ITEM 3. LEGAL PROCEEDINGS
In December, 1996, ETOCO, Inc., which owns a 20% working interest in one producing well operated by the Company, filed a lawsuit against the Company in the district court of Hardin County, Texas, alleging damages due to the Company's refusal to drill an additional well. The plaintiffs currently are seeking $8.2 million in damages, plus costs. Attempts to settle the claim have been unsuccessful, and a trial on the matter is scheduled to commence on April 6, 1998. The Company intends to defend itself vigorously against this claim. Although no assurances can be given, the Company believes that the ultimate outcome of the above litigation will not have a material adverse effect on the Company's financial position.
The Company, in the ordinary course of business, is a claimant and/or a defendant in various other legal proceedings, including proceedings as to which it has insurance coverage, in which its exposure, individually and in the aggregate, is not considered material to the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the Company's common stock, its only class of equity securities.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information below should be read in conjunction with Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(a) INTRODUCTION
The following discussion is intended to assist in an understanding of the Company's financial position and results of operations for each of the three years in the period ended December 31, 1997. This discussion should be read in conjunction with the information contained in the financial statements of the Company included elsewhere in this annual report. All statements other than statements of historical fact included in this annual report, including, without limitation, statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding the Company's financial position, business strategy, plans and objectives of management of the Company for future operations and industry conditions, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct.
(b) GENERAL
A key component of the Company's strategy is based upon growth "through the drill bit", with heavy emphasis on the exploration, exploitation and development of prospects in the shallow and deeper waters of the Gulf of Mexico. This strategy is supported by a capital expenditures plan which increases over the next several years while the Company builds its prospect inventory, then levels out to provide an appropriate mix of exploratory and development spending. Capital resources to support this plan are expected to be provided by a combination of internally generated cash flows, borrowing against the Company's Revolving Credit Facility and equity capital contributions (see pages 20 and 33).
During 1997, the Company achieved the following in support of its growth strategy:
o Proved reserves of 61.2 Bcfe were added, primarily as a result of (1) drilling 4 successful exploratory wells, including 2 in the Deepwater Gulf and (2) acquiring control of the "Pluto" Deepwater Gulf exploitation project (see page 7 for additional information regarding the "Pluto" project).
o The Company increased its prospect inventory, adding 19 new blocks in the Gulf of Mexico covering 13 prospects, including 17 blocks in the Deepwater Gulf covering 11 prospects.
Also, at a Central Gulf of Mexico Oil and Gas Lease Sale conducted by the U.S. Department of the Interior's Minerals Management Service in March 1998, the Company was the apparent successful bidder, solely or with others, on 9 additional blocks in the Gulf deepwater.
This growth and an increased capital expenditures plan for 1998 may cause the Company to exceed its available sources of cash flow from internal sources and its Revolving Credit Facility. In March 1998, Mariner Holdings, Inc. reached an agreement in principle with management shareholders and an affiliate of Enron Corp. to contribute approximately $28.0 million to $28.8 million of net equity capital, which is expected to be used to reduce borrowings on the Company's revolving credit facility and to supplement funding of the Company's 1998 capital expenditure plan. Closing of this transaction is expected to occur in April 1998. See further discussion of this transaction under Item 13 "Certain Relationships and Related Transactions - Planned 1998 Equity Investment". After including the additional equity investment, the Company's capital resources still may not be sufficient to meet its capital requirements for 1998 and 1999, and other sources and debt or equity capital may be necessary for the Company to continue its planned growth strategy.
The Company's revenue, profitability, access to capital and future rate of growth are heavily influenced by prevailing prices for natural gas, oil and condensate, which are dependent upon numerous factors beyond the Company's control, such as economic, political and regulatory developments. Energy market prices have been extremely volatile in recent years, and are expected to continue to be volatile in the future. While the Company uses hedging transactions from time to time to reduce its exposure to price fluctuations, a substantial or extended decline in oil and gas prices could have a material adverse effect on the Company's financial position, results of operations, future exploration and development plans and access to capital. Subsequent to December 31, 1997, prices for oil have declined significantly. However, since the source of approximately 75% of the Company's revenue is from natural gas production, management believes the current oil price decrease will not significantly impact the Company's future plans.
Another significant factor affecting the Company will be competition, both from other sources of energy such as electricity, and from within the industry. For example, activity in the prolific Gulf of Mexico has accelerated in recent years, resulting in increased competition for offshore leases, drilling rigs and services, which is resulting in higher costs to find and develop reserves in the Gulf Coast area.
The Company's results of operations may vary significantly from year to year based upon the factors discussed above and by other factors such as exploratory and development drilling success, curtailments of production due to workover and recompletion activities and the timing and amount of reimbursement for overhead costs received by the Company from its co-owners. Therefore, the results of any one year may not be indicative of future results.
(c) RESULTS OF OPERATIONS
The following table repeats certain operating information found in Item 2. of this report with respect to oil and natural gas production, average sales price received and expenses per unit of production during the periods indicated.
(i) 1997 COMPARED TO 1996
NET PRODUCTION decreased 4% to 23.9 Bcfe in 1997 from 24.9 Bcfe in 1996. Natural gas production decreased by 2.4 Bcf, or 12%, to 18.0 Bcf from 20.4 Bcf. Gas production from offshore properties decreased 3.8 Bcf or 23%, primarily due to natural production decline, while gas production from onshore properties increased 1.4 Bcf or 34%, due primarily to the capacity expansion of the Sandy Lake Central facility, which became operational in the first quarter of 1997. Oil and condensate production increased by 227 Mbbls to 977 Mbbls from 750 Mbbls, also due primarily to the expansion of the Sandy Lake Central facility, offset in part by a decrease in other onshore oil production resulting from the sale of non-core Permian Basin properties in early 1996. The Company expects net production to increase by 7% to 10% in 1998 over 1997, as the result of the commencement of production from several 1996 and 1997 discoveries.
OIL AND GAS REVENUES for 1997 increased by $1.8 million, or 3%, compared to 1996. The increase was primarily the result of increased oil and gas sales prices, offset in part by the production decrease described above. The average realized sales price of natural gas increased 7%, to $2.55 per Mcf in 1997 from $2.39 per Mcf in 1996, while the realized oil sales price increased by 2% to $18.53 per Bbl in 1997 from $18.10 per Bbl in 1996.
HEDGING ACTIVITIES of natural gas for 1997 reduced the average realized sales price received by $0.22 per Mcf and revenues by $3.9 million. In 1996, natural gas hedging activities decreased the average realized sales price received by $0.18 per mcf and revenues by $3.7 million. Hedging activities of crude oil during 1997 reduced the average sales price received by $0.63 per Bbl and revenues by $0.6 million, compared with a reduction in the average realized sales price of $2.55 per Bbl and revenues of $1.9 million during 1996. During 1997, approximately 60% of the Company's equivalent production was subject to hedge positions compared to 64% in 1996. See "Changes in Prices and Hedging Activities" below for a summary of 1998 hedging positions as of the date of this annual report.
LEASE OPERATING EXPENSES decreased 1% to $10.7 million for 1996, from $10.8 million for 1996. Lease operating expense per Mcfe increased to $0.44 for 1997 from $0.43 for 1996, due primarily to relatively fixed operating expenses spread over reduced production volumes.
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE (DD&A) increased 2% to $31.7 million for 1997, from $31.1 million for 1996, as a result of a 6% increase in the unit-of-production depreciation, depletion and amortization rate to $1.33 per Mcfe from $1.25 per Mcfe, due primarily to increased drilling and completion costs, partially offset by a 4% reduction in equivalent volumes produced.
IMPAIRMENT OF OIL AND GAS PROPERTIES amounting to $28.5 million was recorded in the first quarter of 1997 for a non-cash full cost ceiling test impairment using prices in effect at March 31, 1997. Price increases subsequent to March 31, 1997 were sufficient to avoid the impairment charge, but given the unpredictable volatility of future prices, the Company elected to record the charge in order to more conservatively state the book value of its assets. During the second quarter of 1996, a $22.5 million full cost ceiling writedown was recorded in conjunction with Mariner Holdings' acquisition of the Company.
GENERAL AND ADMINISTRATIVE EXPENSES, which are net of overhead reimbursements received by the Company from other working interest owners, increased 3% to $3.2 million in 1997, up from $3.1 million in 1996, due primarily to higher employment and office costs in 1997 which were almost entirely offset by increased overhead reimbursements during 1997. Accordingly, there was no change in general and administrative expense per Mcfe of $0.13 for both 1997 and 1996.
INTEREST EXPENSE decreased 5% to $10.6 million for 1997, from $11.1 million for 1996, due primarily to the 9% decrease in average outstanding debt to $103.2 million, from $113.2 million, which was partially offset by a 7% increase in the average interest rate paid on outstanding debt to 10.38%, from 9.68%. During 1996, the Company wrote off $2.4 million of loan fees related to debt incurred in connection with the Company's management-led buyout in the second quarter of 1996. Interest income also decreased 83% to $0.5 million for 1997, from $2.7 million for 1996, due primarily to the retirement of receivables from affiliates resulting from the acquisition by Mariner Holdings of the stock of the Company.
INCOME (LOSS) BEFORE INCOME TAXES decreased to a loss of $20.2 million for 1997, from a $16.0 million loss for 1996, as a result of the factors described above.
(ii) 1996 COMPARED TO 1995
NET PRODUCTION increased 53% to 24.9 Bcfe in 1996 from 16.3 Bcfe in 1995. During 1996, natural gas production increased by 6.6 Bcf, or 48%, to 20.4 Bcf from 13.8 Bcf. Increased gas production was due to new production from Green Canyon 136 and Garden Banks 240, and the start-up of the Sandy Lake Central facility. These increases were partially offset by natural production decline on other properties. Oil and condensate production in 1996 increased 326 Mbbls, or 77%, to 750 Mbbls from 424 Mbbls, due primarily to the start-up of the Sandy Lake Central facility offset by the sale of several Spraberry properties.
OIL AND GAS REVENUES for 1996 increased by $29.0 million, or 87%, compared to 1995. The increase was primarily the result of increased oil and gas production and increased sales prices for oil and gas. The average realized natural gas sales price increased 36%, to $2.39 per Mcf in 1996 from $1.76 per Mcf in 1995, while the realized oil sales price increased by 5% to $18.10 per Bbl in 1996 from $17.19 per Bbl in 1995.
HEDGING ACTIVITIES of natural gas for 1996 reduced the average realized sales price received per Mcf by $0.18 and revenues by $3.7 million. In 1995, hedging activities increased the average realized sales price received by $0.07 per mcf and revenues by $1.0 million. Hedging activities of crude oil which commenced during 1996 reduced the average sales price received per Bbl by $2.55 and revenues by $1.9 million. During 1996, approximately 64% of the Company's equivalent production was subject to hedge positions as compared to 33% in 1995.
