ITEM 1 - BUSINESS
Hallwood Energy Partners, L.P. ("HEP" or the "Partnership"), is a publicly traded Delaware limited partnership engaged in the production and sale of oil and gas and in the acquisition, exploration, development and operation of oil and gas properties. The principal objectives of HEP are to maintain or expand its reserve base and to provide cash distributions to the holders of its units of limited partner interests ("Units"). HEPGP Ltd. became the general partner of HEP on November 26, 1996 after the former general partner, Hallwood Energy Corporation ("HEC") merged into The Hallwood Group Incorporated ("Hallwood Group"). HEPGP Ltd. is a limited partnership of which Hallwood Group is the limited partner and Hallwood G.P., Inc. ("Hallwood G.P.), a wholly owned subsidiary of Hallwood Group, is the general partner. HEP commenced operations in August 1985 after completing an exchange offer in which HEP acquired oil and gas properties and operations from HEC, 24 oil and gas limited partnerships of which HEC was the general partner and certain working interest owners that had participated in wells with HEC and the limited partnerships.
The activities of HEP are conducted by HEP Operating Partners, L.P. ("HEPO") and EDP Operating, Ltd. ("EDPO"). HEP is the sole limited partner and HEPGP Ltd. is the sole general partner of HEPO and of EDPO. Solely for purposes of simplicity herein, unless otherwise indicated, all references to HEP in connection with the ownership, exploration, development or production of oil and gas properties include HEPO and EDPO.
HEP does not engage in any other line of business nor does it have any employees. Hallwood Petroleum, Inc. ("HPI"), an affiliated entity, operates the properties and administers the day to day activities of HEP and its affiliates. On March 20, 1997, HPI had 127 employees.
Marketing
The oil and gas produced from the properties owned by HEP has typically been marketed through normal channels for such products. Oil is generally sold to purchasers at a premium over field prices posted by the principal purchasers of crude oil in the areas where the majority of producing properties are located. In response to the volatility in the oil markets, HEP entered into financial contracts for hedging the price of between 3% and 46% of its estimated oil production for 1997 through 1999.
The majority of HEP's gas production is sold on the spot market and is transported in intrastate and interstate pipelines. HEP entered into financial contracts for hedging the price of between 18% and 54% of its estimated gas production for 1997 through 2000.
The purpose of the hedges is to provide protection against price drops and to provide a measure of stability in the volatile environment of oil and natural gas spot pricing. The amounts received or paid upon settlement of these contracts is recognized as oil or gas revenue at the time the hedged volumes are sold.
Both oil and natural gas are purchased by refineries, major oil companies, public utilities, industrial customers and other users and processors of petroleum products. HEP is not confined to, nor dependent upon, any one purchaser or small group of purchasers. Accordingly, the loss of a single purchaser, or a few purchasers, would not materially affect HEP's business because there are numerous purchasers in the areas in which HEP sells its production. However, for the years ended December 31, 1996, 1995 and 1994, purchases by the following companies exceeded 10% of the total oil and gas revenues of the Partnership:
1996 1995 1994 ---- ---- ----
Conoco Inc. 28% 30% 23% Marathon Petroleum Company 11% 14% 12%
Factors, if they were to occur, which might adversely affect HEP include decreases in oil and gas prices, the reduced availability of a market for production, rising operational costs of producing oil and gas, compliance with, and changes in, environmental control statutes and increasing costs of transportation.
Competition
In the course of its exploration and development activities, HEP must compete with other entities for the acquisition of undeveloped acreage and desirable leaseholds. As described above under "Marketing," production is sold on the spot market, thereby reducing sales competition; however, oil and gas must compete with coal, atomic energy, hydro-electric power and other forms of energy.
Regulation
Production and sale of oil and gas is subject to federal and state governmental regulation in a variety of ways, including environmental regulations, labor laws, interstate sales, excise taxes and federal and Indian lands royalty payments. Failure to comply with these regulations may result in fines, cancellation of licenses to do business and cancellation of federal, state or Indian leases.
The production of oil and gas is subject to regulation by the state regulatory agencies in the states in which HEP does business. These agencies make and enforce regulations to prevent waste of oil and gas and to protect the rights of owners to produce oil and gas from a common reservoir. The regulatory agencies regulate the amount of oil and gas produced by assigning allowable production rates to wells capable of producing oil and gas.
