ITEM 1. BUSINESS.
(a) GENERAL DEVELOPMENT OF BUSINESS.
Garnet Resources Corporation, a Delaware corporation ("Garnet"), is engaged primarily in the exploration, development and production of oil and gas properties located outside the United States. As used herein, the "Company" shall mean Garnet and its subsidiaries. Since inception, the Company has conducted exploration activities in seven countries, and also owned a small number of working interests in producing oil and gas properties in the United States, which were sold in 1992. During 1996 the Company conducted exploration activities on its properties in the Republic of Colombia ("Colombia") and the Independent State of Papua New Guinea ("Papua New Guinea"), and continued development and production activities in Colombia. The Company has concluded its exploration activities and is no longer active in the remaining five countries.
The Company's activities in Colombia are conducted through Argosy Energy International, a Utah limited partnership ("Argosy") in which Garnet is a limited partner and in which a wholly owned subsidiary of Garnet is the general partner. Argosy has interests in four contracts with Empresa Colombiana de Petroleos, the Colombian national oil company ("Ecopetrol"), involving exploration, development and production activities in the Putumayo Basin of southwestern Colombia. Argosy participates in these contracts through a 55% interest in a joint venture with Neo Energy, Inc., a subsidiary of Aviva Petroleum Inc. ("Neo"). The four contracts with Ecopetrol include (i) a risk sharing contract signed in 1987 (the "Santana Contract") currently covering approximately 86,000 acres (the "Santana Block"), (ii) an association contract signed in 1992 (the "Fragua Contract") covering approximately 32,000 acres contiguous to the northern boundary of the Santana Block (the "Fragua Block"), (iii) an association contract signed in 1995 (the "Yuruyaco Contract") covering approximately 39,000 acres contiguous to the eastern boundaries of the Santana Block and the Fragua Block (the "Yuruyaco Block"), and (iv) Association Agreements signed in 1972, as amended (the "Aporte Putumayo Contracts"), covering approximately 77,000 acres 20 miles south of the Santana Block (the "Aporte Putumayo Block"). The Aporte Putumayo Contracts will expire in 2003, but Argosy and Neo notified Ecopetrol in 1994 that they intend to abandon the remaining wells and relinquish the Aporte Putumayo Block because declining production rates have made continued operation economically unattractive. The abandonment of the wells and associated facilities, which has been delayed because of permitting and equipment problems, is now scheduled for 1997.
The Santana Block has been the focus of the Company's exploration and development activities in Colombia in recent years. The Company has discovered four oil fields on the Santana Block, which produced a total of approximately 8,800,000 barrels of oil during the period from commencement of production in April 1992 through December 1996. The Company's share of this production was approximately 1,800,000 barrels. During 1996 one gross (.4 net) dry exploratory well and two gross (.5 net) productive development wells were drilled on the Santana Block. The Company also commenced a 3-D seismic survey over its Mary and Miraflor fields in 1996 to define the limits of the fields, identify possible locations for additional development wells, and ascertain the exploration potential of areas west of the Mary field. To increase production from existing wells, the Company performed fracture stimulation procedures on a total of seven wells in the four fields in late 1995 and early 1996. See "Properties - Colombia."
In Papua New Guinea, Garnet PNG Corporation ("Garnet PNG"), a wholly owned subsidiary of Garnet, owns a 6% interest (the "PPL-181 Interest") in Petroleum Prospecting License No. 181 ("PPL-181"), a license to explore for oil and gas on approximately 952,000 acres (the "PPL-181 Area"). Garnet PNG also held a 7.73% interest in an adjoining license, Petroleum Prospecting License No. 174 ("PPL-174"), on which an exploratory dry hole was drilled in the first quarter of 1996. For more information regarding PPL-181 and PPL-174, see "Properties - Papua New Guinea".
Garnet was incorporated in the state of Delaware in June 1986. Garnet's principal executive office is located at 11011 Richmond Avenue, Suite 650, Houston, Texas 77042 and its telephone number is (713) 783-0010.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company operates in one industry segment.
(c) NARRATIVE DESCRIPTION OF BUSINESS.
General. The Company is currently engaged in the exploration of oil and gas properties located in Colombia and Papua New Guinea, and is engaged in the production and development of oil from its properties in Colombia. The Company may continue to apply for and to acquire additional oil and gas exploration permits if suitable prospects are available on advantageous terms. The Company may also acquire interests in corporations or other entities which either hold or intend to acquire interests in oil and gas properties.
Risks Associated with the Company's Business. The Company has expended significant amounts of capital on the acquisition, exploration and development of its properties and plans to expend additional capital on such activities. Even if the results of such activities are favorable, as in Colombia where the Company has made four oil discoveries, subsequent drilling at significant costs must be conducted on certain of the properties to determine whether further commercial development of the properties is feasible. To finance its planned exploration and development activities, the Company intends to utilize its existing working capital and cash flow from production in Colombia (see "Properties - Colombia"). The Company may also consider entering into additional arrangements whereby certain costs of exploration will be paid by others to earn an interest in the properties. There can be no assurance that the additional financing which may be necessary to fund the Company's operations and obligations will be available on economically acceptable terms. For additional information on the Company's cash requirements, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
In addition, the Company's ability to continue its exploration and development programs may be dependent upon the ability of its joint venture partners to finance their portion of such costs and expenses. There can be no assurance that the Company's partners will contribute, or be in a position to contribute, their costs and expenses of the joint venture programs. If the Company's partners do not finance their obligations to the joint ventures, the Company may be required to accept an assignment of the partners' interests therein and assume their financing obligations. If sufficient funds cannot be raised to meet the Company's obligations in connection with its properties, the interests in the affected properties might be sold or forfeited. In addition, if sufficient funds are raised, there can be no assurance that the Company will be able to discover,
develop and produce sufficient reserves in Colombia, Papua New Guinea or elsewhere to recover the costs and expenses incurred in connection with the acquisition, exploration and development thereof and achieve profitability.
The Company has invested and may continue to invest primarily in properties located outside the United States, in certain countries which may be considered politically and economically unstable. Accordingly, the Company is subject to risks inherent in the ownership and development of foreign properties including, without limitation, cancellation or renegotiation of contracts, royalty and tax increases, retroactive tax claims, expropriation, adverse changes in currency values, foreign exchange controls, import and export regulations, environmental controls, and other laws, regulations or international developments which may adversely affect the Company's properties. In addition, there are usually significant logistical problems, costs and risks in conducting oil and gas activities in remote, rugged and primitive regions such as Papua New Guinea, or in Colombia where Argosy's operations are exposed to potentially detrimental activities by the leftist guerrillas that have operated there for many years. Argosy's assets have been damaged in the past as a result of guerrilla activities, although the losses have been substantially recovered through insurance. There can be no assurance that Argosy's operations in Colombia will not be the target of similar attacks in the future, or that Argosy will be able to continue to insure its assets against similar losses.