LEASE OPERATING EXPENSES increased 48% to $10.8 million for 1996, from $7.3 million for 1995, due primarily to the Green Canyon 136 and Garden Banks 240 fields that began production in late 1995 and early 1996 and start-up of the Sandy Lake central facility in late 1995. Lease operating expenses per Mcfe decreased to $0.43 from $0.45 in 1996, due to relatively fixed expenses spread over increased production.
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE (DD&A) increased 99% to $31.1 million for 1996, from $15.6 million for 1995, as a result of 53% higher equivalent volumes produced due to initial production on three major properties at the end of 1995 and to a 30% increase in the unit-of-production depreciation, depletion and amortization rate to $1.25 per Mcfe from $0.96 per Mcfe, primarily due to the upward adjustment in oil and gas properties to allocate the purchase price in the Acquisition.
IMPAIRMENT OF OIL AND GAS PROPERTIES amounting to $22.5 million in 1996 was recorded in conjunction with a full cost ceiling writedown relating to Mariner Holdings' acquisition of the Company. No impairment charge was necessary in 1995.
GENERAL AND ADMINISTRATIVE EXPENSES, which are net of overhead reimbursements received by the Company from other working interest owners, increased 55% to $3.1 million for 1996, from $2.0 million for 1995, due primarily to expenses incurred in the first quarter of 1996 in connection with the sale of the predecessor company, the office relocation and lower overhead recovery due to the completion of three major projects at the end of 1995. General and administrative expense per Mcfe increased to $0.13 from $0.12 in 1995, due to the higher net expenses described above spread over increased production.
INTEREST EXPENSE decreased 13% to $11.1 million for 1996, from $12.8 million for 1995, due primarily to the 31% decrease in average outstanding debt to $113.2 million, from $165.1 million, which was partially offset by an 18% increase in the average interest rate paid on outstanding debt to 9.68%, from 8.19%. During 1996, the Company wrote off $2.4 million of loan fees related to the JEDI Bridge Loan (see page 33) as a result of refinancing a portion of the amount with the Revolving Credit Facility (see pages 20 and 33). Interest income also decreased 71% to $2.7 million for 1996, from $9.3 million for 1995, due primarily to the retirement of receivables from affiliates resulting from the Acquisition.
INCOME (LOSS) BEFORE INCOME TAXES decreased to a loss of $16.0 million for 1996, from $4.8 million income for 1995, as a result of the factors described above.
PROVISION FOR INCOME TAXES in 1996 is zero, compared to $0.3 million of tax payments in 1995 due to the imposition of alternative minimum taxes as a result of a gain on sale of oil and gas properties in that year.
(d) LIQUIDITY AND CAPITAL RESOURCES
(i) CASH FLOWS
Liquidity is a company's ability to generate cash to meet its needs for cash. As of December 31, 1997, the Company had cash and cash equivalents of approximately $9.1 million and negative working capital of approximately $8.6 million, compared with cash of $10.8 million and positive working capital of $5.6 million as of December 31, 1996. The decrease in working capital from 1996 to 1997 was caused by an increase in accounts payable and accrued liabilities, due to higher levels of drilling activity in late 1997 compared to late 1996. As of February 28, 1998, the Company's working capital had returned to a positive position, as a result of increased accounts receivable from partners due to the increased drilling activity in late 1997 and early 1998.
Primary sources of cash during the three year period ended December 31, 1997 were funds generated from operations, proceeds from the sale of oil and gas properties, proceeds from the issuance of notes, bank borrowings and capital contributions by the Company's former and present parent companies. Primary uses of cash for the same period were funds used in exploration and production expenditures, repayment of notes and bank debt, and the purchase of Hardy Oil & Gas USA, Inc.
The Company had a net cash outflow of $1.7 million in 1997, compared to a net cash inflow of $10.8 million in 1996 and a net cash inflow of $1.1 million in 1995. A discussion of the major components of cash flows for these years follows.
Cash flows provided by operating activities in 1997 increased by $8.6 million compared to 1996 primarily due to increased oil and gas prices and changes in working capital. Cash flows from operating activities in 1996 increased by $22.3 million from 1995 primarily due to increased production volumes and prices.
Cash flows used in investing activities in 1997 decreased by $152.9 million compared to 1996 primarily because in 1996 cash was used to fund the acquisition of Hardy Oil & Gas USA, Inc. for $184.7 million, offset by an increase of $22.6 million for capital expenditures for oil and gas properties in 1997 over 1996 and $7.5 million lower proceeds from the sale of oil and gas properties from 1996 to 1997. Cash flows used in investing activities in 1996 increased by $98.5 million compared to 1995 primarily due to cash used to fund the acquisition of Hardy Oil & Gas USA, Inc. for $184.7 million, an increase of $3.9 million for capital expenditures for oil and gas properties and $13.2 million lower proceeds from the sale of oil and gas properties, offset in part by a $106.0 million decrease in issuance of long-term receivables to the Company's former affiliate.
Cash flows provided by financing activities in 1997 decreased by $174.0 million compared to 1996 primarily because in 1996 cash was provided by $92.2 million of equity contributed by the Company's shareholders and the issuance of $99.5 million of senior subordinated notes, offset in part by proceeds of borrowings from the revolving credit facility in 1997 of $14.0 million. Cash flows provided by financing activities in 1996 increased by $85.9 million compared to 1995 primarily due to $92.2 million of equity contributed by the Company's shareholders and the issuance of $99.5 million of senior subordinated notes in 1996, compared to issuance of $60.0 million of senior notes and $46.0 million capital contributions by the Company's former parent during 1995.
(ii) CHANGES IN PRICES AND HEDGING ACTIVITIES
The energy markets have historically been very volatile, and there can be no assurance that oil and gas prices will not be subject to wide fluctuations in the future. In an effort to reduce the effects of the volatility of the price of oil and natural gas on the Company's operations, management has adopted a policy of hedging oil and natural gas prices from time to time through the use of commodity futures, options and swap agreements. While the use of these hedging arrangements limits the downside risk of adverse price movements, it also limits future gains from favorable movements.
The following table sets forth the increase (decrease) in the Company's oil and gas sales as a result of hedging transactions and the effects of hedging transactions on prices during the periods indicated.
The following table sets forth the Company's open hedging contracts for oil and natural gas and the weighted average prices hedged under various swap agreements as of December 31, 1997.
Subsequent to December 31, 1997, the Company entered into additional commodity price hedging contracts under swap agreements covering 1,240,000 Mmbtu of March 1998 natural gas production at an average fixed price of $2.18 per Mmbtu. Hedging arrangements through October 1998 cover approximately 37% of the Company's anticipated equivalent production for 1998.
(iii) CAPITAL EXPENDITURES AND CAPITAL RESOURCES
The following table presents major components of capital and exploration expenditures for each of the three years ended December 31.
Total capital expenditures for 1997 were $22.5 million more than 1996. The increase was due primarily to (1) the Company's continued focus on building and evaluating its exploration and exploitation prospect inventory, as evidenced by the increase in both leasehold acquisition-unproved properties ($7.3 million) and oil and gas exploration ($4.9 million) and (2) increased development-related spending, both to acquire additional interest in an existing proved property ($3.2 million) and in development expenditures on successful exploratory prospects ($7.1 million) . Total capital expenditures in 1996 were $4.6 million greater than 1995. The increase was due primarily to the Company's increased focus on building and evaluating its prospect inventory, as evidenced by the increase in both leasehold acquisition ($9.7 million) and oil and gas exploration ($9.6 million), offset by a decrease in development expenditures.
The Company's board of directors has approved a plan to increase its 1998 capital expenditures to approximately $95.7 million, including approximately $7.0 million of capitalized interest and indirect costs, an increase of 39% from $68.9 million in 1997. Exploration spending, including leasehold acquisition of unproved properties, is planned at $53.8 million for 1998, up 10% from $49.0 million in 1997. Planned exploration expenditures include $20 million to augment the Company's leasehold position and seismic database, principally in the Deepwater Gulf of Mexico. The remainder
of the exploration budget is slated for exploration and exploitation drilling of 11 or 12 wells, including 5 or 6 in the Deepwater Gulf of Mexico, 5 in the shallow waters of the Gulf and 1 onshore Gulf Coast. Planned development and other spending is $41.9 million, up 111% from $19.9 million in 1997. The 1998 development plan includes development expenditures for 4 exploratory discoveries made in 1997, 2 of which were in the Deepwater Gulf, and initial work on Mariner's "Pluto" Deepwater Gulf exploitation project. Also, at a Central Gulf of Mexico Oil and Gas Lease Sale conducted by the U.S. Department of the Interior's Minerals Management Service in March 1998, the Company was the apparent successful bidder, solely or with others, on 9 additional blocks in the Gulf deepwater. The Company's share of its apparent high bids was $29.2 million, net of partner reimbursements. After the award of these additional lease blocks, which is expected to occur in the second quarter of 1998, the Company's Deepwater Gulf of Mexico leasehold position and related 1998 capital expenditures are expected to exceed amounts anticipated in the Company's 1998 budget.
Capital spending plans will be continuously evaluated throughout the year. Actual levels of capital expenditures may vary significantly due to a variety of factors, including drilling results, oil and gas prices, industry conditions including drilling rig availability, future acquisitions and availability of capital. Though the 1998 capital expenditures plan does not include any acquisitions, the Company expects to selectively pursue acquisition opportunities for proved reserves where it believes significant operating improvement or exploration potential exists.
The Company has used its Revolving Credit Facility with NationsBank of Texas, N.A. (see Note 4 to the Financial Statements) to partially fund its expenditures. The Revolving Credit Facility, which provides for a maximum $150 million revolving credit loan, carried a borrowing base of $58.0 million as of December 31, 1997, and $14.0 million of debt was outstanding as of December 31, 1997. The borrowing base is subject to semi-annual redetermination as of June 30 and December 31 of each year, and one additional redetermination per year may be requested by either NationsBank or the Company.
In August 1996, the Company issued $100.0 million in 10 1/2% Senior Subordinated Notes Due 2006. Of the net proceeds of this issuance, $42.0 million was used to pay a dividend to Mariner Holdings, which in turn used the dividend to repay indebtedness incurred in connection with the Acquisition, and $50.0 million was used to repay all indebtedness then outstanding under the Company's Revolving Credit Facility.
Equity capital has represented a significant source of capital for the Company. In 1996, $95.0 million was contributed to finance part of the Acquisition. In March 1998, Mariner Holdings, Inc. reached an agreement in principle with management shareholders and an affiliate of Enron Corp. to contribute approximately $28.0 million to $28.8 million of net equity capital, which is expected to be used to reduce borrowings on the Company's revolving credit facility and to supplement funding of the Company's 1998 capital expenditure plan. Closing of this transaction is expected to occur in April 1998. See further discussion of this transaction under Item 13. "Certain Relationships and Related Transactions - Planned 1998 Equity Investment".
The Company expects to fund its activities in 1998 through a combination of cash flow from operations, the use of its Revolving Credit Facility to borrow funds required from time to time to supplement internal cash flows and by the equity financing mentioned above. However, after including the additional equity investment, the Company's capital resources still may not be sufficient to meet the Company's anticipated future requirements for working capital, capital expenditures and scheduled payments of principal and interest on its indebtedness. There can be no assurance that anticipated growth will be realized, that the Company's business will generate sufficient cash flow from operations or that future borrowings or equity capital will be available in an amount sufficient to enable the Company to service its indebtedness or make necessary capital expenditures.