Environmental Considerations
The exploration for, and development of, oil and gas involve the extraction, production and transportation of materials which, under certain conditions, can be hazardous or can cause environmental pollution problems. In light of the current interest in environmental matters, the general partner cannot predict what effect possible future public or private action may have on the business of HEP. The general partner is continually taking actions it believes are necessary in its operations to ensure conformity with applicable federal, state and local environmental regulations and does not presently anticipate that the compliance with federal, state and local environmental regulations will have a material adverse effect upon capital expenditures, earnings, cash flows or the competitive position of HEP in the oil and gas industry.
Insurance Coverage
HEP is subject to all the risks inherent in the exploration for, and development of, oil and gas, including blowouts, fires and other casualties. HEP maintains insurance coverage as is customary for entities of a similar size engaged in operations similar to that of HEP, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not insured or not fully insured could have an adverse impact upon HEP's earnings, cash flows and financial position.
ITEM 2
ITEM 2 - PROPERTIES
Exploration and Development Projects
In 1996, HEP incurred $12,615,000 in direct property additions and exploration and development costs, and approximately $441,000 for the purchase of HCRC shares. The costs were comprised of approximately $9,467,000 for domestic exploration and development expenditures and approximately $3,148,000 for property acquisitions. In 1996, HEP participated in approximately 120 drilling or recompletion projects, the highlights of which are discussed below. HEP's 1996 capital program led to the replacement, through drilling and acquisitions, of 75% of the equivalent barrels produced during 1996. Overall replacement, including revisions to prior year reserves, was 145% of 1996 production. Sales of reserves in place in 1996 which were approximately 8% of 1996 production, were excluded from this calculation. Approximately $1,325,000 of the 1996 capital expenditures were for land and seismic data anticipated to yield prospects for 1997 and subsequent years.
Property Sales
During the first quarter of 1996, HEP received approximately $1,300,000 for the sale of its interests in the Hoople Field in Crosby County, Texas. HEP also received $88,000 in early April for the sale of various nonstrategic properties at auction. In June 1996, HEP completed the sale of its interests in the Bethany Longstreet area of Louisiana (approximately 575,000 equivalent barrels of oil, measured using December 31, 1995 pricing) for approximately $3,800,000.
Capital Projects
During the second quarter of 1996, HEP purchased 12,965 shares of common stock of HCRC for $34 per share. The shares were originally purchased by HCRC in connection with an odd lot repurchase offer and then were resold to HEP at the price paid by HCRC for such shares.
HEP continued to devote capital resources to the West Texas Kermit area in 1996. During 1996, HEP drilled or participated in the drilling of seventeen wells, fifteen of which were successful, and participated in nine recompletions, six of which were successful, for a total cost to HEP of approximately $1,359,000. The wells in this area are currently producing approximately 750 gross equivalent barrels of oil per day. HEP's interest in these wells averages 22%. HEP plans to drill or recomplete up to fifteen additional wells in 1997. HEP has begun discussing secondary recovery operations with the other working interests owners.
During 1996, HEP acquired 106 square miles of three dimensional (3-D) seismic data on the Cowden Ranch in Crane County, Texas. The prospect is operated by a major oil company, and HEP has a 12.5% working interest. HEP's share of costs in 1996 is $435,000. Seismic interpretation was completed in the third quarter. Two exploratory wells, both of which were dry, were drilled in the fourth quarter at a cost to HEP of $160,000, and a third exploratory well is being drilled in 1997.
HEP acquired 3-D seismic data and related acreage in the Merkel Project Area which covers 18 square miles in Jones, Taylor and Nolan Counties, Texas. Expenditures by HEP during 1996 totaled $515,000. Thus far, HEP has participated in drilling eight wells on four exploration prospects for a total cost to HEP of $184,000, including one well drilled in late 1995. Seven of the eight wells have been successful. These wells are currently producing approximately 375 gross barrels of oil per day. HEP's nonoperating interest in this production is 9%. HEP acquired an additional 74 square miles of 3-D seismic data, which is presently being interpreted in the same area. HEP's working interest in this area averages 27.5%, and prospect exploratory drilling will begin in the first quarter of 1997. HEP anticipates at least ten prospects will be tested in 1997 and subsequent years on this portion of the project area.