The Company is subject to all the risks normally incident to drilling for and producing oil and gas, including blowouts, cratering and fires, any of which could result in damage to or loss of life or property. In accordance with industry practice, the Company is not fully insured against these risks, nor are all such risks insurable.
Competition. The oil and gas business is extremely competitive in all of its phases and particularly in exploration for and development of new sources of crude oil and natural gas. The Company must compete with other companies that are larger and financially stronger in acquiring properties suitable for exploration, in contracting for drilling equipment, and in securing trained personnel. The Company is not a significant participant in the oil and gas industry.
Markets. There is substantial uncertainty as to the prices which the Company may receive for production from its existing oil reserves or from oil and gas reserves, if any, which the Company may discover. The availability of a ready market and the prices received for oil and gas produced depend upon numerous factors beyond the control of the Company including, but not limited to, adequate transportation facilities (such as pipelines), the marketing of competitive fuels, fluctuating market demand, governmental regulation and world political and economic developments. World oil and gas markets are highly volatile and shortage or surplus conditions substantially affect prices. As a result, there have been dramatic swings in both oil and gas prices in recent years. The sale of oil from the Santana Block in Colombia is governed by contracts with Ecopetrol. There is no market for natural gas from the Putumayo Region of Colombia. See "Properties - Colombia." It is possible that, under market conditions prevailing in the future, the production and sale of oil or gas, if any, from the Company's properties in Papua New Guinea may not be commercially feasible.
Regulation. The Company's foreign operations are subject to regulations imposed by the local regulatory authorities including, without limitation, currency regulation, import and export regulation, taxation and environmental controls. The regulations also generally specify, among other things, the extent to which acreage may be acquired or relinquished, permits necessary for
drilling of wells, spacing of wells, measures required for preventing waste of oil and gas resources and, in some cases, rates of production and sales prices to be charged to purchasers.
Specifically, Colombian operations are governed by a number of ministries and agencies including Ecopetrol, the Ministry of Mines and Energy, and the Ministry of the Environment. In 1993 Instituto de Recursos Naturales y Ambiente ("Inderena"), a federal environmental agency in Colombia, began reviewing the environmental standards and permitting processes for the oil industry and in 1994 the Ministry of the Environment was organized. Accordingly, it is possible that the review of current environmental laws, regulations and the administration and enforcement thereof, or the passage of new environmental laws or regulations in Colombia, could result in substantial costs and liabilities in the future or in delays in obtaining the necessary permits to conduct the Company's operations in that country.
The Company's operations in Papua New Guinea are currently governed by the Department of Mining and Petroleum, which has jurisdiction over all petroleum exploration in that country. In the event the Company develops and operates a petroleum business in Papua New Guinea, the Company will be subject to regulation by the Investment Promotion Authority, which regulates almost all business operations with significant foreign equity or with foreign management control.
Employees. The Company's operations are managed from its Houston, Texas office, which consists of a staff of five employees, using professional consulting services as needed.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.
Financial information about foreign and domestic operations may be found in Note 9 of the Notes to Consolidated Financial Statements contained in Item 8 of Part II.
ITEM 2.
ITEM 2.PROPERTIES.
COLOMBIA.
Through its interests in Argosy, the Company presently has a 54.6% indirect interest in the Santana Contract, a 54.6% indirect interest in the Fragua Contract, and a 55% indirect interest in the Yuruyaco Contract. Argosy has 100 employees in Colombia and serves as the operator of the Santana Block, the Fragua Block and the Yuruyaco Block under operating agreements with Ecopetrol and with Neo.
The Colombian properties are located in the Putumayo Region of southern Colombia which is bounded by the Andes mountains on the west and northwest and the Upper Amazon Platform on the east and which lies within the northern portion of a larger regional basin extending nearly 800 miles southward through Ecuador into eastern Peru and western Brazil.
Argosy's responsibilities as operator of the joint venture with Neo are governed by the terms of operating agreements by and between Argosy and Neo, which provide for the establishment of operating committees which consist of two representatives from each of Argosy and Neo. Argosy has exclusive charge of carrying out the program of operations within the budgets
approved by the operating committees and may demand payment in advance from each party of its respective share of estimated monthly expenditures.
The Santana Contract, the Fragua Contract and the Yuruyaco Contract have a term of 28 years, including an exploration period of 10 years, with partial relinquishments of acreage required at the end of years six and eight. At the end of the 10th year, which will occur in July 1997 for the Santana Contract, the oldest of the three contracts, all acreage must be relinquished except acreage contained within productive fields plus a three-mile reserve zone around each such field. Under the terms of the contracts, Ecopetrol will receive a royalty equal to 20% of production on behalf of the Colombian Government and, in the event a discovery is deemed commercially feasible, Ecopetrol will acquire a 50% interest in the remaining production from the field, bear 50% of the development costs, and reimburse the joint venture, from Ecopetrol's share of future production from each well, for 50% of the joint venture's costs of certain exploration activities. After June 1996, when accumulated oil production from the Santana Contract exceeded seven million barrels, Ecopetrol continued to bear 50% of development costs, but its interest in production revenues and operating costs applicable to wells on the Santana Block increased to 65%. If a commercial field on the Fragua Block produces in excess of 60 million barrels, Ecopetrol's interest in production and costs increases in 5% increments from 50% to 70% as accumulated production from the field increases in 30 million barrel increments from 60 million barrels to 150 million barrels. If a commercial field on the Yuruyaco Block produces in excess of 60 million barrels, Ecopetrol's interest in production and costs ranges from 50% to 75%, based on annual measurements of profitability as defined in the Yuruyaco Contract. The joint venture paid all costs of the exploration program for the Santana Block during the first two years of the contract and thereafter the joint venture and Ecopetrol have been obligated to pay 70% and 30%, respectively, of such exploration costs. The joint venture bears all costs and risks of exploration activities on the Fragua Block and the Yuruyaco Block, subject to Ecopetrol's right to acquire a 50% interest in commercial discoveries. If a discovery is made and is not deemed by Ecopetrol to be commercially feasible, the joint venture may continue to develop the field at its own expense and will recover 200% of the costs thereof, at which time Ecopetrol will acquire a 50% interest therein at no cost to Ecopetrol or further reimbursement by Ecopetrol to Argosy or Neo.
The Company's resulting net participation in revenues and costs for the Santana Contract, the Fragua Contract and the Yuruyaco Contract is as follows:
The joint venture has completed its seismic acquisition and drilling obligations for the first nine years of the Santana Contract, resulting in the discovery of four oil fields, all of which have been declared commercial by Ecopetrol. The joint venture has also completed its seismic obligations for the first two years of the Fragua Contract and the Yuruyaco Contract.