(e) YEAR 2000 ISSUES
Year 2000 issues result from the inability of computer programs or computerized equipment to accurately calculate, store or use a date subsequent to December 31, 1999. The erroneous date can be interpreted in a number of different ways; typically the year 2000 is represented as the year 1900. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business transactions.
The Company has reviewed the majority of its mission-critical software systems with the vendors from which the software was purchased, and the Company believes that these systems will be in compliance during 1998. Further assessment of less critical software systems is continuing and should be completed before the end of 1998. The Company believes that the potential impact, if any, of these systems not being Year 2000 compliant should not impact the Company's ability to continue exploration, drilling, production and sales activities. Based on software reviews conducted to date and other preliminary information, costs of addressing potential problems are not expected to have a material adverse impact on the Company's financial position, results of operations, or cash flows in future periods. If, however, the Company, its customers or vendors are unable to adequately resolve such processing issues in a timely manner, the Company's operations and financial results may be adversely affected.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholder Mariner Energy, Inc. Houston, Texas
We have audited the accompanying financial statements of Mariner Energy, Inc. (the "Company"), formerly Hardy Oil & Gas USA Inc. (the"Predecessor Company"), as listed in the Index to Financial Statements in Item 8. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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 financial statements referred to above present fairly, in all material respects, the financial position of Mariner Energy, Inc. as of December 31, 1997 and 1996, and the results of its operations and cash flows for the year ended December 31, 1997, the nine months ended December 31, 1996, the three months ended March 31, 1996, and the year ended December 31, 1995, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Houston, Texas March 20, 1998
MARINER ENERGY, INC. BALANCE SHEETS (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements
MARINER ENERGY, INC. STATEMENTS OF OPERATIONS (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements
MARINER ENERGY, INC. STATEMENTS OF STOCKHOLDER'S EQUITY (IN THOUSANDS, EXCEPT NUMBER OF SHARES)
The accompanying notes are an integral part of these financial statements
MARINER ENERGY, INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The accompanying notes are an integral part of these financial statements
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION -- For the year ended December 31, 1995, and for the three months ended March 31, 1996, Hardy Oil & Gas USA Inc., (the "Predecessor Company"), was a wholly owned subsidiary of Hardy Holdings Inc., which is a wholly owned subsidiary of Hardy Oil & Gas plc ("Hardy plc"), a public company incorporated in the United Kingdom. Pursuant to a stock purchase agreement dated April 1, 1996, Joint Energy Development Investments Limited Partnership ("JEDI"), which is an affiliate of Enron Capital & Trade Resources Corp. ("ECT"),together with members of management of the Predecessor Company, formed Mariner Holdings, Inc. ("Mariner Holdings"), which then purchased from Hardy Holdings Inc. all of the issued and outstanding stock of the Predecessor Company for a purchase price of approximately $185.5 million effective April 1, 1996 for financial accounting purposes (the "Acquisition"). (See Notes 2 and 3 to the Financial Statements.) As a result of the sale of Hardy Oil & Gas USA Inc.'s common stock, the Predecessor Company changed its name to Mariner Energy, Inc. (the "Company"). Additionally, ECT and Mariner Holdings entered into agreements with certain members of the Predecessor Company's management providing for a continued role of management in the Company after the Acquisition. The Company is primarily engaged in the exploration and exploitation for and development and production of oil and gas reserves, with principal operations both onshore and offshore Texas and Louisiana.
CASH AND CASH EQUIVALENTS -- All short-term, highly liquid investments that have an original maturity date of three months or less are considered cash equivalents.
ACCOUNTS RECEIVABLE -- Substantially all of the Company's accounts receivable arise from sales of oil or natural gas, or from reimbursable expenses billed to the other participants in oil and gas wells for which the Company serves as operator.
OIL AND GAS PROPERTIES -- Oil and gas properties are accounted for using the full-cost method of accounting. All direct costs and certain indirect costs associated with the acquisition, exploration and development of oil and gas properties are capitalized. Amortization of oil and gas properties is provided using the unit-of-production method based on estimated proved oil and gas reserves. No gains or losses are recognized upon the sale or disposition of oil and gas properties unless the sale or disposition represents a significant quantity of oil and gas reserves. The net carrying value of proved oil and gas properties is limited to an estimate of the future net revenues (discounted at 10%) from proved oil and gas reserves based on period-end prices and costs plus the lower of cost or estimated fair value of unproved properties. As a result of this limitation, a permanent impairment of oil and gas properties of approximately $28,514,000 and $22,500,000 was recorded during 1997 and 1996, respectively. Unproved properties are reviewed for impairment annually.
OTHER PROPERTY AND EQUIPMENT -- Depreciation of other property and equipment is provided on a straight-line basis over their estimated useful lives which range from five to seven years.
DEFERRED LOAN COSTS -- Deferred loan costs, which are included in other assets, are stated at cost and amortized straight-line over their estimated useful lives, not to exceed the life of the related debt.
INCOME TAXES -- The Predecessor Company's and the Company's taxable income are included in a consolidated United States income tax return with Hardy Holdings Inc. and Mariner Holdings Inc., respectively. The intercompany tax allocation policy provides that each member of the consolidated group compute a provision for income taxes on a separate return basis. The Company records its income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under SFAS No. 109, an asset and liability approach is required which results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax bases of assets and liabilities (see Note 8 to the Financial Statements).
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS - (Continued)
CAPITALIZED INTEREST COSTS -- The Company capitalizes interest based on the cost of major development projects which are excluded from current depreciation, depletion, and amortization calculations. Capitalized interest costs approximated $729,000, $449,000 and $1,265,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
ACCRUAL FOR FUTURE ABANDONMENT COSTS -- Provision is made for abandonment costs calculated on a unit-of-production basis, representing the Company's estimated liability at current prices for costs which may be incurred in the removal and abandonment of production facilities at the end of the producing life of each property.
HEDGING PROGRAM -- The Company enters into swap agreements to reduce the effects of the volatility of the price of natural gas on the Company's operations. During 1996, the Company extended its hedging program to include its production of crude oil. These agreements involve the receipt of fixed price amounts in exchange for variable payments based on NYMEX prices and specific volumes. The differential to be paid or received is accrued in the month of the related production and recognized as a component of gas and oil revenues.
REVENUE RECOGNITION -- The Company recognizes oil and gas revenue from its interests in producing wells as oil and gas from those wells is produced and sold. Oil and gas sold is not significantly different from the Company's share of production.
FINANCIAL INSTRUMENTS -- The Company's financial instruments consist of cash and cash equivalents, receivables, payables, and debt. At December 31, 1997 and 1996, the estimated fair value of the Company's Senior Subordinated Notes was approximately $100,000,000. The estimated fair value was determined based on borrowing rates available at December 31, 1997 and 1996, respectively, for debt with similar terms and maturities. The carrying amount of the Company's other financial instruments approximates fair value.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates.
PRICE FLUCTUATIONS -- Subsequent to December 31, 1997, crude oil and natural gas market prices had fallen from the December 31, 1997 levels used by the Company to establish price assumptions for the calculation of its oil and gas reserve basis at December 31, 1997. The NYMEX crude oil contract price was $16.15 per Bbl for the month of March 1998, down from an average price of $18.320 per Bbl for the month of December 1997. The final three day NYMEX average price of natural gas for the month of March 1998 was $2.227 per Mmbtu, down from the average for the month of December 1997 of $2.682 per Mmbtu.
MAJOR CUSTOMERS -- During the year ended December 31, 1997, sales of oil and gas to four purchasers accounted for 19%, 19%, 18% and 14% of total revenues. During the year ended December 31, 1996, sales of oil and gas to four purchasers accounted for 15%, 13%, 13% and 10% of total revenues. During the year ended December 31, 1995, sales of oil and gas to three purchasers accounted for 20%, 20% and 12% of total revenues. Management believes that the loss of any of these purchasers would not have a material impact on the Company's financial condition or results of operations.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. THE ACQUISITION
Effective April 1, 1996, Mariner Holdings, Inc. acquired all the capital stock of the Company from Hardy Holdings Inc. for an aggregate purchase price of approximately $185.5 million, including $14.5 for net working capital. In connection with the Acquisition, substantial intercompany indebtedness and receivables and third-party indebtedness of the Company were eliminated.
The sources and uses of funds related to financing the Acquisition (See Note 1 to the Financial Statements) were as follows:
(1) The JEDI Bridge Loan (see page 32) was incurred by Mariner Holdings to fund a portion of the consideration paid in the Acquisition, which has been pushed down for accounting purposes to the Company.
(2) As contemplated in connection with the Acquisition and shortly after the consummation thereof, certain members of the Company's management purchased approximately 4% of the capital stock of Mariner Holdings (and thereby acquired beneficial ownership of approximately 4% of the capital stock of the Company) for an aggregated consideration valued at approximately $3.6 million. Such consideration consisted of approximately $0.6 million in cash and approximately $3.0 million of overriding royalty interests, which amounts are not included in the above sources and uses of funds related to the Acquisition.
(3) Includes $2.9 million of fees and expenses paid to JEDI associated with the purchase of the common stock by JEDI, $2.6 million of expenses paid to JEDI associated with the implementation of the JEDI Bridge Loan and $2.0 million of other transaction fees and expenses (See Note 4 to the financial statements).
The Acquisition has been accounted for using the purchase method of accounting. As such, JEDI's cost to acquire the Company, including transaction costs, have been allocated to the assets and liabilities acquired based on estimated fair values. As a result, the Company's financial position and operating results subsequent to the date of the Acquisition reflect a new basis of accounting and are not comparable to prior periods. In addition, $1.3 million of interest was imputed for the period from April 1, 1996 to the date of closing.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The allocation of JEDI's purchase price to the assets and liabilities of the Company resulted in a significant increase in the carrying value of the Company's oil and gas properties. Under the full cost method of accounting, the carrying value of oil and gas properties is generally not permitted to exceed the sum of the present value (10% discount rate) of estimated future net cash flows from proved reserves, based on current prices and costs, plus the lower of cost or estimated fair value of unproved properties (the "cost center ceiling"). Based upon the allocation of JEDI's purchase price, estimated proved reserves and product prices in effect at the date of the Acquisition, the purchase price allocated to oil and gas properties was in excess of the cost center ceiling by approximately $22.5 million. The resulting writedown was a non-cash charge and was included in the results of operations for the nine months ended December 31, 1996.
The allocation of the purchase price (including fees and expenses) is summarized as follows (in millions of dollars):
The following unaudited pro forma financial data have been prepared assuming that the Acquisition and the related financing were consummated on January 1, 1995. Amounts are in thousands:
3. RELATED-PARTY TRANSACTIONS
RECEIVABLES FROM AFFILIATES -- Effective May 26, 1993, the Company entered into a $20 million lending facility with Hardy Petroleum Limited. At December 31, 1995, $1 million was outstanding under this lending facility. Advances bore interest at 7.88% and the Company earned interest income of approximately $3,000 on the receivable for the three months ended March 31, 1996, and $314,000 on the receivable for the year ended December 31, 1995. (See Note 2 to the Financial Statements).