HEP participated in the drilling of two nonoperated wells in Williams County, North Dakota in the latter part of 1995 and the first quarter of 1996, one of which was dry and the other only marginally successful, for a total cost to HEP of approximately $330,000. HEP also drilled an exploratory dry hole in Richland County, Montana, at a cost of $150,000. HEP completed an Interlake Formation development well, drilled in the second quarter, at a total cost to HEP of approximately $600,000. This well is currently producing at a rate of 80 gross barrels of oil per day, and HEP's interest is 45%.
HEP incurred approximately $235,000 in the first quarter, net to HEP's interest, for four recompletions and one drilled well in the Rocker "b" Ranch in Reagan County, Texas. During the first quarter, HEP also acquired interests in five additional producing leases on the Rocker "b" Ranch for a total of $93,000. In prior years, HEP financed $6,033,000 of its drilling through Hallwood Spraberry Drilling Company, L.L.C. ("HSD") on the Rocker "b" Ranch. Effective April 1, 1996, HEP repaid its share of the debt of HSD through additional borrowings under its bank credit agreement and assumed direct ownership of its share of HSD's properties. In the second and third quarters of 1996, HEP recompleted seven wells, three of which were successful, and drilled one additional well for a total cost to HEP of $270,000. Current production from all Rocker "b" 1996 capital projects averages 185 gross equivalent barrels of oil per day. HEP's share of this production is approximately 29%. Minimal additional drilling or workovers are expected in the area in 1997. HEP drilled or worked over a total of 95 wells in this area over the past three years.
In the San Juan Basin area, HEP acquired interests in four wells in Rio Arriba County, New Mexico, and through an affiliate, LaPlata Associates LLC ("LPA"), acquired interests in 34 coal bed methane wells located in LaPlata County, Colorado for $1,734,000. HEP's interest in the wells added nine bcf of gas to its reserve base, which represents approximately 55% of its estimated 1996 production. The acquisition was completed on July 1, 1996. Nine refracs/recompletions have been completed since July 1 at a net cost to HEP of approximately $690,000. The recompletion work has performed according to expectations. Numerous other facility projects were completed in 1996 at an estimated net cost to HEP of $270,000. Gross production has increased by 4,000 mcf of gas per day as a result of the work done thus far. Similar activity levels in 1997 are anticipated on these newly acquired properties. In other parts of the New Mexico portion of the San Juan Basin area, HEP recompleted three wells, two of which were successful, drilled two wells and converted another well to be a produced water disposal well. The total cost for this work was $575,000, and HEP's interest in this area is approximately 50%.
HEP participated in a 13 square mile 3-D seismic shoot at the Packsaddle Project in the Big Horn Basin of Wyoming. The data is now being processed and additional development and exploration is expected in the area following HEP's previous discovery. HEP's ownership in the Big Horn Basin continues to increase through a joint venture created to evaluate a 4,000 mile 2-D Seismic Data Base from which HEP hopes to create additional drillable prospects.
In September, HEP spent $225,000 for a recompletion of the A. L. Boudreaux well into a shallower interval of the Bol Mex 3 Formation after the previous completion in the Bol Mex 3 Formation began to produce water and sand. Production after the recompletion is averaging 21 mmcf per day and 420 barrels of condensate per day.
HEP also incurred approximately $150,000 in 1996 for the successful drilling of a 10,000 foot exploratory well in a structural 3-D seismic play in Glasscock County, Texas. Production from this well is currently averaging 250 gross equivalent barrels of oil per day. HEP's interest in this well is 13%. Additional nonproducing reserves from another zone were recorded at year end as well. As of year end, HEP has committed to at least one more exploratory well in 1997.
Numerous other projects, which are individually less significant, have been completed or are underway in Kansas, Louisiana, Texas and New Mexico, including participation in five other 3-D seismic data acquisition programs not included in the above activity.
1997 Plans
For 1997, HEP's capital budget, which will be paid from cash generated from operations and cash on hand, has been set at $12,500,000. In addition to the above mentioned plans, HEP's domestic exploration plans include projects in Texas, Wyoming, Oklahoma, Colorado, Louisiana and New Mexico. HEP will continue to consider international projects in 1997 on a selective basis.
HEP will aggressively pursue exploitation and development of existing opportunities in Texas, Wyoming, Colorado, Kansas, New Mexico and Utah. HEP is also actively pursuing acquisitions in strategic areas.