Oil production from the Santana Block moves through the 25-mile Uchupayaco-Santana pipeline built and completed by the joint venture in 1994 to Ecopetrol's Trans-Andean pipeline, where it then is transported an additional 230 miles to the Pacific coast export terminal at Tumaco. Under the terms of a contract with Ecopetrol, all oil produced from the Santana Block is sold to Ecopetrol. If Ecopetrol exports the oil, the price paid is the export price received by Ecopetrol, adjusted for quality differences, less a handling and commercialization fee of $.465 per barrel ($.515 per barrel, effective February 1, 1997). If Ecopetrol does not export the oil, the price paid is based on the price received from Ecopetrol's Cartagena refinery, adjusted for quality differences, less Ecopetrol's cost to transport the crude to Cartagena and a handling and commercialization fee of $.365 per barrel ($.415 per barrel effective February 1, 1997). The average sales price per barrel of oil produced from the Santana Block during 1996 was $19.82. The contract also requires Argosy to pay a tariff to transport its oil through the Trans-Andean pipeline, the amount of which is presently $1.23 per barrel. Under the terms of its contract with Ecopetrol, 25% of all revenues from oil sold to Ecopetrol is paid in Colombian pesos which may only be utilized in Colombia.
In 1994 Argosy entered into a finance agreement with Overseas Private Investment Corporation, an agency of the United States government ("OPIC"), pursuant to which OPIC agreed to guarantee up to $9,200,000 in bank loans to Argosy. The loans were funded in two stages of $4,400,000 in August 1994 and $4,800,000 in October 1995. The Company used these funds to drill development wells and construct pipelines and production facilities in Colombia. OPIC's guaranty is secured by Argosy's interest in the Santana Contract and related assets, as well as the pledge of Garnet's direct and indirect interests in Argosy. The maximum term of the loans is not to exceed seven years, and the principal amortization schedule is based on projected cash flows from wells on the Santana Block. The loans bear interest at the lender's eurodollar deposit rate plus .25% per annum for periods of two, three or six months as selected by Argosy. In consideration for OPIC's guaranty, Argosy pays OPIC a guaranty fee of 2.4% per annum on the outstanding balance of the loans guaranteed.
Argosy's net income, as defined under Colombian law, from Colombian sources is subject to Colombian taxation at a rate of 35%, although a "presumptive" minimum income tax based on net assets may apply under certain circumstances. Unless Argosy transfers such net income to its assigned capital account, an additional remittance tax will accrue at the rate of 12% in 1996, 10% in 1997 and 7% after 1997. Payment of the additional remittance tax, if any, may be deferred under certain circumstances if Argosy has reinvested such income in Colombia. For oil fields discovered before 1995, the Colombian Government also imposes a production tax equal to 7% of the crude oil price through 1997 if the field began producing before 1995, or 5.5%, 4% and 2.5%, respectively, of the crude oil prices in 1998, 1999 and 2000 if the field began producing after 1994.
PAPUA NEW GUINEA.
The PPL-181 Area is located in the Western, Gulf and Southern Highland Provinces of Papua New Guinea. The northern section of the PPL-181 Area is in a mountainous tropical rain forest while the southern section of PPL-181 is predominantly lowlands jungle and coastal swamps. In 1986 oil was discovered approximately 10 miles from the northern border of PPL-181 in an adjoining license area.
Under the terms of an agreement pertaining to PPL-181, Occidental International Exploration and Production Company ("Occidental") has agreed to drill and complete at its cost a test well on the PPL-181 Area by September 1997. The well was commenced in March 1997. PPL-181 is owned by Occidental (88%), Garnet PNG (6%) and Niugini Energy Pty. Limited (6%).
In the first quarter of 1996, an exploratory dry hole was drilled on the PPL-174 area. Garnet PNG contributed approximately $238,000 to the costs of the well.
Under the provisions of PPL-181, the terms of any oil and gas development are set forth in a Petroleum Agreement with the Government of Papua New Guinea. The Petroleum Agreement provides that the operator must carry out an appraisal program after a discovery to determine whether the discovery is of commercial interest. If the appraisal is not carried out or the discovery is not of commercial interest, the license may be forfeited. If the discovery is of commercial interest, the operator must apply for a Petroleum Development License. The Government retains a royalty on production equal to 1.25% of the wellhead value of the petroleum and, at its election, may acquire up to a 22.5% interest in the petroleum development after recoupment by the operator of the project costs attributable thereto out of production. In addition, income from petroleum operations is subject to a Petroleum Income Tax at the rate of 50% of net income, which is defined as gross revenue less royalties, allowances for depreciation, interest deductions, operating costs and previous tax losses carried forward. An Additional Profits Tax of 50% of cash flow (after deducting ordinary income tax payments) is also payable when the accumulated value of net cash flows becomes positive. For annual periods in which net cash flows are negative, the cumulative amount is carried forward and increased at an annual accumulation rate of 27%. The Additional Profits Tax is calculated separately for each Petroleum Development License. In calculating the applicable tax, interest expenses paid by Garnet PNG prior to the issuance of a Petroleum Development License and, thereafter, to the extent that Garnet PNG's debt to equity ratio exceeds two-to-one, are not deductible.
SUPPLEMENTARY INFORMATION IN RESPECT OF OIL AND GAS PROPERTIES.
Reserves Reported to Other Agencies. No estimates of the Company's total proved net oil and gas reserves have been filed with or included in reports to any federal authority or agency other than the Securities and Exchange Commission and OPIC.
Productive Wells and Acreage. As of December 31, 1996, the Company owned 12 gross (1.8 net) productive oil wells and 3,706 gross (923 net) developed acres in Colombia.
Undeveloped Acreage. The following table sets forth estimates of the undeveloped acreage for which oil and gas leases or concessions were held by the Company as of December 31, 1996:
Drilling Activity. The following table sets forth the number of wells drilled by the Company during the three years ended December 31, 1996.
Present Activities. As of December 31, 1996, no wells were in progress.
Additional Information. Reference is made to the Supplemental Oil and Gas Information included in the consolidated financial statements contained in Item 8 of Part II for additional information regarding the Company's oil and gas producing activities prepared in accordance with the requirements of Statement of Financial Accounting Standards No. 69 "Disclosures About Oil and Gas Producing Activities."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings to which the Company is a party or to which any of its property is subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) MARKET INFORMATION.
Shares of Garnet's Common Stock are traded on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol "GARN". The range of reported high and low sales prices for shares of Garnet's Common Stock as supplied by Nasdaq was as follows:
(b) HOLDERS.
As of February 28, 1997, shares of Garnet's Common Stock were held of record by approximately 1,600 persons, including several holders who are nominees for an undetermined number of beneficial owners.
(c) DIVIDENDS.
Garnet has neither declared nor paid any cash dividends on its Common Stock. Under the terms of an agreement with the holders of its 9 1/2% convertible subordinated debentures (the "Debentures"), Garnet has agreed that it will not pay dividends or make distributions to the holders of its Common Stock while the Debentures are outstanding. Any future determination as to declaration and payment of dividends, if permitted, will be made at the discretion of the Board of Directors. The ability to pay dividends may be further restricted by the agreements and regulations described below.