Effective January 10, 1995, the Company entered into a $23 million lending facility with Hardy plc. At December 31, 1995, $23 million was outstanding under this lending facility. The maturity date of May 31, 2001 could be extended to May 31, 2003 at the election of either party, and advances bore interest at 7.77%. The Company earned interest income of approximately $452,000 on the receivable for the three months ended March 31, 1996 and $1,762,000 on the receivable for the year ended December 31, 1995. (See Note 2 to the Financial Statements).
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Effective January 11, 1995, the Company entered into a $23 million lending facility with Hardy plc which bore interest on advances at 7.07% and matured on November 30, 1997. At December 31, 1995, $23 million was outstanding under this lending facility. The Company earned interest income of approximately $411,000 on the receivable for the three months ended March 31, 1996, and $1,599,000 on the receivable for the year ended December 31, 1995. (See Note 2 to the Financial Statements).
Effective January 12, 1995, the Company entered into a $59 million lending facility with Hardy plc. At December 31, 1995, $59 million was outstanding under this lending facility. The maturity date of November 30, 2000 could be extended to November 30, 2004 at the election of either party, and advances bore interest at 8.46%. The Company earned interest income of approximately $1,244,000 on the receivable for the three months ended March 31, 1996, and $4,780,000 on the receivable for the year ended December 31, 1995. (See Note 2 to the Financial Statements).
DEBT TO AFFILIATE -- At December 31, 1995, the Company had $23,500,000 outstanding under a $45 million loan facility with Hardy plc. The borrowed amount bore interest at the London Interbank Offered Rate ("LIBOR") plus 0.75%. The agreement, as modified, contained certain restrictive covenants relating to the maintenance of certain measures of financial position during the term of the loan. At December 31, 1995, the Company was in compliance with all such covenants. The loan was to mature on June 1, 1998. The Company incurred interest expense of approximately $381,000 on the debt during the three months ended March 31, 1996 and $1,610,000 on the debt during the year ended December 31, 1995. (See Note 2 to the Financial Statements).
GENERAL AND ADMINISTRATIVE EXPENSES -- Prior to April 1, 1996, the Company paid an affiliate for various administrative support services. Included in general and administrative expenses was approximately $29,000 for the three months ended March 31, 1996, and $230,000 for the year ended December 31, 1995, for such services. In management's opinion, such allocated expenses reasonably represented expenses incurred by the affiliate on behalf of the Company.
AFFILIATE TRANSACTIONS SUBSEQUENT TO THE ACQUISITION -- Enron Corp. is the parent of ECT, and an affiliate of Enron and ECT is the general partner of JEDI. Accordingly, Enron may be deemed to control JEDI, Mariner Holdings and the Company. In addition, six of the Company's directors are officers of Enron or affiliates of Enron. Enron and certain of its subsidiaries and other affiliates collectively participate in many phases of the oil and natural gas industry and are, therefore, competitors of the Company. In addition, ECT and JEDI have provided, and may in the future provide, and ECT Securities Corp. has assisted, and may in the future assist, in arranging financing to non-affiliated participants in the oil and natural gas industry who are or may become competitors of the Company. Because of these various conflicting interests, ECT, the Company, JEDI and the members of the Company's management who are also stockholders of Mariner Holdings have entered into an agreement that is intended to make clear that Enron and its affiliates have no duty to make business opportunities available to the Company.
The Company expects that from time to time it will engage in various commercial transactions and have various commercial relationships with Enron and certain affiliates of Enron, such as holding and exploring, exploiting and developing joint working interests in particular prospects and properties, engaging in hydrocarbon price hedging arrangements and entering into other oil and gas related or financial transactions. For example, there are several prospects in which both an affiliate of Enron and the Company have working interests. Such interests were acquired in the ordinary course of business pursuant to bids, joint or otherwise. Any wells drilled will be subject to joint operating agreements relating to exploration and possible production and will be subject to customary business terms. Furthermore, the Company has entered into several agreements with Enron or affiliates of Enron for the purpose of hedging oil and natural gas prices on the Company's future production. Certain of the Company's debt instruments restrict the Company's ability to engage in transaction with its affiliates, but those restrictions are subject to significant exceptions. See "Item 13 Certain Relationships and Related Transactions -- Enron". The Company believes that its current agreements with Enron and its affiliates are, and anticipates that any future agreements with Enron and its affiliates will be, on terms no less favorable to the Company than would be contained in an agreement with a third party.
4. LONG-TERM DEBT
GUARANTEED SENIOR NOTES -- Effective June 1, 1992, the Company issued to institutional investors 9.05% Guaranteed Senior Notes, Series A ("Series A"), and 8.45% Guaranteed Senior Notes, Series B ("Series B"), in the aggregate amounts of $45,000,000 and $15,000,000 due June 1, 2002 and 1999, respectively. The Series A and Series B notes were guaranteed by Hardy Holdings Inc. and Hardy plc. In addition to paying the entire outstanding principal amount and the interest due on the maturity dates of the Series A and Series B notes, the Company was required to prepay the lesser of (a) $9,000,000 and $3,000,000, respectively, or (b) the principal amount of the notes then outstanding on June 1 of each year, commencing June 1, 1998 and 1995, respectively. (See Note 2 to the Financial Statements).
Effective May 1, 1993, the Company issued to institutional investors 7.88% Guaranteed Senior Notes in the aggregate principal amount of $25,000,000 due June 1, 2003. The notes were guaranteed by Hardy Holdings Inc. and Hardy plc. In addition to paying the entire outstanding principal amount and the interest due on the notes on the respective maturity date, the Company was required to prepay the lesser of (a) $5,000,000 or (b) the principal amount of the notes then outstanding on June 1 of each year, commencing June 1, 1999. (See Note 2 to the Financial Statements).
Effective January 11, 1995, the Company issued to institutional investors 8.46% Guaranteed Senior Notes in the aggregate principal amount of $60,000,000 due June 1, 2004. The notes were guaranteed by Hardy Holdings Inc. and Hardy plc. In addition to paying the entire principal amount and the interest due on the notes on the respective maturity date, the Company was required to prepay the lesser of (a) $12,000,000 or (b) the principal amount of the notes then outstanding on December 1 of each year, commencing December 1, 2000. The entire remaining principal amount of the notes was due and payable on December 1, 2004. (See Note 2 to the Financial Statements).
The Guaranteed Senior Notes required, among other things, that the Company meet certain financial ratios and maintain a minimum tangible net worth. As of December 31, 1995, the Company was in compliance with all such requirements.
JEDI BRIDGE LOAN -- In connection with the Acquisition, JEDI and Mariner Holdings entered into a Credit, Subordination and Further Assurances Agreement dated May 16, 1996, pursuant to which JEDI provided a loan commitment to Mariner Holdings of $105 million. Under this commitment Mariner Holdings borrowed $92 million (the "JEDI Bridge Loan") to partially fund the Acquisition. The JEDI Bridge Loan bore interest at 6% above LIBOR. The JEDI Bridge Loan was repaid with proceeds from dividends paid by the Company to Mariner Holdings; the Company used proceeds of $50 million from borrowings under the Revolving Credit Facility (see below) and $42 million from the issuance of the 10 1/2% Senior Subordinated Notes (see below) to pay such dividends. As a result of the repayments, the JEDI Bridge Loan was terminated. In connection with the $92 million repayment, $2.4 million of the JEDI Bridge Loan debt fees were written off during the nine months ended December 31, 1996.
REVOLVING CREDIT FACILITY -- On June 28, 1996, the Company entered into a revolving credit facility (the "Revolving Credit Facility") with NationsBank of Texas, N.A. as agent for a group of lenders (the "Lenders"). The Revolving Credit Facility provides for a maximum $150 million revolving credit loan and matures on June 28, 1999. The borrowing base under the Revolving Credit Facility is currently $58 million and is subject to periodic redetermination. The Revolving Credit Facility is unsecured. On June 28, 1996, the Company borrowed $50 million under the Revolving Credit Facility and used the proceeds to pay a dividend to Mariner Holdings, which was used by Mariner Holdings to partially repay the JEDI Bridge Loan. During August 1996, the outstanding balances of both the Revolving Credit Facility and the JEDI Bridge Loan were repaid with the proceeds from the issuance of the Company's 10 1/2% Senior Subordinated Notes.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Borrowings under the Revolving Credit Facility bear interest, at the option of the Company, at either (i) LIBOR plus 0.75% to 1.25% (depending upon the level of utilization of the Borrowing Base) or (ii) the higher of (a) the agent's prime rate or (b) the federal funds rate plus 0.5%. The Company incurs a quarterly commitment fee ranging from 0.25% to 0.375% per annum on the average unused portion of the Borrowing Base, depending upon the level of utilization.
The Revolving Credit Facility contains various restrictive covenants which, among other things, restrict the payment of dividends, limit the amount of debt the Company may incur, limit the Company's ability to make certain loans and investments, limit the Company's ability to enter into certain hedge transactions and provide that the Company must maintain a specified relationship between cash flow and fixed charges and cash flow and interest on indebtedness. As of December 31, 1997, the Company was in compliance with all such requirements.
10 1/2% SENIOR SUBORDINATED NOTES -- On August 14, 1996 the Company completed the sale of $100 million principal amount of 10 1/2% Senior Subordinated Notes Due 2006, (the "Notes"). The proceeds of the Notes were used by the Company to (i) pay a dividend to Mariner Holdings, which used the dividend to fully repay the JEDI Bridge Loan incurred in the Acquisition, and (ii) repay the Revolving Credit Facility. The Notes bear interest at 10 1/2% payable semiannually in arrears on February 1 and August 1 of each year. The Notes are unsecured obligations of the Company, and are subordinated in right of payment to all senior debt (as defined in the indenture governing the Notes) of the Company, including indebtedness under the Revolving Credit Facility.
The indenture pursuant to which the Notes are issued contains certain covenants that, among other things, limit the ability of the Company to incur additional indebtedness, pay dividends, redeem capital stock, make investments, enter into transactions with affiliates, sell assets and engage in mergers and consolidations. As of December 31, 1997, the Company was in compliance with all such requirements.
The Notes are redeemable at the option of the Company, in whole or in part, at any time on or after August 1, 2001, initially at 105.25% of their principal amount, plus accrued interest, declining ratably to 100% of their principal amount, plus accrued interest, on or after August 1, 2003. In addition, at the option of the Company, at any time prior to August 1, 1999, up to an aggregate of 35% of the original principal amount of the Notes will be redeemable from the net proceeds of one or more public equity offerings, at 110.5% of their principal amount, plus accrued interest, provided that any such redemption shall occur within 60 days of the date of the closing of such public equity offering.