Partnership Reserves, Production and Discussion by Significant Areas and Fields
The following table presents the December 31, 1996 reserve data by significant areas and fields.
The following table presents the oil and gas production for significant areas and fields.
The following table presents the Partnership's extensions and discoveries by significant areas and fields.
Scott/West Ridge
The Scott/West Ridge area consists of 10 active gas wells, one shut-in gas well and six salt water disposal wells located in Lafayette Parish, Louisiana. The wells produce principally from the Bol Mex formations at 13,500 to 14,500 feet and are operated by HPI. The four most significant wells in the area, all of which were drilled by HPI since 1989, are the A. L. Boudreaux #1, the G. S. Boudreaux Estate #1, the Lessin Fontenot #1 and the Evangeline Shrine Club #1. During 1996, HEP performed one workover in this area which was successful, and HEP participated in one unsuccessful exploration well operated by another party.
West Texas
The West Texas area is comprised of three significant groups of properties. The West Texas Spraberry area consists of 363 producing wells, nine salt water disposal wells and 24 shut-in wells in Dawson, Upton, Reagan and Irion Counties. HPI operates 387 of these wells. Most of the current production from the wells is from the Upper and Lower Spraberry, Clearfork, Canyon, Dean and Fusselman at depths ranging from 5,000 feet to 9,000 feet. During 1996, HEP sold its interest in 35 operated and 31 outside operated properties in this area. Adding to the field discovered in 1995, HEP successfully drilled two wells and recompleted 23 wells in eastern Reagan County, 19 of which were successful. HEP plans several recompletions in this area in 1997.
The West Texas Kermit/Keystone area consists of 48 producing wells, 33 of which are operated by HPI. The primary focus of this area is the development of the Holt and San Andres formations at a depth of 5,100 feet on several leases in Winkler County. During 1996, HEP drilled 15 wells, 12 of which were successful. During 1997 up to 16 wells may be drilled. A study is underway for a secondary recovery project.
The West Texas Merkel/SW Lana area consists of seven producing wells in Jones, Nolan and Taylor Counties, Texas. All of these wells are outside operated. The primary focus of the area is exploitation of the Canyon, Strawn and Ellenburger formations. HEP conducted a 3-D seismic project during 1996 and, during 1997, will drill locations identified by the seismic project.
Kansas
The Kansas area consists of 223 producing wells, of which 213 are operated by HPI and 10 are operated by unaffiliated entities. The wells are located in 15 counties primarily in the Central Kansas Uplift and produce principally from the Arbuckle and numerous Lansing-Kansas City formation zones from 3,000 feet to 6,500 feet. During 1996, HEP drilled one successful development well and performed 15 recompletions, nine of which were successful. The Kansas area is a mature operation where recompletions and limited development drilling represent the most prudent plans for future asset base protection. HEP plans to sell three properties in this area in 1997 and will continue to evaluate and divest nonstrategic properties.
San Juan Basin
The San Juan Basin region consists of wells located in San Juan County, New Mexico and LaPlata County, Colorado. In 1996, HEP and Hallwood Consolidated Resources Corporation ("HCRC") acquired interests in 38 wells from a subsidiary of Public Service Company of Colorado. The wells are located primarily in LaPlata County, Colorado and produce from the Fruitland Coal formation at approximately 3,200 feet. An unaffiliated large East Coast financial institution formed an entity to effectively utilize the Section 29 tax credits generated by the wells. The project was financed through a third party lender with a production payment structure. Since the acquisition, HEP has recompleted 10 of the newly acquired wells, seven successfully. Several additional recompletions will be done in 1997.
In San Juan County, New Mexico, HPI operates 54 wells, 34 of which produce from the Fruitland Coal formation at approximately 2,200 feet and 20 of which produce from the Pictured Cliffs, Mesa Verde and Dakota formations at 1,200 to 7,000 feet. During 1996, HPI successfully drilled two additional coal bed methane wells, recompleted a well for use as a salt water disposal well in the Entrada formation and recompleted two Fruitland Coal wells, one successfully. HEP's acreage position has been fully drilled. Several recompletions are planned for 1997.
Southeastern New Mexico
The Southeastern New Mexico area consists of 60 producing wells, 38 of which are operated by HPI, which produce primarily gas and are located on the northwestern edge of the Delaware Basin in Lea, Eddy and Chaves Counties, New Mexico. These wells produce at depths ranging from approximately 2,500 feet to 14,000 feet from the Delaware, Atoka, Bone Springs and Morrow formations. During 1996, HEP participated as a nonoperator in two successful development wells and as an operator, performed four recompletions, three of which were successful. During 1997, HEP plans to perform several additional recompletions.