The terms of the guaranty agreement between Argosy and OPIC restrict Argosy's ability to make distributions to its partners prior to the repayment of the guaranteed loans. Also, under the terms of its contracts with Ecopetrol, 25% of all revenues from oil sold to Ecopetrol is paid in Colombian pesos which may only be utilized in Colombia. To date, Argosy has experienced no
difficulty in repatriating the remaining 75% of such payments which are payable in United States dollars.
Upon presentation of a tax clearance certificate evidencing Garnet PNG's compliance with the relevant provisions of Papua New Guinea's income tax laws, profits, dividends and certain other payments, if any, up to an amount of 500,000 kina (approximately $US360,000) per year may be fully remitted out of Papua New Guinea. Amounts in excess of 500,000 kina may also be remitted, subject to clearance from the Bank of Papua New Guinea.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of Part II.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(a) LIQUIDITY AND CAPITAL RESOURCES.
For the three years ended December 31, 1996, the Company expended approximately $21,300,000 for the acquisition, exploration and development of its oil and gas properties. Such expenditures include approximately $19,000,000 for exploration and development activities in Colombia, approximately $550,000 for exploration and related costs in Papua New Guinea, and approximately $1,750,000 for acquisition and exploration activities in Turkey, France, Canada and other countries.
These activities have been financed primarily by proceeds from (i) the issuance of the Debentures in 1993, the net proceeds of which totalled $14,231,000, and (ii) loans guaranteed by OPIC, the net proceeds of which amounted to approximately $8,425,000. The Company has no significant lines of credit.
Argosy and its joint venture partner have completed the seismic acquisition and drilling obligations for the first nine years of the Santana Contract, resulting in the discovery of four oil
fields. The Company is completing the interpretation of additional seismic work performed on the Santana Block in 1996 and, depending upon the results of the seismic interpretation, may drilll an additional exploratory well in 1997 or 1998 on the Santana Block, with estimated total costs to the Company of approximately $1,700,000. The Company also plans to drill up to three additional development wells on the Santana Block in 1997 and 1998. The Company's share of the costs of drilling and completing each of the wells in these fields is expected to range from $1,000,000 to $1,200,000. The seismic programs required during the first two years of the Fragua Contract have also been completed. In early 1997 the Company conducted a seismic program on the Yuruyaco Block, for which its share of the costs was approximately $275,000.
The Toroyaco and Linda fields, the first two fields discovered on the Santana Block, began producing in 1992. The Mary and Miraflor fields, the last two fields discovered, were declared commercial by Ecopetrol in 1993. Production from the four fields is presently approximately 11,000 barrels of oil per day. The Company's share of such production is 15.3%; it also receives an additional 28.4% of the production from one well until it recovers the drilling and completion costs for that well allocable to Ecopetrol but paid by the Company.
As described herein, the Company's operations are primarily located outside the United States. Although certain of such operations are conducted in foreign currencies, the Company considers the U.S. dollar to be the functional currency in most of the countries in which it operates. In addition, the Company has no significant operations in countries with highly inflationary economies. As a result, the Company's foreign currency transaction gains and losses have not been significant. Exchange controls exist for the repatriation of funds from Colombia and Papua New Guinea. See "Market for Registrant's Common Equity and Related Stockholder Matters - Dividends." The Company believes that the continuing viability of its operations in these countries will not be affected by such restrictions.
It is anticipated that the Company's foreign exploration and development activities will require substantial amounts of capital. To finance its planned exploration and development activities, the Company intends to utilize its existing working capital and cash flow from production in Colombia. The Company may also consider entering into additional arrangements whereby certain costs of exploration will be paid by others to earn an interest in the properties. As of December 31, 1996, Garnet was not in compliance with the minimum net worth covenant required by the Debentures. The Debenture holders have waived compliance with this requirement through January 1, 1998 subject to the termination of such waiver on April 30, 1997 if the ratio of the aggregate principal amount of outstanding Debentures to the sum of (i) the number of net barrels of proved oil reserves as of March 31, 1997 plus (ii) the number of net barrels of oil produced during the period from April 1, 1996 through March 31, 1997 is greater than 4.5 to 1. Such ratio was 3.9 to 1 as of December 31, 1996. If Garnet is unable to increase its net worth to the minimum required by January 1, 1998 (or by April 30, 1997 if the waiver is terminated as a result of the failure to maintain the aforementioned ratio), it will be necessary to extend the waiver or renegotiate the terms of the debt, which will otherwise mature in December 1998. In February 1997, Garnet retained Rauscher Pierce Refsnes, Inc. to assist Garnet in negotiating a transaction intended to maximize shareholder value such as a debt restructuring, recapitalization and/or sale of assets. If the Company does not consummate any such transaction prior to the maturity date of the Debentures, the Company will be required to renegotiate the terms of the Debentures or repay the Debentures out of cash flow from operations. If the Company is required to repay the Debentures out of cash flow, in the absence of significant increases in reserves, production or oil prices, it may be necessary for the Company to alter its planned exploration and development activities or take other measures to improve is liquidity.
The present environment for financing the acquisition of oil and gas properties or the ongoing obligations of an oil and gas business is uncertain due, in part, to the substantal instability in oil and gas prices in recent years and to the volatility of financial markets. There can be no assurance that the additional financing which may be necessary to fund the Company's operations and obligations will be available on economically acceptable terms. In addition, the Company's ability to continue its exploration and development programs may be dependent upon its joint venture partners' financing their portion of such costs and expenses. There can be no assurance that the Company's partners will contribute, or be in a position to contribute, their costs and expenses of the joint venture programs. If the Company's partners cannot finance their obligations to the joint ventures, the Company may be required to accept an assignment of the partners' interests therein and assume their financing obligations. If sufficient funds cannot be raised to meet the Company's obligations in connection with its properties, the interests in such properties might be sold or forfeited.
The foregoing discussion contains, in addition to historical information, forward-looking statements. The forward-looking statements were prepared on the basis of certain assumptions which relate, among other things, to costs expected to be incurred in the development of the Company's properties, the receipt of environmental and other necessary administrative permits required for such development, future oil prices, future production rates, and the ability to renegotiate the terms of the Company's outstanding Debentures if the Company is unsuccessful in increasing its net worth. Even if the assumptions on which the projections are based prove accurate and appropriate, the actual results of the Company's operations in the future may vary widely from the financial projections due to unforeseen engineering, mechanical or technological difficulties in drilling or working over wells, regional political issues, general economic conditions, increased competition, changes in government regulation or intervention in the oil and gas industry, and other risks described herein. Accordingly, the actual results of the Company's operations in the future may vary widely from the forward-looking statements included herein.
(b) RESULTS OF OPERATIONS.
The Company incurred net losses of $2,059,897 ($.18 per share), $4,623,322 ($.40 per share) and $7,425,527 ($.67 per share) for the years ended December 31, 1996, 1995 and 1994, respectively.