In the event of a change of control of the Company (as defined in the indenture pursuant to which the Notes are issued), each holder of the Notes (the "Holder") will have the right to require the Company to repurchase all or any portion of such Holder's Notes at a purchase price equal to 101% of the principal amount thereof, plus accrued interest.
As required in the indenture, in January 1997 the Company exchanged all of the Notes for Series B notes with substantially the same terms as to principal amount, interest rate, maturity and redemption rights. If the exchange offer had not been consummated, the interest rate on the Notes would have increased by 0.5% per annum.
The Company paid interest on all outstanding indebtedness of $10,926,000 for the year ended December 31, 1997 and $10,656,000 for the nine months ended December 31, 1996, and the Predecessor Company paid $466,000 for the three months ended March 31, 1996 and $13,670,000 for the year ended December 31, 1995.
5. STOCKHOLDER'S EQUITY
PRE-ACQUISITION CAPITAL CONTRIBUTIONS -- The Predecessor Company received capital contributions of $46,000,000 from Hardy Holdings Inc., which was ultimately contributed from Hardy plc, during the year ended December 31, 1995.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
STOCK OPTION PLAN -- During June 1996, Mariner Holdings established the Mariner Holdings, Inc. 1996 Stock Option Plan (the "Plan") providing for the granting of stock options to key employees and consultants. Options granted under the Plan will not be less than the fair market value of the shares at the date of grant. The maximum number of shares of Mariner Holdings common stock that may be issued under the Plan is 142,800.
At December 31, 1997, options (the "Options") to purchase 140,169 shares had been granted at an exercise price of $100 per share. The Options generally become exercisable as to one-fifth on each of the first five anniversaries of the date of grant. The Options expire seven years after the date of grant.
The Company applies APB Opinion 25 and related interpretations in accounting for the Plan. Accordingly, no compensation cost has been recognized for the Plan. Had compensation cost for the Company's Plan been determined based on the fair value at the grant date for awards under the Plan consistent with the method of Financial Accounting Standards Board Statement 123 ("FAS 123"), the Company's net loss for the year ended December 31, 1997 and for the nine months ended December 31, 1996 would have increased $777,000 and $356,000, respectively to $20,987,000 and $19,048,000 respectively. The effects of applying FAS 123 in this pro forma disclosure are not indicative of future amounts. The fair value of each option grant is estimated on the date of grant using a present value calculation, risk free interest of 6.6%, no dividends and expected life of 5 years. Stock options available for future grant amounted to 2,631 shares at December 31, 1997. Exercisable stock options amounted to 25,666 shares at December 31, 1997.
SUBSEQUENT EVENT: PLANNED 1998 EQUITY INVESTMENT -- In March 1998, Mariner Holdings, Inc. reached an agreement in principle with management shareholders and an affiliate of Enron Corp. to contribute approximately $28.0 million to $28.8 million of net equity capital, which is expected to be used to reduce borrowings on the Company's revolving credit facility and to supplement funding of the Company's 1998 capital expenditure plan. Closing of this transaction is expected to occur in April 1998.
6. EMPLOYEE BENEFIT AND ROYALTY PLANS
EMPLOYEE CAPITAL ACCUMULATION PLAN -- The Company provides all full-time employees participation in the Employee Capital Accumulation Plan (the "Plan") which is comprised of a contributory 401(k) savings plan and a discretionary profit sharing plan. Under the 401(k) feature, the Company, at its sole discretion, may contribute an employer-matching contribution equal to a percentage not to exceed 50% of each eligible participant's matched salary reduction contribution as defined by the Plan. Under the discretionary profit sharing contribution feature of the Plan, the Company's contribution, if any, shall be determined annually and shall be 4% of the lesser of the Company's operating income or total employee compensation and shall be allocated to each eligible participant pro rata to his or her compensation. During 1997, 1996 and 1995, the Company contributed $200,000, $165,000 and $163,000, respectively, to the Plan. This plan is a continuation of a plan provided by the Predecessor Company.
OVERRIDING ROYALTY INTERESTS -- Pursuant to agreements, certain key employees and consultants are entitled to receive, as incentive compensation, overriding royalty interests ("Overriding Royalty Interests") in certain oil and gas prospects acquired by the Company. Such Overriding Royalty Interests entitle the holder to receive a specified percentage of the gross proceeds from the future sale of oil and gas (less production taxes), if any, applicable to the prospects.
7. COMMITMENTS AND CONTINGENCIES
MINIMUM FUTURE LEASE PAYMENTS -- The Company leases certain office facilities and other equipment under long-term operating lease arrangements. Minimum rental obligations under the Company's operating leases in effect at December 31, 1997 are as follows (in thousands):
Rental expense, before capitalization, was approximately $544,000, $427,000 and $391,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
HEDGING PROGRAM -- The Company conducts a hedging program with respect to its sales of crude oil and natural gas using various instruments whereby monthly settlements are based on the differences between the price or range of prices specified in the instruments and the settlement price of certain crude oil and natural gas futures contracts quoted on the open market. The instruments utilized by the Company differ from futures contracts in that there is no contractual obligation which requires or allows for the future delivery of the product.
The following table sets forth the results of hedging transactions during the periods indicated:
The following table sets forth the Company's open hedging contracts for oil and natural gas and the weighted average prices fixed under various swap agreements entered into as of December 31, 1997.
(1) The fair market value was calculated using prices derived from NYMEX futures contract prices and related basis swap contract prices existing at December 31, 1997.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
The following table sets forth a reconciliation of the statutory federal income tax with the income tax provision:
No federal income taxes were paid by the Company during the year ended December 31, 1997, the nine months ended December 31, 1996, or the three months ended March 31, 1996. Federal income tax paid by the Company during the year ended December 31, 1995 was $338,000.
The Company's deferred tax position reflects the net tax effects of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting. The deferred tax position for 1995 relates to the Predecessor. For tax purposes, a new entity was deemed to have been created as a result of an election made in accordance with Internal Revenue Code Section 338 (h)(10) to treat the stock acquisition of Hardy Oil & Gas USA Inc. as a deemed asset acquisition whereby the acquired assets and liabilities were revalued to their fair market value for tax purposes. As a result, the Company has a deferred tax position for 1997 and 1996 that bears no relation to the deferred tax position of the Predecessor for 1995. Significant components of the deferred tax assets and liabilities are as follows (in thousands):
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1997, the Company has a cumulative net operating loss carryforward ("NOL") for federal income tax purposes of approximately $30.6 million, which expires in the year 2012 or after. SFAS No. 109 requires that a valuation allowance be recorded against tax assets which are not likely to be realized. Because of the uncertain nature of their ultimate realization, as well as past performance and the NOL expiration date, the Company has established a valuation allowance against this NOL carryforward benefit and for all net deferred tax assets in excess of net deferred tax liabilities.
9. OIL AND GAS PRODUCING ACTIVITIES AND CAPITALIZED COSTS
The results of operations from the Company's oil and gas producing activities were as follows (in thousands):
Costs incurred in property acquisition, exploration and development activities were as follows (in thousands, except per equivalent mcf amounts):
The Company capitalizes internal costs associated with exploration activities. These capitalized costs approximated $4,418,000, $4,362,000 and $4,264,000, for the years ended December 31, 1997, 1996 and 1995, respectively.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes costs related to unevaluated properties which have been excluded from amounts subject to amortization at December 31, 1997. The Company regularly evaluates these costs to determine whether impairment has occurred. The majority of these costs are expected to be evaluated and included in the amortization base within three years.
Approximately 79% of excluded costs at December 31, 1997 relate to activities in the Deepwater Gulf of Mexico and the remaining 21% relates to activities in the Gulf of Mexico shallow waters and onshore areas near the Gulf.
10. SUPPLEMENTAL OIL AND GAS RESERVE AND STANDARDIZED MEASURE INFORMATION (UNAUDITED)
Estimated proved net recoverable reserves as shown below include only those quantities that can be expected to be commercially recoverable at prices and costs in effect at the balance sheet dates under existing regulatory practices and with conventional equipment and operating methods. Proved developed reserves represent only those reserves expected to be recovered through existing wells. Proved undeveloped reserves include those reserves expected to be recovered from new wells on undrilled acreage or from existing wells on which a relatively major expenditure is required for recompletion. Also included in the Company's proved undeveloped reserves as of December 31, 1997 were reserves expected to be recovered from wells for which certain drilling and completion operations had occurred as of that date, but significant future capital expenditures were required to bring the wells into commercial production.
Reserve estimates are inherently imprecise and may be expected to change as additional information becomes available. Furthermore, estimates of oil and gas reserves, of necessity, are projections based on engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured exactly, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Accordingly, estimates of the economically recoverable quantities of oil and natural gas attributable to any particular group of properties, classifications of such reserves based on risk of recovery and estimates of the future net cash flows expected therefrom prepared by different engineers or by the same engineers at different times may vary substantially. There also can be no assurance that the reserves set forth herein will ultimately be produced or that the proved undeveloped reserves set forth herein will be developed within the periods anticipated. It is likely that variances from the estimates will be material. In addition, the estimates of future net revenues from proved reserves of the Company and the present value thereof are based upon certain assumptions about future production levels, prices and costs that may not be correct when judged against actual subsequent experience. The Company emphasizes with respect to the estimates prepared by
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
independent petroleum engineers that the discounted future net cash flows should not be construed as representative of the fair market value of the proved reserves owned by the Company since discounted future net cash flows are based upon projected cash flows which do not provide for changes in oil and natural gas prices from those in effect on the date indicated or for escalation of expenses and capital costs subsequent to such date. The meaningfulness of such estimates is highly dependent upon the accuracy of the assumptions upon which they were based. Actual results will differ, and are likely to differ materially, from the results estimated.
Estimated Quantities of Proved Reserves (in thousands)
Estimated Quantities of Proved Developed Reserves (in thousands)
The following is a summary of a standardized measure of discounted net cash flows related to the Company's proved oil and gas reserves. The information presented is based on a valuation of proved reserves using discounted cash flows based on year-end prices, costs and economic conditions and a 10% discount rate. The additions to proved reserves from new discoveries and extensions could vary significantly from year to year; additionally, the impact of changes to reflect current prices and costs of reserves proved in prior years could also be significant. Accordingly, the information presented below should not be viewed as an estimate of the fair value of the Company's oil and gas properties, nor should it be considered indicative of any trends.
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Standardized Measure of Discounted Future Net Cash Flows (in thousands)
During recent years, there have been significant fluctuations in the prices paid for crude oil in the world markets and in the United States, including the posted prices paid by purchasers of the Company's crude oil. The weighted average prices of oil and gas at December 31, 1997, 1996 and 1995, used in the above table, were $16.43, $25.16 and $18.08 per Bbl, respectively, and $2.79, $4.50 and $2.54 per Mcf, respectively.
The following are the principal sources of change in the standardized measure of discounted future net cash flows (in thousands):
MARINER ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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
Set forth below are the names, ages and positions of the executive officers and directors of the Company and a key consultant to the Company as of March 1, 1998. All directors are elected for a term of one year and serve until their successors are elected and qualified. All executive officers hold office until their successors are elected and qualified.