Average Sales Prices and Production Costs
The following table presents the average oil and gas sales price and average production costs per equivalent barrel computed at the ratio of six mcf of gas to one barrel of oil.
The following table summarizes the productive oil and gas wells as of December 31, 1996 attributable to HEP's direct interests. Productive wells are producing wells and wells capable of production. Gross wells are the total number of wells in which HEP has an interest. Net wells are the sum of HEP's fractional interests owned in the gross wells.
Gross Net
Productive Wells Oil 736 273 Gas 369 127 ------ --- Total 1,105 400 ===== ===
Oil and Gas Acreage
The following table sets forth the developed and undeveloped leasehold acreage held directly by HEP as of December 31, 1996. Developed acres are acres which are spaced or assignable to productive wells. Undeveloped acres are acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether or not such acreage contains proved reserves. Gross acres are the total number of acres in which HEP has a working interest. Net acres are the sum of HEP's fractional interests owned in the gross acres.
Gross Net
Developed acreage 176,795 79,311 Undeveloped acreage 130,618 50,103 ------- ------- Total 307,413 129,414 ======= =======
States in which HEP holds undeveloped acreage include Texas, Louisiana, Montana, Wyoming, New Mexico, Kansas, Colorado, North Dakota and Michigan.
Drilling Activity
The following table sets forth the number of wells attributable to HEP's direct interest drilled in the most recent three years.
Office Space
HPI leases office space in Denver, Colorado containing approximately 41,000 square feet, for approximately $600,000 per year. The lease payments are included in the allocation of general and administrative expenses to HEP and other affiliated entities. HEP is guarantor of 60% of the lease obligation, and HCRC is guarantor of the remaining 40% of the obligation.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
See Notes 12 and 13 to the financial statements included in Item 8 - Financial Statements and Supplementary Data.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 1996.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED UNITHOLDER MATTERS
HEP's Class A Units are traded on the American Stock Exchange (the "Exchange") under the symbol "HEP." As of March 20, 1997, 9,977,254 Class A Units were outstanding, held by approximately 20,995 unitholders of record and 143,773 Class B Units were outstanding, held by Hallwood Group. The Class B Units are not publicly traded. The following table sets forth, for the periods indicated, the high and low reported sales prices for the Class A Units as reported on the Exchange and the distributions paid per Class A Unit for the corresponding periods. The Class B Units received a $.20 per unit distribution per quarter during 1995. HEP's debt agreements limit aggregate distributions paid by HEP in any twelve month period to 50% of cash flow from operations before working capital changes plus distributions received from affiliates.
Class A Units High Low Distributions
First quarter 1995 6 1/4 5 3/8 $.20 Second quarter 1995 5 15/16 5 1/8 .20 Third quarter 1995 5 1/2 4 .20 Fourth quarter 1995 4 11/16 3 3/4 .20 --- $.80
First quarter 1996 5 1/4 3 3/4 $.13 Second quarter 1996 6 3/4 4 5/8 .13 Third quarter 1996 7 3/8 5 7/8 .13 Fourth quarter 1996 9 6 1/4 .13 --- $.52
On January 17, 1996, HEP's new Class C Units began trading on the Exchange under the symbol "HEPCWI." As of March 20, 1997, 664,063 Class C Units were outstanding, held by approximately 15,856 unitholders of record. The following table sets forth, for the periods indicated, the high and low reported sales prices for the Class C Units as reported on the Exchange and distributions paid per Class C Unit for the corresponding periods.
Class C Units High Low Distributions
First quarter 1996 7 7/8 6 1/2 $ .25 Second quarter 1996 8 1/2 7 3/8 .25 Third quarter 1996 9 5/8 8 3/16 .25 Fourth quarter 1996 9 7/8 8 3/4 .25 ---- $1.00
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth selected financial data regarding HEP's financial position and results of operations as of the dates indicated. As a result of the issuance of Class A Units in connection with a litigation settlement, all Unit and per Unit information for periods prior to December 31, 1995 has been retroactively restated.