Increases in 1996 in oil and gas revenues, production costs and depreciation, depletion and amortization reflect higher oil prices, and production from new wells and fracture stimulation treatments on existing wells in Colombia. Production costs per barrel decreased because of a cost reduction program implemented in the third quarter of 1995. The effect of these increases was partially offset in 1996 by the contractual reduction in the Company's percentage share of production in the second quarter of 1996. The Company's comparative average daily sales volumes, average sales prices and costs per barrel in Colombia for such periods were as follows, expressed in barrels of oil per day ("BOPD"):
During 1994 the Company recorded as expense the costs of a dry hole drilled in Turkey ($576,250), investments in leases, license blocks or permit applications in Canada ($583,500), Turkey ($1,174,080) and France ($186,000), costs pertaining to oil and gas exploration activities in other countries ($74,532), and interest previously capitalized in connection with these activities ($220,448). Based on declining market conditions for sales of oil and gas properties and management's expectations of the amounts to be realized from disposition of the remaining royalty and mineral interests acquired in mergers in 1991, the Company further reduced the carrying value of such assets by $1,900,000 in 1994. During 1995 the Company charged to expense its remaining investments in Papua New Guinea ($609,700) and France ($672,592), costs pertaining to oil and gas exploration in other countries ($74,461), and interest previously capitalized in connection with these activities ($190,525). During 1996 the Company recorded a loss of $42,748 on the final disposition of the royalty and mineral assets, and charged to expense $40,112 pertaining to ongoing costs in countries other than Colombia.
Interest income in 1996 and 1995 declined from 1994 as a consequence of the expenditure of cash balances. General and administrative expenses decreased in 1996 as a result of the absence of nonrecurring severance costs incurred in connection with management changes, and legal and professional fees in 1995 relating to the consideration of a business combination, as well as a cost reduction program implemented in the third quarter of 1995. The increases in interest expense, net of amounts capitalized, resulted from the receipt of the OPIC-guaranteed loans in 1994 and 1995, and decreases in costs attributable to assets eligible for interest capitalization. The provision for current income taxes, all of which relates to Colombian operations, was higher each year because of increases in the Colombian presumptive income tax attributable to ongoing capital expenditures related to productive assets. These increases were partially offset by the effects of a deferred tax benefit recorded in 1994. The foreign currency translation gain recorded in 1995 resulted from an approximate 19% devaluation in the Colombian peso during 1995 and the settlement of a liability.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Financial Statements and Financial Statement Schedules included separately herein.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required with respect to directors is set forth under the caption "Election of Directors" in Garnet's definitive Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.
The following table lists the names, ages, and principal occupations of each of the executive officers of Garnet. Each executive officer serves at the discretion of the Board of Directors.
Montague H. Hackett, Jr. Mr. Hackett has been employed as Chairman of the Board of Garnet since January 1995 and has served as a director of Garnet since April 1987. Since January 1996, Mr. Hackett has been employed by Victory Ventures LLC, a privately held limited liability company ("Victory") that conducts its operations through small and medium-sized companies in which Victory holds controlling or other significant equity interests. From October 1989 through June 1994, Mr. Hackett served as President and as a director of Wood River Capital Corporation, a Small Business Investment Company. From October 1991 through December 1995, Mr. Hackett was also employed by Noel Group, Inc., a publicly traded company which also conducts its operations through small and medium-sized companies
Douglas W. Fry. Mr. Fry has been employed as President of Garnet and has served as a director of Garnet since September 1995, and has been Chief Executive Officer of Garnet since February 1996. Since 1980 he has also been President of Argosy Energy Incorporated, a wholly owned subsidiary of Garnet, or of the subsidiary's predecessor.
W. Kirk Bosche'. Mr. Bosche' has served as Vice President and Treasurer of Garnet since its inception, and as Secretary of Garnet since February 1996.
Edgar L. Dyes. Mr. Dyes has served as Vice President - Finance of Garnet since February 1997. From February 1991 through February 1997, he was employed by Argosy in Colombia, most recently as Vice President - Finance and Administration.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required is set forth under the captions "Executive Compensation" and "Certain Relationships and Related Transactions" in Garnet's definitive Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required is set forth under the caption "Security Ownership of Certain Beneficial Owners" in Garnet's definitive Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required is set forth under the caption "Certain Relationships and Related Transactions" in Garnet's definitive Proxy Statement to be filed pursuant to Regulation 14A and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
a. The following documents are filed as part of this report:
(1)-(2) Financial statements and financial statement schedules - see the accompanying Index to Financial Statements and Financial Statement Schedule.
(3) Exhibits - see the accompanying Index of Exhibits.
b. No Reports on Form 8-K were filed by Registrant during the three months ended December 31, 1996.
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.
GARNET RESOURCES CORPORATION (Registrant)
By: /s/ Douglas W. Fry ------------------------------ Douglas W. Fry President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
PAGE ---- GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants Consolidated Balance Sheets, December 31, 1996 and 1995 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements Supplemental Oil and Gas Information
GARNET RESOURCES CORPORATION FINANCIAL STATEMENT SCHEDULE
Schedule I - Condensed Financial Information of Registrant Balance Sheets, December 31, 1996 and 1995 Statements of Operations for the years ended December 31, 1996, 1995 and 1994 Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Garnet Resources Corporation:
We have audited the accompanying consolidated balance sheets of Garnet Resources Corporation (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Garnet Resources Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule listed in the index to financial statements and financial statement schedule is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. The financial statement schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Houston, Texas March 20, 1997
GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS CONTINUED
The accompanying notes are an integral part of these consolidated financial statements.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED
The accompanying notes are an integral part of these consolidated financial statements.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES-
Nature of operations-
Garnet Resources Corporation, a Delaware corporation ("Garnet"), and its subsidiaries (collectively referred to as the "Company") are engaged in the exploration, development and production of oil and gas properties located outside the United States. The Company operates primarily in Colombia and Papua New Guinea.
Principles of consolidation-
The consolidated financial statements include the accounts of Garnet and its majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated. The Company accounts for its investment in Argosy Energy International, a limited partnership ("Argosy") in which Garnet is a limited partner and a wholly owned subsidiary of Garnet is the general partner (see Note 2), using the proportionate consolidation method.
Cash equivalents-
Cash equivalents include highly liquid debt instruments with an initial maturity of three months or less at the date of purchase. The Company had no cash equivalents at December 31, 1996 and 1995.
Inventories-
Inventories consist of oilfield equipment, materials and supplies, and crude oil. For presentation in the accompanying consolidated statements of cash flows, changes in oilfield equipment inventory are included as investing activities because they relate to the Company's exploration and development activities, while changes in other types of inventories are included as operating activities.