Mr. Henderson has been Chairman of the Board of the Company since May 1996, President and Chief Executive Officer since 1987 and a director since 1985. From 1984 to 1987, he served the Co mpany or predecessors as Vice President of Finance and Chief Financial Officer. From 1976 to 1984, he held various positions with ENSTAR Corporation. Additionally, Mr. Henderson served as the Company's Chief Financial Officer from August 1996, when the former Chief Financial Officer ceased to serve in that position, through November 1996.
Mr. Clark has served the Company in various engineering and operations activities since 1984 and has been Senior Vice President of Production since 1991 and a director since 1988. Prior to joining the Company he worked as a Production Engineer in the Offshore Production Group of Shell Oil Company.
Mr. Strickler joined the Company in 1984 and has served the Company since such time in its geological and exploration activities. He has served as Senior Vice President of Exploration of the Company since 1991 and a director since 1989.
Mr. Fitzpatrick joined the Company in 1984 and has served as Vice President of Land and Legal since 1990 and Corporate Secretary since May 1996. Prior to joining the Company he had been a petroleum landman for Pend Oreille Oil and Gas Company and for Exxon Company U.S.A.
Mr. Harless has served as Vice President of Oil and Gas Marketing of the Company since 1990. Prior to joining the Company in 1988, he was Vice President of Marketing and Regulatory Affairs of Enron Oil and Gas Company.
Mr. Hodge has served as Vice President of Administration of the Company since 1991. Prior to joining the Company in 1985, he was Purchasing Manager of Santa Fe Minerals Company.
Mr. Pici became Vice President of Finance and Chief Financial Officer in December 1996. Prior to joining the Company, Mr. Pici was employed by Cabot Oil & Gas Corporation holding several positions since 1989, including Corporate Controller since 1994.
Mr. Smith joined the Company in 1987 and has served as Vice President of Operations since 1991. Prior to joining the Company he worked on both domestic and international assignments for Phillips Oil Company and Eaton Engineering.
Mr. Huber, a consultant to the Company, serves the Company in a number of respects, particularly with respect to exploration, exploitation and development of deepwater prospects, in which he has significant expertise, and is regarded by the Company as a key personnel resource. Mr. Huber is an independent project management consultant and is the Company's deepwater project manager. The Company has engaged the services of Mr. Huber from time to time since 1991. Mr. Huber was employed by Hamilton Oil Corporation (which was acquired by BHP Petroleum in 1991) in the North Sea from 1981 to 1991, holding the positions of production manager, planning and economics manager, and engineering manager. He was the deepwater drilling engineering supervisor for Esso Exploration, Inc. from 1974 to 1980.
Mr. Buy has served as a director since January 1997. Since 1994 he has been an employee of ECT, currently serving as a Managing Director of Enron Capital Management, a division of Enron Corp. Prior to joining ECT Mr. Buy was a Vice President at Bankers Trust in the Energy Group.
Mr. Haedicke has served as a director since October 1997. He is currently Managing Director, Legal, of ECT. Mr. Haedicke also serves on the board of directors of the International Swaps and Derivatives Association, Inc. and he holds a seat on the New York Mercantile Exchange. He has been associated with ECT since its inception in 1990.
Mr. Horn has served as a director since November 1997. Since 1996, he has been as employee and Vice President, Equity Investments, of ECT. Prior to joining ECT, Mr. Horn was a principal in Yellowstone Energy Partners, a private equity investing firm in Houston, Texas.
Mr. Humphrey has served as a director since May 1996. Since 1990 he has been an employee of ECT, currently serving as Vice Chairman. Prior to joining ECT Mr. Humphrey was a Vice President in Citibank's Petroleum Department.
Mr. Overdyke has served as a director since May 1996. Since 1991 he has been an employee of ECT or one of its affiliates, currently serving as a Managing Director of Enron International, Inc. Mr. Overdyke has over 20 years of experience in the energy sector and has held various financial and management positions with public and private independent exploration and production companies.
Mr. Stabler has served as a director since May 1996. He is currently a Managing Director of Enron International, Inc. and has held positions with ECT since 1992. From 1989 to 1992, Mr. Stabler served as Manager of Investor Services for American Exploration Company.
The Stockholders' Agreement requires that the Board of Directors of the Company include at least three nominees of the Management Stockholders. Currently, those three representatives are Messrs. Henderson, Clark and Strickler. The remaining board members are to include nominees of JEDI. See "Certain Relationships and Related Transactions -- Stockholders' Agreement and Related Matters" on page 49.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the annual compensation for the Company's Chief Executive Officer and the four other most highly compensated executive officers for the three fiscal years ended December 31, 1997. These individuals are sometimes referred to as the "named executive officers".
(1) Amounts shown reflect the Company's contribution under the discretionary profit sharing feature of its Employee Capital Accumulation Plan. See "-- 401(k) Plan". For each of the named executive officers, the aggregate amount of perquisites and other personal benefits did not exceed the lesser of $50,000 or 10% of the officer's total annual salary and bonus and information with respect thereto is not included. (2) Does not include amounts received as a result of sales of overriding royalty interests by individuals, normally in connection with sales of properties by the Company. No such sales were made in 1997 or 1996. (3) Amounts shown reflect insurance premiums paid by the Company with respect to term life insurance for the benefit of the named executive officers.
EMPLOYMENT AGREEMENTS
The Company and each of the named executive officers have entered into employment agreements (each, an "Employment Agreement" and collectively, the "Employment Agreements") for initial terms of five years in the case of Messrs. Henderson, Clark and Strickler and three years in the case of Messrs. Pici and Smith. The Employment Agreements then extend for six months in the case of Messrs. Henderson, Clark and Strickler and three months in the case of Messrs. Pici and Smith, unless notice of termination is given by either the Company or the named executive officer at least three or six months before the end of the term. Under the Employment Agreements, the annual salaries are $255,000, $185,000, $165,000, $146,000 and $140,700 for Messrs. Henderson, Clark, Strickler, Pici and Smith, respectively, which the Company may in its discretion increase. The named executive officers are eligible for participation in any medical, dental, life and accidental death and dismemberment insurance programs and retirement, pension, deferred compensation and other benefit programs instituted by the Company from time to time. The employees are also entitled to vacation, reimbursement of certain expenses and, depending upon the Employment Agreement, either an automobile allowance or a leased vehicle of the Company's choice and reimbursement for expenses related to the use of that leased vehicle. As incentive compensation, the named executive officers are entitled to overriding royalty interests in certain oil and gas prospects acquired by the Company. See "Overriding Royalty Program".
If a named executive officer's Employment Agreement is terminated by the Company, with or without Cause (as defined in each Employment Agreement) or by the named executive officer for Good Reason (as defined in each Employment Agreement), the named executive officer will be entitled to, among other things, (i) his or her salary and other benefits through the end of the initial term or extended term of the Employment Agreement (to be paid in a lump sum cash payment in the case of termination by the Company without Cause or termination by the named executive officer for Good Reason), (ii) a lump sum cash payment equal to six, nine or 12 months' salary, depending upon the Employment Agreement (12 months in the case of Mr. Henderson, nine months in the case of Messrs. Clark and Strickler, and six months in the case of Messrs. Pici and Smith), (iii) a lump sum cash payment equal to all vacation time carried forward from a previous year and all earned and unused vacation time for the then current year and (iv) an assignment of vested overriding royalty interests. See "-- Overriding Royalty Interests". If a named executive officer's Employment Agreement is terminated by the named executive officer without Good Reason, he will be entitled to the amounts specified in the preceding sentence except that he will not be entitled to the lump sum cash payment described in clause (ii). Any amounts paid on termination of an Employment Agreement will be grossed-up to cover any applicable taxes.
Each named executive officer has agreed that during the term of his Employment Agreement, and for 12 months thereafter in the case of Messrs. Henderson, Clark and Strickler and six months thereafter in the case of Messrs. Pici and Smith, if the named executive officer's Employment Agreement is terminated by the Company for Cause or by the named executive officer other than for Good Reason, he will not compete with the Company for business or hire away the Company's employees.
STOCK OPTION PLAN
Under the Mariner Holdings, Inc. 1996 Stock Option Plan (the "Stock Option Plan"), a committee of the board of directors of Mariner Holdings (the "Committee") is authorized to grant options to purchase shares of Mariner Holdings common stock, including options qualifying as "incentive stock options" under Section 422 of the Code ("ISOs") and options that do not so qualify ("NSOs"), to employees and consultants as additional compensation for their services to Mariner Holdings and its subsidiaries. The Stock Option Plan is intended to promote the long-term financial interests of Mariner Holdings and its subsidiaries by providing a means whereby designated employees and consultants may develop a sense of proprietorship and personal involvement in the development and financial success of Mariner Holdings and its subsidiaries, and to encourage them to remain with and devote their best efforts to the business of Mariner Holdings and its subsidiaries, thereby advancing the interests of Mariner Holdings and its stockholders.
The aggregate number of shares of Mariner Holdings common stock that may be issued under options granted under the Stock Option Plan is 142,800 shares, subject to adjustment in the event of a stock split, stock dividend or other change in the Mariner Holdings common stock or the capital structure of Mariner Holdings.
Subject to the provisions of the Stock Option Plan, the Committee is authorized to determine who may participate in the Stock Option Plan, the number of shares that may be issued under each option and the terms, conditions and limitations applicable to each grant. Subject to certain limitations, the board of directors of Mariner Holdings is authorized to amend, alter or terminate the Stock Option Plan.
Shares of Mariner Holdings common stock purchased pursuant to the exercise of an Option are subject to the terms of the Stockholders' Agreement. See "Certain Relationships and Related Transactions--Stockholders' Agreement and Related Matters" on page 49.
The following table sets forth certain information with respect to individual grants of options by Mariner Holdings to the named executive officers during 1997.
(1) Options to purchase Mariner Holdings common stock were granted as part of a stock purchase by management. One fifth of the options vest and become exercisable on each of the first five anniversaries of the date of grant; the options become fully exercisable upon the occurrence of certain other events, including the completion of an initial public offering by the Company.
(2) The potential realizable value of the options, if any, granted in 1997 to each of these executive officers was calculated by multiplying those options by the excess of (a) the assumed value, at July 1, 2004, of Mariner Holdings' Common Stock if the value of Mariner Holdings' Common Stock were to increase 5% or 10% in each year of the option's 7 year term over (b) the base price shown. This calculation does not take into account any taxes or other expenses which might be owed. There is no market whatsoever for Mariner Holdings' Common Stock. For purposes of this chart, the Company has assumed a value of $100 per share based on the exercise price of the options. The Company makes no representation as to the actual value of Mariner Holdings' Common Stock. The assumed value at a 5% assumed annual appreciation rate over the 7 year term is $140.71 and such value at a 10% assumed annual appreciation rate over that term is $194.87. At $140.71 the total market value of the shares of Mariner Holdings' Common Stock outstanding on March 1, 1998 would be $139,199,197, which would be an increase of $40,272,897 from the assumed value of such shares at the close of business on December 31, 1997. At $194.87, the total value of the shares of Common Stock outstanding on March 1, 1997 would be $192,777,681, which would be an increase of $93,851,381 from the assumed value of such shares at the close of business on December 31, 1997. The 5% and 10% appreciation rates are set forth in the Securities and Exchange Commission rules and no representation is made that the Common Stock will appreciate at these assumed rates or at all.