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES
Liquidity and Capital Resources
Cash Flow
HEP generated $26,423,000 of cash flow from operating activities during 1996.
The other primary cash inflows were:
o $9,000,000 in proceeds from long-term debt;
o $5,294,000 in proceeds from the sale of property.
Cash was used primarily for:
o Distributions to partners of $8,176,000;
o Additions to property, exploration and development costs incurred of $12,615,000;
o Payments of long-term debt of $11,373,000;
o Refinance of Spraberry investment of $4,715,000,
o Payments of contract settlement obligations of $305,000.
When combined with miscellaneous other cash activity during the year, the result was an increase in HEP's cash of $563,000, from $4,977,000 at December 31, 1995 to $5,540,000 at December 31, 1996.
Property Purchases, Sales and Capital Budget
In 1996, HEP incurred $12,615,000 in direct property additions and exploration and development costs, and approximately $441,000 for the purchase of HCRC shares. The costs were comprised of approximately $9,467,000 for domestic exploration and development expenditures and approximately $3,148,000 for property acquisitions. HEP's 1996 capital program led to the replacement, through acquisitions and drilling, of 75% of the equivalent barrels produced during 1996. Overall replacement, including revisions to prior year reserves, was 145% of its 1996 production.
HEP's significant direct exploration and development expenditures in 1996 included approximately $1,359,000 for the drilling of seventeen wells, fifteen of which were successful, and participation in nine recompletions, six of which were successful, in the West Texas Kermit area; approximately $435,000 for 3-D seismic data and $160,000 for two exploratory wells, both of which were dry, in Crane County, Texas; approximately $515,000 for 3-D seismic data and related acreage and $184,000 for the drilling of eight wells, seven of which were successful, in the Merkel Project area in Texas; approximately $330,000 for the drilling of two nonoperated wells, one of which was successful, in North Dakota; approximately $150,000 for an exploratory dry hole and approximately $600,000 for an Interlake Formation development well in Montana; approximately $505,000 for 11 recompletions and two drilled wells in Reagan County, Texas; and approximately $225,000 for the recompletion of one well in Louisiana.
In the San Juan Basin area of Colorado and New Mexico, HEP, directly and through an affiliate acquired interests in 38 coal bed methane wells for $1,734,000. Nine recompletions have been performed in this area for a cost of approximately $690,000, and numerous other facility projects were completed for approximately $270,000. HEP spent approximately $575,000 in New Mexico for the recompletion of three wells and the drilling of two wells in New Mexico.
HEP received $1,300,000 during 1996 for the sale of its interests in the Hoople Field in Crosby County, Texas, $3,800,000 for the sale of its interests in the Bethany Longstreet area of Louisiana and $88,000 for the sale of various nonstrategic properties.
For 1997, HEP's capital budget, which will be paid from cash generated from operations and cash on hand, has been set at $12,500,000. HEP's domestic exploitation plans include projects in Texas, Wyoming, Louisiana, Oklahoma, Colorado and New Mexico. HEP will continue to consider international projects in 1997, utilizing stringent screening criteria.
During 1996, HEP adopted Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). SFAS 121 provides the standards for accounting for the impairment of various long-lived assets. Substantially all of HEP's long-lived assets consist of oil and gas properties, which are accounted for using the full cost method of accounting, which requires an impairment to be recorded when total capitalized costs exceed the present value, discounted at 10%, of estimated future net revenues from proved oil and gas reserves. Therefore, the adoption of SFAS 121 did not have a material effect on the financial position or results of operations of HEP.
See Item 2 - Properties, for further discussion.
Distributions
On January 19, 1996, HEP paid a dividend of one new Class C Unit for every 15 HEP Class A Units held as of the record date of December 18, 1995. Pursuant to the regulations of the American Stock Exchange, holders of Class A Units who sold their Units between December 14, 1995 and January 19, 1996 also sold their right to receive the associated Class C Unit dividend. Class C Units are a newly created class of units that trade separately from HEP's Class A Units. The Class C Units have a distribution preference of $1.00 per year, payable quarterly, and distributions on the new units commenced the first quarter of 1996. Class C Units were created to give HEP greater flexibility in structuring future acquisitions by allowing HEP to issue a security with a fixed distribution rate. During 1996, HEP declared distributions of $.52 per Class A Unit and $1.00 per Class C Unit to its Unitholders.