Oil and gas properties-
The Company follows the full-cost method of accounting for oil and gas properties. Under this method, all productive and nonproductive costs incurred in connection with the exploration and development of oil and gas reserves are capitalized in separate cost centers for each country. Such capitalized costs include contract and concession acquisition, geological, geophysical and other exploration work, drilling, completing and equipping oil and gas wells, constructing production facilities and pipelines, and other related costs. The Company also capitalizes interest costs related to unevaluated oil and gas properties. The Company incurred total interest costs of $2,410,958, $2,252,483 and $1,831,803 in 1996, 1995 and 1994, respectively, of which $302,612, $761,352 and $831,677 were capitalized as additional costs of oil and gas properties.
The capitalized costs of oil and gas properties in each cost center are amortized on a composite unit-of-production method based on future gross revenues from proved reserves. Sales
or other dispositions of oil and gas properties are normally accounted for as adjustments of capitalized costs. Gain or loss is not recognized in income unless a significant portion of a cost center's reserves is involved. Capitalized costs associated with the acquisition and evaluation of unproved properties are excluded from amortization until it is determined whether proved reserves can be assigned to such properties or until the value of the properties is impaired. Unproved properties are assessed at least annually to determine whether any impairment has occurred. If the net capitalized costs of oil and gas properties in a cost center exceed an amount equal to the sum of the present value of estimated future net revenues from proved oil and gas reserves in the cost center and the costs of properties not being amortized, both adjusted for income tax effects, such excess is charged to expense.
Revenue recognition-
Oil and gas revenues from producing wells are recognized when the oil or gas is sold.
Stock-based compensation-
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), encourages but does not require companies to record compensation costs for stock-based employee plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair market value of Garnet's common stock at the date of grant over the amount an employee must pay to acquire the stock.
Net loss per share-
Net loss per share is computed using the weighted average number of shares of common stock outstanding. No effect was given to common stock equivalents as the effect would be antidilutive.
Use of estimates-
The preparation of these financial statements requires the use of certain estimates by management in determining the Company's assets, liabilities, revenues and expenses. Depreciation, depletion and amortization of oil and gas properties and the impairment of oil and gas properties are determined using estimates of oil and gas reserves. There are numerous uncertainties in estimating the quantity of proved reserves and in projecting the future rates of production and timing of development expenditures. Reference is made to the Supplemental Oil and Gas Information for additional information regarding the process of estimating proved reserve quantities and related cash flows.
(2) COLOMBIAN OPERATIONS-
Through its ownership of interests in Argosy, the Company has an indirect interest in a risk sharing contract in Colombia (the "Santana Contract") with Empresa Colombiana de Petroleos, the Colombian national oil company ("Ecopetrol"). The Santana Contract currently entitles Argosy and its joint venture partner to explore for oil and gas on approximately 86,000 acres located in the Putumayo Region of Colombia (the "Santana Block") and provides for a ten-year exploration period expiring in 1997, subject to a requirement for additional partial relinquishments in 1997, and for a production period expiring in 2015. Argosy and its joint venture partner also have two association
contracts (the "Fragua Contract" and the "Yuruyaco Contract") with Ecopetrol. The Fragua Contract covers an area of approximately 32,000 acres contiguous to the northern boundary of the Santana Block (the "Fragua Block"), while the Yuruyaco Contract covers an area of approximately 39,000 acres contiguous to the eastern boundaries of the Santana Block and the Fragua Block (the "Yuruyaco Block"). The 10-year exploration periods provided by the Fragua Contract and the Yuruyaco Contract will expire in 2002 and 2005, respectively, and the 28-year contract terms will expire in 2020 and 2023, respectively. Argosy and its joint venture partner also have the right until 2003 to explore for and produce oil and gas from approximately 77,000 acres located in the Putumayo Region (the "Aporte Putumayo Block") pursuant to other agreements with Ecopetrol. Argosy and its joint venture partner notified Ecopetrol in 1994 that they intend to abandon the remaining wells and relinquish the Aporte Putumayo Block because declining production rates have made continued operation economically unattractive.
Argosy serves as the operator of the Colombian properties under joint venture agreements. The Santana Contract, the Fragua Contract and the Yuruyaco Contract provide that Ecopetrol will receive a royalty equal to 20% of production on behalf of the Colombian government and, in the event a discovery is deemed commercially feasible, Ecopetrol will acquire a 50% interest in the remaining production from the field, bear 50% of the development costs, and reimburse the joint venture, from Ecopetrol's share of future production from each well, for 50% of the joint venture's costs of successful exploratory wells in the field. After June 1996, when accumulated oil production from the Santana Contract exceeded seven million barrels, Ecopetrol continued to bear 50% of development costs, but its interest in production revenues and operating costs applicable to wells on the Santana Block increased to 65%. If a commercial field on the Fragua Block produces in excess of 60 million barrels, Ecopetrol's interest in production and costs will increase in 5% increments from 50% to 70% as accumulated production from the field increases in 30 million barrel increments from 60 million barrels to 150 million barrels. If a commercial field on the Yuruyaco Block produces in excess of 60 million barrels, Ecopetrol's interest in production and costs ranges from 50% to 75%, based on annual measurements of profitability as defined in the Yuruyaco Contract. The joint venture paid all costs of the exploration program for the Santana Block during the first two years of the contract and thereafter the joint venture and Ecopetrol have been obligated to pay 70% and 30%, respectively, of such exploration costs. The joint venture bears all costs and risks of exploration activities on the Fragua Block and the Yuruyaco Block, subject to Ecopetrol's right to acquire a 50% interest in commercial discoveries. If a discovery is made and is not deemed by Ecopetrol to be commercially feasible, the joint venture may continue to develop the field at its own expense and will recover 200% of the costs thereof, at which time Ecopetrol will acquire a 50% interest therein at no cost to Ecopetrol or further reimbursement by Ecopetrol to Argosy.
In March 1995 the Company increased its ownership in Argosy by exchanging 366,625 shares of Garnet's common stock with a value of $3.00 per share and cash totalling $142,703 for the partnership interests held by certain of Argosy's limited partners.
The Company's resulting net participation in revenues and costs for the Santana Contract, the Fragua Contract and the Yuruyaco Contract is as follows:
The joint venture has completed its seismic acquisition and drilling obligations for the first nine years of the Santana Contract, resulting in the discovery of four oil fields, all of which have been declared commercial by Ecopetrol. The joint venture has the right to continue the exploration program through 1997. The joint venture has also completed its seismic obligations for the first two years of the Fragua Contract and the Yuruyaco Contract.
Under the terms of a contract with Ecopetrol, all oil produced from the Santana Block is sold to Ecopetrol. If Ecopetrol exports the oil, the price paid is the export price received by Ecopetrol, adjusted for quality differences, less a handling and commercialization fee of $.465 per barrel ($.515 per barrel, effective February 1, 1997). If Ecopetrol does not export the oil, the price paid is based on the price received from Ecopetrol's Cartagena refinery, adjusted for quality differences, plus or minus a sales value differential to be determined by independent analysis, less Ecopetrol's cost to transport the crude to Cartagena and a handling and commercialization fee of $.365 per barrel ($.415 per barrel, effective February 1, 1997) Under the terms of its contract with Ecopetrol, 25% of all revenues from oil sold to Ecopetrol is paid in Colombian pesos which may only be utilized in Colombia. To date, Argosy has experienced no difficulty in repatriating the remaining 75% of such payments which are payable in United States dollars.