OVERRIDING ROYALTY PROGRAM
Pursuant to agreements, the named executive officers are entitled to receive from the Company, as incentive compensation, overriding royalty interests ("Overriding Royalty Interests") in certain oil and gas prospects ("Prospects") acquired by the Company. These agreements generally apply to Prospects acquired by the Company on or after April 18, 1996. Under similar predecessor agreements that pre-date these agreements, certain of the named executive officers became entitled to receive Overriding Royalty Interests in respect of Prospects that were acquired by the Company during various periods before April 18, 1996. Under these agreements, the aggregate percentage of all Overriding Royalty Interests affecting the Company's working interests in Prospects does not exceed 3% before well payout, or 7.5% after well payout, of the Company's working interest in such Prospects.
Each Employment Agreement provides that the named executive officer is entitled to receive, as incentive compensation, Overriding Royalty Interests equal to certain specified undivided percentages of the Company's working interest percentage in Prospects acquired by the Company within the United States and its coastal waters while the Employee is employed by the Company and during the term or extended term of the Employment Agreement. For purposes of each Employment Agreement, oil and gas prospects acquired by the Company on or after April 18, 1996 are deemed to have been acquired by the Company during the term of the Employment Agreement.
The Overriding Royalty Interest percentage of the Company's working interest percentage to which each named executive officer is entitled with respect to each well drilled on a Prospect, for the period before well payout, is one-fourth of that named executive officer's Overriding Royalty Interest percentage for the period after well payout. These percentages range from 0.09375% to 0.23250% before payout and from 0.375% to 0.93000% after payout for the named executive officers.
In instances in which all or a portion of the Company's working interest in a Prospect will be sold or farmed out to unaffiliated third parties, and the Company determines in good faith that the Company's interest will not be marketable on satisfactory terms if marketed subject to the named executive officer's Overriding Royalty Interest affecting such Prospect, the Company, as a general rule, may elect to adjust the named executive officer's Overriding Royalty Interest in such Prospect. In such instances, a committee designated by the Board of Directors of the Company (at least half of the members of which are required to be individuals who have been granted an Overriding Royalty Interest by the Company) are to exercise discretion on behalf of the Company in reducing or modifying the named executive officer's Overriding Royalty Interest in such Prospect in accordance with certain parameters set forth in the Employment Agreement. Certain decisions of the committee require the approval of the Board of Directors of the Company. Such modifications or reductions of the named executive officer's Overriding Royalty Interest apply only to the portion of the Company's working interest sold or farmed out to such third party and do not affect the named executive officer's Overriding Royalty Interest in any interest retained by the Company.
In addition to the provisions for reduction or other adjustment of the Employee's Overriding Royalty Interest as mentioned above, the Company may also elect in its sole discretion, within 60 days after the end of each fiscal year of the Company, to reduce the named executive officer's Overriding Royalty Interest set forth in the Employment Agreement with respect to all Prospects subject to the Employment Agreement that were acquired by the Company during such fiscal year, based upon certain levels of exploration and development costs actually incurred by the "Company Group" (which consists of the Company and certain other entities affiliated with the Company or anticipated to participate in exploration prospects with the Company) during such fiscal year in respect of all Prospects subject to the Employment Agreement. Further, with respect to certain deepwater types of Prospects, the Company may elect in its sole discretion to make other reductions and adjustments to the Employee's Overriding Royalty Interest based upon certain levels of exploration and development costs estimated to be incurred by the Company Group in respect of such deepwater types of Prospects.
The Company retains a right of first refusal to purchase any Overriding Royalty Interest assigned to a named executive officer pursuant to an Employment Agreement. This right applies to any third party offer received by the named executive officer during the term or within one year from the expiration of an Employment Agreement.
Set forth below is certain information relating to the participation of the named executive officers in the overriding royalty program.
(1) At the time overriding royalty interests are received, they have only a nominal value because no reserves have been proven on the prospects at such time.
DIRECTORS' COMPENSATION
Members of the Board of Directors of the Company do not receive compensation for any services provided in their capacities as directors, other than the reimbursement of reasonable expenses incurred in connection with attending meetings of the Board of Directors.
401(k) PLAN
The Company has an Employee Capital Accumulation Plan that is intended to be a Section 401(k) plan under the Code. All employees of the Company, including the named executive officers of the Company, are eligible to participate in the plan. Employees may make contributions to the plan under a salary reduction program. The Company may, in its discretion, make "profit sharing" contributions to the plan on behalf of the plan participants. Contributions by both employees and the Company to the plan are restricted in number and amount, and the aggregate contributions by the Company are not significant. This plan is a continuation of a plan provided by the Predecessor Company. See Note 5 to the Financial Statements of the Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Until the Acquisition in April 1996, the Company was a wholly owned subsidiary of Hardy plc, which through its board of directors and officers set the compensation of the executive officers of the Company. As a director of Hardy plc until the Acquisition, Mr. Henderson participated in deliberations concerning the compensation of executive officers of the Company. After the Acquisition, the Board of Directors of the Company set the compensation of the executive officers, and Mr. Henderson participated in deliberations on those matters. In January 1997, the Board of Directors established a Compensation Committee, composed of Messrs. Henderson, Buy and Stabler.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company is a wholly owned subsidiary of Mariner Holdings. The following table sets forth the name and address of the only stockholder of Mariner Holdings that is known by the Company to beneficially own more than 5% of the outstanding shares of common stock of Mariner Holdings, the number of shares beneficially owned by such stockholder, and the percentage of outstanding shares of common stock of Mariner Holdings so owned, as of March 1, 1998. As of March 1, 1998, there were 989,263 shares of common stock of Mariner Holdings outstanding.
(1) JEDI primarily invests in and manages certain natural gas and energy related assets. JEDI's general partner is Enron Capital Management Limited Partnership, a Delaware limited partnership, whose general partner is Enron Capital Corp., a Delaware corporation and a wholly owned subsidiary of ECT. The general partner of JEDI exercises sole voting and investment power with respect to such shares.
The table appearing below sets forth information as of March 1, 1998, with respect to shares of common stock of Mariner Holdings beneficially owned by each of the Company's directors, the Company's Chief Executive Officer and the four other most highly compensated executive officers for the fiscal year ended December 31, 1997, a key consultant of the Company and all directors and executive officers and such key consultant as a group, and the percentage of outstanding shares of common stock of Mariner Holdings so owned by each.
(1) All shares are owned directly by the named person and such person has sole voting and investment power with respect to such shares.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
STOCKHOLDERS' AGREEMENT AND RELATED MATTERS
Mariner Holdings, ECT, JEDI and each other stockholder of Mariner Holdings is a party to a Stockholders' Agreement ("Stockholders' Agreement"). The Stockholders' Agreement was originally entered into by ECT, Mariner Holdings, and Messrs. Henderson, Clark, Strickler and Huber in contemplation of Mariner Holdings' acquisition of all of the outstanding shares of stock of the Company. Mariner Holdings was formed by ECT for the purpose of acquiring the Company. The Stockholders' Agreement provides for the capitalization of Mariner Holdings by ECT, its affiliates and certain employees and consultants of the Company, certain aspects of Mariner Holdings' organization and management and certain rights and obligations of the stockholders of Mariner Holdings.
The Management Stockholders and JEDI own approximately 4% and approximately 96%, respectively, of the outstanding shares of Mariner Holdings stock. On a fully diluted basis (assuming that all options granted to the Management Stockholders pursuant to the Stockholders' Agreement have been exercised), the Management Stockholders would own or have the right to acquire an aggregate of 179,432 shares, which would represent approximately 16% of all shares that would be outstanding, and JEDI would own approximately 84% of all outstanding shares on that basis. The stock options granted to the Management Stockholders generally vest and become exercisable as to one-fifth on each of the first five anniversaries of the date of grant, and 25,666 shares were exercisable as of December 31, 1997.
Under the Stockholders' Agreement, Mariner Holdings paid or agreed to pay certain amounts, including payment or reimbursement to ECT, JEDI and the Management Stockholders for all reasonable fees and expenses of third parties incurred by them in connection with the Stockholders' Agreement, the JEDI Bridge Loan and Mariner Holdings' purchase of the stock of the Company. In addition, Mariner Holdings agreed to reimburse each Management Stockholder who paid for shares of Mariner Holdings stock by assignment of overriding royalty interests for any additional taxes and related costs incurred by such Management Stockholder to the extent, if any, that the transfer of the overriding royalty interests does not qualify as a tax-free exchange under federal tax laws. Of the amounts agreed to be paid by Mariner Holdings, approximately $5.0 million was, or will be, paid by the Company. In addition, Mariner Holdings has certain ongoing obligations pursuant to the Stockholders' Agreement. Since Mariner Holdings has no independent cash flow and no assets other than its interest in the Company, it will be dependent upon dividends, distributions or advances from the Company to meet any cash requirements flowing from such obligations.
Under the terms of the Stockholders' Agreement, each Management Stockholder entered into a new or amended employment or consulting agreement with the Company. See "Management -- Employment, Consulting and Stock Option Agreements". These agreements, among other things, afford the Management Stockholders the benefits of the Company's overriding royalty program. See "Overriding Royalty Program". In addition, the Company must keep certain employee benefit plans in effect until June 1999.
The Stockholders' Agreement requires that the board of directors of Mariner Holdings (as well as the board of directors of each subsidiary of Mariner Holdings, including the Company) will include at least three Management Directors. Currently, those three representatives are Messrs. Henderson, Clark and Strickler. The Stockholders' Agreement requires that the remaining board members consist of nominees of JEDI. See "Management -- Executive Officers and Directors". In addition, any executive committee of the board of directors must include at least two members who are Management Directors and any compensation committee of the board of directors must include at least one member who is a Management Director; however, no Management Director is to be appointed to any audit committee. The Stockholders' Agreement also requires that certain provisions be included in the certificate of incorporation and bylaws of Mariner Holdings (as well as each of its subsidiaries, including the Company) to ensure that the Management Directors are elected to the board and that certain provisions indemnifying the officers, directors and employees of Mariner Holdings and of the Company are maintained.
Under the terms of the Stockholders' Agreement, Enron and its affiliates (which include, without limitation, ECT and JEDI) are specifically permitted to compete with Mariner Holdings and the Company, and neither Enron nor any of its affiliates has any obligation to bring any business opportunity to Mariner Holdings or the Company. Similarly, Mariner Holdings and the Company may compete with Enron and its affiliates and do not have any obligation to bring any business opportunity to Enron or any affiliate of Enron, including, without limitation, ECT and JEDI. See "Enron".