The Board of Directors of HEP's General Partner is considering the distribution level for future quarters, taking into account oil and gas prices and the capital needs of HEP.
Unit Option Plan
On January 31, 1995, the board of directors of the general partner approved the adoption of the 1995 Unit Option Plan to be used for the motivation and retention of directors, employees and consultants performing services for HEP. The plan authorizes the issuance of options to purchase 425,000 Class A Units. Grants of the total options authorized were made on January 31, 1995, vesting one-third at that time, an additional one-third on January 31, 1996 and the remaining one-third on January 31, 1997. The exercise price of the options is $5.75, which was the closing price of the Class A Units on January 30, 1995. No options have been exercised.
During 1996, HEP adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). SFAS 123 requires entities to use the fair value method to either account for, or disclose, stock based compensation in their financial statements. Because the Partnership elected the disclosure provisions of SFAS 123, the adoption of SFAS 123 did not have a material effect on the financial position or results of operations of HEP.
Financing
During the first quarter of 1995, HEP and its lenders amended HEP's Amended and Restated Credit Agreement ("Credit Agreement") to extend the term date of its line of credit to May 31, 1997. Under the Credit Agreement and an Amended and Restated Note Purchase Agreement ("Note Purchase Agreement") (collectively referred to as the "Credit Facilities"), HEP has a borrowing base of $48,000,000. HEP has amounts outstanding at December 31, 1996 of $26,700,000 under the Credit Agreement and $8,571,000 under the Note Purchase Agreement. HEP's borrowing base is further reduced by an outstanding contract settlement obligation of $2,512,000; therefore, its unused borrowing base totaled $10,217,000 at March 20, 1997.
Borrowings under the Note Purchase Agreement bear interest at an annual rate of 11.85%, which is payable quarterly. Annual principal payments of $4,286,000 began April 30, 1992, and the debt is required to be paid in full on April 30, 1998. HEP intends to fund the payment due in April 1997 through additional borrowings under the Credit Agreement; thus, no portion of HEP's Note Purchase Agreement is classified as current as of December 31, 1996.
Borrowings against the Credit Agreement bear interest at the lower of the Certificate of Deposit rate plus 1.875%, prime plus 1/2% or the Euro-Dollar rate plus 1.75%. At December 31, 1996 the applicable interest rate was 7.4%. Interest is payable monthly, and 16 quarterly principal payments of $1,937,000, as adjusted for the anticipated borrowings to fund the Note Purchase Agreement payment due in 1997, commence May 31, 1997. HEP intends to extend the maturity date of its Credit Agreement prior to the commencement of the amortization period.
The borrowing base for the Credit Facilities is redetermined semiannually in March and September of each year. The Credit Facilities are secured by a first lien on approximately 80% in value of HEP's oil and gas properties. Additionally, aggregate distributions paid by HEP in any 12 month period are limited to 50% of cash flow from operations before working capital changes plus distributions received from affiliates.
HEP entered into contracts to hedge its interest rate payments on $10,000,000 of its debt through the end of 1996, $15,000,000 for each of 1997 and 1998 and $10,000,000 for each of 1999 and 2000. HEP does not use the hedges for trading purposes, but rather for the purpose of providing a measure of predictability for a portion of HEP's interest payments under its debt agreement, which has a floating interest rate. In general, it is HEP's goal to hedge 50% of the principal amount of its debt for the next two years and 25% for each year of the remaining term of the debt. HEP has entered into four hedges, one of which is an interest rate collar pursuant to which it pays a floor rate of 7.55% and a ceiling rate of 9.85%, and the others are interest rate swaps with fixed rates ranging from 5.75% to 6.57%. The amounts received or paid upon settlement of these transactions are recognized as interest expense at the time the interest payments are due.
Gas Balancing
HEP uses the sales method for recording its gas balancing. Under this method, HEP recognizes revenue on all of its sales of production, and any over-production or under-production is recovered or repaid at a future date.
As of December 31, 1996, HEP had a net over-produced position of 166,000 mcf ($372,000 valued at average annual gas prices). The general partner believes that this imbalance can be made up from production on existing wells or from wells which will be drilled as offsets to existing wells and that this imbalance will not have a material effect on HEP's results of operations, liquidity and capital resources. The reserves disclosed in Item 8
Item 8 - Financial Statements and Supplementary Data (Note 10 to the Financial Statements).