As general partner, the Company's subsidiary is contingently liable for any obligations of Argosy and may be contingently liable for claims generally related to the conduct of Argosy's business.
(3) EXPLORATION LICENSES IN PAPUA NEW GUINEA-
Garnet PNG Corporation, a wholly owned subsidiary of Garnet ("Garnet PNG"), owns a 6% interest (the "PPL-181 Interest") in Petroleum Prospecting License No. 181 ("PPL-181") which covers 952,000 acres (the "PPL-181 Area"). Garnet PNG also held a 7.73% interest in an adjoining license, Petroleum Prospecting License No. 174, on which an exploratory dry hole was drilled in the first quarter of 1996. In 1986, oil was discovered approximately 10 miles from the northern border of the PPL-181 Area in an adjoining license area.
Under the terms of an agreement pertaining to PPL-181, Occidental International Exploration and Production Company ("Occidental") agreed to drill and complete at its cost a test well on the PPL-181 Area by September 1997. PPL-181 is owned by Occidental (88%), Garnet PNG (6%) and Niugini Energy Pty. Limited (6%).
Upon presentation of a tax clearance certificate evidencing Garnet PNG's compliance with the relevant provisions of Papua New Guinea's income tax laws, profits, dividends and certain other payments, if any, up to an amount of 500,000 kina (approximately $US360,000) per year may be fully remitted out of Papua New Guinea. Amounts in excess of 500,000 kina may also be remitted, subject to clearance from the Bank of Papua New Guinea.
(4) LONG-TERM DEBT-
Long-term debt at December 31, 1996 and 1995 consisted of the following:
In December 1993 Garnet issued $15,000,000 of convertible subordinated debentures (the "Debentures") due December 1998. The Debentures bear interest at 9 1/2% per annum payable quarterly and are convertible at the option of the holders into Garnet common stock at $5.50 per share. If the Company elects to prepay the Debentures under certain circumstances, it will issue warrants under the same economic terms as the Debentures. At the option of a holder, in the event of a change of control of the Company, the Company will be required to prepay such holder's Debenture at a 30% premium. The Debentures are secured by a pledge of all of the common stock of Garnet's wholly owned subsidiary which serves as the general partner of Argosy (see Note 2). Under the terms of an agreement with the holders of its Debentures, Garnet has agreed that it will not pay dividends or make distributions to the holders of its common stock. As of December 31, 1996, Garnet was not in compliance with the minimum net worth required by the Debentures. The Company has classified the Debentures as long-term debt in the accompanying consolidated balance sheets because the Debenture holders have waived compliance with this requirement through January 1, 1998 subject to the termination of such waiver on April 30, 1997 if the ratio of the aggregate principal amount of outstanding Debentures to the sum of (i) the number of net barrels of proved oil reserves as of March 31, 1997 plus (ii) the number of net barrels of oil produced during the period from April 1, 1996 through March 31, 1997 is greater than 4.5 to 1. Such ratio was 3.9 to 1 as of December 31, 1996.
In 1994 Argosy entered into a finance agreement with Overseas Private Investment Corporation, an agency of the United States government ("OPIC"), pursuant to which OPIC agreed to guarantee up to $9,200,000 in bank loans to Argosy. The loans were funded in two stages of $4,400,000 in August 1994 and $4,800,000 in October 1995. The Company used these funds to drill development wells and construct pipelines and production facilities in Colombia. OPIC's
guaranty is secured by Argosy's interest in the Santana Contract and related assets, as well as the pledge of Garnet's direct and indirect interests in Argosy. The terms of the guaranty agreement also restrict Argosy's ability to make distributions to its partners prior to the repayment of the guaranteed loans. The maximum term of the loans is not to exceed seven years, and the principal amortization schedule is based on projected cash flows from wells on the Santana Block. The loans bear interest at the lender's eurodollar deposit rate plus .25% per annum for periods of two, three or six months as selected by Argosy. The interest rate at December 31, 1996 was 5.78%. In consideration for OPIC's guaranty, Argosy pays OPIC a guaranty fee of 2.4% per annum on the outstanding balance of the loans guaranteed . As of December 31, 1996, Argosy was not in compliance with the debt service coverage ratios required under the finance agreement. OPIC has waived compliance with this requirement through January 1, 1998.
In 1993 Argosy received a loan from a Colombian bank, which was secured by receivables from Ecopetrol for well costs allocable to Ecopetrol but paid by Argosy. The loan bore interest at U.S. prime plus 2%, and was repaid in varying amounts from Ecopetrol's share of production from the wells, with the final installment paid in the third quarter of 1996.
(5) STOCK OPTION PLANS-
Garnet and a predecessor entity have adopted stock option plans (the "Employee Plans") pursuant to which an aggregate of 1,478,000 shares of Garnet's common stock is authorized to be issued upon exercise of options granted to officers, employees and certain other persons or entities performing substantial services for or on behalf of Garnet or its subsidiaries.
The Stock Option and Compensation Committee of Garnet's Board of Directors (the "Committee") is vested with sole and exclusive authority to administer and interpret the Employee Plans, to determine the terms upon which options may be granted, to prescribe, amend and rescind such interpretations and determinations and to grant options to directors. Current Committee members are not eligible to receive options under the Employee Plans.
In addition, Garnet has adopted the 1990 Directors' Stock Option Plan (the "1990 Directors' Plan") pursuant to which an aggregate of 265,000 shares of Garnet's common stock was issuable as of December 31, 1996 upon exercise of options granted thereunder to directors who are not employees of the Company. As the 1990 Directors' Plan expired in accordance with its terms on March 8, 1996, no further options may be issued thereunder.
Each option is exercisable for a period of 10 years and 30 days from the date of grant. The purchase price of shares issuable upon exercise of an option may be paid in cash or by delivery of shares with a value equal to the exercise price of the option. The Committee has determined that the right to exercise non-incentive options issued to employees vests over a period of four years, so that 20% of the option is exercisable on the date of grant and 20% becomes exercisable on each anniversary of the date of grant. Non-incentive options issued to directors and other eligible participants generally are fully exercisable on and after the date of grant.
Company has adopted the disclosure-only provisions of SFAS 123. Accordingly no compensation cost has been recognized for the Employee Plans and the Directors' Plan. Had compensation cost for these plans been determined based on the fair value at the grant date for awards in 1996 and 1995 consistent with the provisions of SFAS 123, the Company's net loss and net loss per share would have been increased to the pro forma amounts indicated below.
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
The following is a summary of stock option activity and related information for 1996, 1995 and 1994.
