s/ Bill I. Pennington
-------------------- ------------------------
Bill I. Pennington
Chief Executive Officer
Chief Financial Officer
Date: November 12, 1999 By: /s/ Michael J. Stevens
-------------------- -----------------------
Michael J. Stevens
Vice President, Secretary and
Treasurer
(Principal Accounting Officer)
21