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of February 27, 1997, about any individual, partnership or corporation which is known to HEP to be the beneficial owner of more than 5% of each class of Units issued and outstanding.
As of February 27, 1997, officers and directors of the general partner, as a group, held 803 Class A Units and currently exercisable options to purchase 386,750 Class A Units, or 3.7% of the total Class A Units currently outstanding assuming exercise of all currently exercisable options held by officers and directors, and 52 Class C Units, or less than .01% of the total Class C Units currently outstanding.
See Item 8 - Financial Statements and Supplementary Data (Note 9 to the Financial Statements) for a description of HEP's Unit Option Plan.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Item 8 - Financial Statements and Supplementary Data (Note 10 to the Financial Statements).
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules. (See Index at Item 8). (b) Reports on Form 8-K. HEP filed no current reports on Form 8-K during the last quarter of the period covered by this report. (c) Exhibits.
(1) 4.1 - Third Amended and Restated Agreement of Limited Partnership of Hallwood Energy Partners, L. P. (5) 4.2 - Unit Purchase Rights Agreement dated as of February 6, 1995 between HEP and The First National Bank of Boston. (9) 4.3 - First Amendment to the Third Amended and Restated Agreement of Limited Partnership of Hallwood Energy Partners, L. P. 4.4 - Amendment to the Third Amended and Restated Agreement of Limited Partnership of Hallwood Energy Partners, L.P. (3) 10.1 - Third Amended and Restated Agreement of Limited Partnership of HEP Operating Partners, L.P. (7) 10.3 - Second Amended and Restated Credit Agreement dated March 31, 1995. (2) 10.4 - Amended and Restated Note Purchase Agreement dated May 7,1990. (Exhibit 10.2) (3) 10.5 - Amended and Restated Agreement of Limited Partnership of EDP Operating, Ltd. (6) 10.6 - Financial Consulting Agreement between The Hallwood Group Incorporated and Hallwood Petroleum, Inc. dated June 30,1993. (4) 10.7 - Financial Consulting Agreement between The Hallwood Group Incorporated and Hallwood Petroleum, Inc. dated June 30,1994. * (4) 10.8 - Compensation Agreement between Hallwood Petroleum, Inc. and Anthony J. Gumbiner dated August 1, 1994. * (7) 10.9 - Domestic Incentive Plan between the Partnership and Hallwood Petroleum, Inc. dated January 14, 1993. * (8) 10.10 - 1995 Unit Option Plan * (7) 10.11 - 1995 Unit Option Plan Loan Program 10.12 - Amendment to the Third Amended and Restated Agreement of Limited Partnership of HEP Operating Partners, L.P. 10.13 - Second Amendment to the Second Amended and Restated Agreement of Limited Partnership of EDP Operating, Ltd. (9) 21 - Subsidiaries of Registrant 23.1 - Consent of Deloitte & Touche LLP 23.2 - Consent of Deloitte & Touche LLP 23.3 - Consent of Deloitte & Touche LLP
(1) Incorporated by reference to Prospectus/Proxy Statement dated February 14, 1990 as supplemented March 22, 1990, March 30, 1990 and April 5, 1990, of Hallwood Energy Partners, L. P., filed as part of Registration Statement No. 33-33452. (2) Incorporated by reference to the exhibit shown in parentheses filed with current report on Form 8-K dated May 9, 1990 of Hallwood Energy Partners, L.P. (3) Incorporated by reference to the same exhibit number filed with the Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1990. (4) Incorporated by reference to the same exhibit number filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994. (5) Incorporated by reference to Exhibit 1 filed with the Registrant's Form 8-A for Limited Partner Unit Purchase Rights filed with the SEC on February 8, 1995. (6) Incorporated by reference to the same exhibit number filed with the Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1993.
(7) Incorporated by reference to the same exhibit number filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995. (8) Incorporated by reference to the same exhibit number filed with the Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1994. (9) Incorporated by reference to the same exhibit number filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995.
*Designates management contracts or compensatory plans or arrangements.
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.
HALLWOOD ENERGY PARTNERS, L.P. BY: HEPGP LTD. General Partner BY: HALLWOOD G.P., INC. General Partner
Date: March 20, 1997 By:/s/William L. Guzzetti ------------------------------------------- ---------------------- William L. Guzzetti President 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.
Document: P:\DOC\HEPK.DOC
Document: P:\DOC\HEPK.DOC