The following table summarizes information about stock options outstanding at December 31, 1996:
(6) INCOME TAXES-
Income (loss) before income taxes and the provision for income taxes consisted of the following:
The provisions for income taxes and deferred income taxes payable relate to the Colombian activities of Argosy. No United States deferred taxes were provided because the tax bases of the Company's assets exceed the financial statement bases, resulting in a deferred tax asset which the Company has determined is not presently realizable.
The Company's net deferred income tax liabilities as of December 31, 1996 and 1995 were as follows:
Temporary differences included in the deferred tax liabilities related primarily to property and equipment. Deferred tax assets principally consisted of net operating loss carryforwards.
As of December 31, 1996, the Company had a regular tax net operating loss carryforward and an alternative minimum tax loss carryforward of approximately $30,200,000 and $29,800,000, respectively. These loss carryforwards will expire beginning in 2001 if not utilized to reduce U.S. income taxes otherwise payable in future years, and are limited as to utilization because of the occurrences of "ownership changes" (as defined in Section 382 of the Internal Revenue Code of 1986, as amended) in 1991 and earlier years. Such loss carryforwards also exclude regular tax net operating loss carryforwards aggregating approximately $4,500,000 attributable to certain of Garnet's subsidiaries, which can be used in certain circumstances to offset taxable income generated by such subsidiaries.
(7) FAIR VALUE OF FINANCIAL INSTRUMENTS-
The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities approximate fair value because of the short maturity of these items. The carrying amounts of notes payable by Argosy to U.S. and Colombian banks approximate fair value because the interest rates on these instruments change with market interest rates. There are no quoted market prices for the Debentures. Because the Debentures are convertible into shares of Garnet's common stock, the fair value of the Debentures is contingent on market prices for the common stock, the value of the Company's assets, and the results of its operations. In addition the Debentures contain unique terms, conditions, covenants and restrictions. Consequently the Company is unable to estimate the fair value of the Debentures.
(8) CONCENTRATION OF CREDIT RISK-
During the years ended December 31, 1996, 1995 and 1994, all of the Company's oil production was purchased by Ecopetrol. As of December 31, 1996 and 1995, accounts receivable included approximately $2,866,000 and $1,513,000, respectively, from Ecopetrol. The Company believes that its oil production could be sold to other purchasers at similar prices in lieu of sales to Ecopetrol.
(9) OPERATIONS BY GEOGRAPHIC AREA-
The Company operates in one industry segment. Information about the Company's operations for the years ended December 31, 1996, 1995 and 1994 by different geographic areas is shown below.
The operating loss in other foreign areas represents oil and gas acquisition and exploration costs charged to expense, of which $674,554 was in Papua New Guinea, $798,263 was in France and $74,461 was in other countries.
The operating loss in the United States reflects a provision for loss on net assets held for disposition of $1,900,000. The operating loss in other foreign areas represents oil and gas acquisition, exploration and capitalized interest costs charged to expense, of which $1,878,094 was in Turkey, $651,913 was in Canada, $206,625 was in France, and $78,177 was in other countries.
GARNET RESOURCES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL OIL AND GAS INFORMATION
The following tables set forth information about the Company's oil and gas producing activities pursuant to the requirements of SFAS No. 69 "Disclosures About Oil and Gas Producing Activities."
CAPITALIZED COSTS DECEMBER 31, ------------------------------ 1996 1995 ------------ ------------
Proved properties $ 56,500,390 $ 46,044,011
Unproved properties 227,846 4,598,001 ------------ ------------
56,728,236 50,642,012
Accumulated depreciation, depletion and amortization (17,610,628) (11,286,629) ------------ ------------
Net capitalized costs $ 39,117,608 $ 39,355,383 ============ ============
As of December 31, 1996 and 1995, all capitalized costs pertained to oil and gas properties in Colombia.
The Company's investment in oil and gas properties as of December 31, 1996 includes $227,846 in unevaluated properties which have been excluded from amortization. Such costs will be evaluated in future periods based on management's assessment of exploration activities, expiration dates of licenses, permits and concessions, changes in economic conditions and other factors.
RESULTS OF OPERATIONS
During the years ended December 31, 1996, 1995 and 1994, all of the Company's oil and gas producing operations were located in Colombia.
During 1996, 1995 and 1994 the Company also charged to expense a total of $40,112, $1,547,278 and $2,814,809 respectively, of acquisition and exploration costs pertaining to its activities in other foreign areas.
OIL AND GAS RESERVE QUANTITIES (UNAUDITED)
Proved reserves represent estimated quantities of crude oil and natural gas which geological and engineering data demonstrate to be reasonably recoverable in the future from known reservoirs under existing economic and operating conditions. Proved developed reserves can be expected to be recovered through existing wells with existing equipment and operating methods.
Estimates of proved and proved developed oil and gas reserves are subject to numerous uncertainties inherent in the process of developing the estimates including the estimation of the reserve quantities and estimated future rates of production and timing of development expenditures. The accuracy of any reserve estimate is a function of the quantity and quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of the estimate may justify revision of such estimate. Additionally, the estimated volumes to be commercially recoverable may fluctuate with changes in prices of oil and natural gas.
Estimates of the Company's proved reserves and related valuations, as shown in the following tables, were developed pursuant to SFAS No. 69. Estimates of future recoverable oil reserves and projected future net revenues were provided by Huddleston & Co., Inc. The Company's proved reserves were comprised entirely of crude oil in Colombia, and are stated in barrels.
The following tables present the standardized measure of discounted future net cash flows relating to proved oil and gas reserves and the changes in the standardized measure of discounted future net cash flows. Future cash inflows and costs were computed using prices and costs in effect at the end of the applicable year without escalation. Future income taxes were computed by applying the appropriate statutory income tax rate to the pretax future net cash flows reduced by future tax deductions and net operating loss carryforwards.
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
The standardized measure of discounted future net cash flows does not purport to present the fair market value of the Company's proved reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves in excess of proved reserves, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates.
SCHEDULE I
GARNET RESOURCES CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
DECEMBER 31, ------------------------------ ASSETS 1996 1995 ------ ------------ ------------
CURRENT ASSETS: Cash $ 86,119 $ 1,088,683 Accounts receivable 494,261 1,986,660 Prepaid expenses 24,124 26,100 ------------ ------------
Total current assets 604,504 3,101,443 ------------ ------------
INVESTMENTS IN AND ADVANCES TO SUBSIDIARIES 34,427,950 34,079,600 ------------ ------------
PROPERTY AND EQUIPMENT, at cost: Furniture and equipment 69,928 63,918 Less - Accumulated depreciation (41,731) (47,064) ------------ ------------
28,197 16,854 ------------ ------------
OTHER ASSETS 309,497 459,062 ------------ ------------
$ 35,370,148 $ 37,656,959 ============ ============
These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of Part II.
SCHEDULE I
GARNET RESOURCES CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(CONTINUED)
These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of Part II.
SCHEDULE I
GARNET RESOURCES CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of Part II.
SCHEDULE I
GARNET RESOURCES CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of Part II.
INDEX OF EXHIBITS
* Incorporated by reference