Under the terms of the Stockholders' Agreement, the stockholders of Mariner Holdings have the preemptive right to acquire additional securities proposed to be issued by Mariner Holdings to any other party, on the same terms proposed to be applicable to the other party. Each stockholder has the right to acquire a number of shares representing his or her proportionate interest in all of the outstanding shares of Mariner Holdings, but to the extent a stockholder does not exercise any preemptive rights, the remaining stockholders have the right to acquire the shares offered to the non-acquiring stockholder.
The Stockholders' Agreement provides for indemnification by Mariner Holdings of Messrs. Henderson, Clark, Strickler and Huber for any expenses they incur in an action based on their participation in the transactions described in the Stockholders' Agreement brought by or in the right of the Company's former parent, Hardy plc.
ENRON
Enron Corp. ("Enron") is the parent of ECT, and an affiliate of Enron and ECT is the general partner of JEDI. Accordingly, Enron may be deemed to control JEDI, Mariner Holdings and the Company. See "Ownership of Securities." In addition, six of the Company's directors are officers of Enron or affiliates of Enron: Mr. Buy is a Managing Director of Enron Capital Management, Mr. Haedicke is a Managing Director of ECT, Mr. Humphrey is Vice Chairman of ECT, Mr. Horn is a Vice President of ECT and Messrs. Overdyke and Stabler are Managing Directors of Enron International, Inc.
Enron and certain of its subsidiaries and other affiliates collectively participate in nearly all phases of the oil and natural gas industry and are, therefore, competitors of the Company. In addition, ECT and JEDI have provided, and may in the future provide, and ECT Securities Corp. has assisted, and may in the future assist, in arranging financing to non-affiliated participants in the oil and natural gas industry who are or may become competitors of the Company. Because of these various conflicting interests, ECT, the Company, JEDI and the Management Stockholders have entered into an agreement that is intended to make clear that Enron and its affiliates have no duty to make business opportunities available to the Company.
Under the Revolving Credit Facility, the Company has covenanted that neither it nor Mariner Holdings nor any subsidiary of either will engage in any transaction with any of its affiliates (including Enron, ECT, JEDI and affiliates of such entities) providing for the rendering of services or sale of property unless such transaction is as favorable to such party as could be obtained in an arm's-length transaction with an unaffiliated party in accordance with prevailing industry customs and practices. The Revolving Credit Facility excludes from this covenant (i) any transaction permitted by the Stockholders' Agreement, (ii) the grant of options to purchase or sales of equity securities to directors, officers, employees and consultants of the Company and Mariner Holdings and (iii) the assignment of any overriding royalty interest pursuant to an employee incentive compensation plan.
The Indenture, dated as of August 1, 1996, between the Company and United States Trust Company of New York (the "Indenture"), under which the Company's 10 1/2% Senior Subordinated Notes Due 2006 were issued, contains similar restrictions. Under the Indenture, the Company has covenanted not to engage in any transaction with an affiliate unless the terms of that transaction are no less favorable to the Company than could be obtained in an arm's-length transaction with a nonaffiliate. Further, if such a transaction involves more than $1 million, it must be approved in writing by a majority of the Company's disinterested directors, and if such a transaction involves more than $5 million, it must be determined by a nationally recognized banking firm to be fair, from a financial standpoint, to the Company. However, this covenant is subject to several significant exceptions, including, among others, (i) certain industry-related agreements made in the ordinary course of business where such agreements are approved by a majority of the Company's disinterested directors as being the most favorable of several bids or proposals, (ii) transactions under employment agreements or compensation plans entered into in the ordinary course of business and consistent with industry practice and (iii) transactions described in this Item 13.
The Company expects that from time to time it will engage in various commercial transactions and have various commercial relationships with Enron and certain affiliates of Enron, such as holding and exploring, exploiting and developing joint working interests in particular prospects and properties, engaging in hydrocarbon price hedging arrangements and entering into other oil and gas related or financial transactions. For example, there are several prospects in which both an affiliate of Enron and the Company have working interests. Such interests were acquired in the ordinary course of business pursuant to bids, joint or otherwise. Any wells drilled will be subject to joint operating agreements relating to exploration and possible production and will be subject to customary business terms. Furthermore, the Company has entered into several agreements with Enron or affiliates of Enron for the purpose of hedging oil and natural gas prices on the Company's future production. The Company believes that its current agreements with Enron and its affiliates are, and anticipates that, but can provide no assurances that, any future agreements with Enron and its affiliates will be, on terms no less favorable to the Company than would be contained in an agreement with a third party.
Pursuant to a Participation Agreement dated as of May 16, 1996 (the "Participation Agreement") by and between Hardy plc and Mariner Holdings, Hardy plc has an option to purchase participation rights in certain prospects generated by the Company until May 16, 1999. This option entitles Hardy plc to acquire up to 25% of any leasehold or working interest the Company holds in any exploitation prospect that (i) is located in the Gulf, (ii) the Company, in its reasonable
judgment, plans to develop, (iii) the Company reasonably expects to exploit using a floating production facility or a subsea tieback system that will require estimated gross capital expenditures in excess of $150.0 million and (iv) is generated by the Company and is expected to be operated by the Company. The Company is required to provide notice to Hardy plc within ten days of acquiring an interest, or a contractual right to acquire an interest, in such a prospect. Hardy plc must exercise its option with respect to such prospect within ten days of receiving such notice from the Company. If Hardy plc exercises its participation right as to any prospect, it must pay the Company a ratable portion of the Company's costs and expenses in generating and acquiring the prospect, including a ratable portion of a $250,000 prospect fee. In addition to the interest in the prospect it acquires from the Company, Hardy plc would then have the right to copy any geological and geophysical data owned by the Company and pertaining to the prospect in which it is participating, unless the Company is restricted from doing so by another agreement.
PLANNED 1998 EQUITY INVESTMENT
In March 1998, Mariner Holdings, Inc. reached an agreement in principle with certain of its existing stockholders, including JEDI, pursuant to which its stockholders will purchase additional shares of Mariner Holdings for approximately $175.00 per share, for an aggregate investment of $30.0 million. The Company expects to pay approximately $1.2 million as a structuring fee, on a pro rata basis, to existing stockholders participating in this transaction. Approximately $1.0 million of this fee is expected to be paid to ECT Securities Corp., an affiliate of JEDI. The Company expects to close this transaction in April 1998.
GLOSSARY
The terms defined in this glossary are used throughout this annual report.
Bbl. One stock tank barrel, or 42 U.S. Gallons liquid volume, used herein in reference to crude oil, condensate or other liquid hydrocarbons.
Bcf. One billion cubic feet of natural gas.
Bcfe. One billion cubic feet of natural gas equivalent (see Mcfe for equivalency).
"behind the pipe" Hydrocarbons in a potentially producing horizon penetrated by a well bore the production of which has been postponed pending the production of hydrocarbons from another formation penetrated by the well bore. These hydrocarbons are classified as proved but non-producing reserves.
2-D. (Two-Dimensional Seismic) -- geophysical data that depicts the subsurface strata in two dimensions.
3-D. (Three-Dimensional Seismic) -- geophysical data that depicts the subsurface strata in three dimensions. 3-D seismic typically provides a more detailed and accurate interpretation of the subsurface strata than can be achieved using 2-D seismic.
"development well" A well drilled within the proved boundaries of an oil or natural gas reservoir with the intention of completing the stratigraphic horizon known to be productive.
"exploitation well" Ordinarily considered to be a development well drilled within a known reservoir. The Company uses the word to refer to deepwater wells which are drilled on offshore leaseholds held (usually under farmout agreements) where a previous exploratory well showing the existence of potentially productive reservoirs was drilled, but the reservoir was by-passed for development by the owner who drilled the exploratory well; thus the Company distinguishes its development wells on its own properties from such exploitation wells.
"exploratory well" A well drilled in unproven or semi-proven territory for the purpose of ascertaining the presence underground of a commercial petroleum deposit and which can be contrasted with a "development well".
"farm-in" A term used to describe the action taken by the person to whom a transfer of an interest in a leasehold in an oil and gas property is made pursuant to a farmout agreement.
"farmout" The term used to describe the action taken by the person making a transfer of a leasehold interest in an oil and gas property pursuant to a farmout agreement.
"farmout agreement" A common form of agreement between oil and gas operators pursuant to which an owner of an oil and gas leasehold interest who is not desirous of drilling at the time agrees to assign the leasehold interest, or some portion of it, to another operator who is desirous of drilling the tract. The assignor in such a transaction may retain some interest in the property such as an overriding royalty interest or a production payment and, typically, the assignee of the leasehold interest has an obligation to drill one or more wells on the assigned acreage as a prerequisite to completion of the transfer to it.
"finding and development cost" Generally, the cost of finding and developing commercial oil and gas including all costs involved in acquiring acreage, seismic survey costs and the cost of drilling, completion and other development activities.
"generate" Generally refers to the creation of an exploration or exploitation idea after evaluation of seismic and other available data.
"infill well" A well drilled between known producing wells to better exploit the reservoir.
"lease operating expenses" The expenses of lifting oil or gas from a producing formation to the surface, and the transportation and marketing thereof, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, short-lived assets, maintenance, allocated overhead costs, ad valorem taxes and other expenses incidental to production, but not including lease acquisition, drilling or completion expenses or other "finding costs".
Mbbls. One thousand barrels of crude oil or other liquid hydrocarbons.
Mcf. One thousand cubic feet of natural gas.
Mcfe. One thousand cubic feet of natural gas equivalent (converting one barrel of oil to six Mcf of natural gas based on commonly accepted rough equivalency of energy content).
MMBTU. One million British thermal units.
Mmcf. One million cubic feet of natural gas.
Mmcfe. One million cubic feet of natural gas equivalent (see Mcfe for equivalency).
NYMEX. New York Mercantile Exchange.
"payout" Generally refers to the recovery by the incurring party to an agreement of its costs of drilling, completing, equipping and operating a well before another party's participation in the benefits of the well commences or is increased to a new level.
"present value of estimated future net revenues" An estimate of the present value of the estimated future net revenues from proved oil and gas reserves at a date indicated after deducting estimated production and ad valorem taxes, future capital costs and operating expenses, but before deducting any estimates of federal income taxes. The estimated future net revenues are discounted at an annual rate of 10%, in accordance with Securities and Exchange Commission practice, to determine their "present value". The present value is shown to indicate the effect of time on the value of the revenue stream and should not be construed as being the fair market value of the properties. Estimates of future net revenues are made using oil and natural gas prices and operating costs at the date indicated and held constant for the life of the reserves.
"producing well" or "productive well" A well that is producing oil or natural gas or that is capable of production without further capital expenditure.
"proved developed reserves" Proved developed reserves are those quantities of crude oil, natural gas and natural gas liquids that, upon analysis of geological and engineering data, are expected with reasonable certainty to be recoverable in the future from known oil and natural gas reservoirs under existing economic and operating conditions. This classification includes: (a) proved developed producing reserves, which are those expected to be recovered from currently producing zones under continuation of present operating methods; and (b) proved developed non-producing reserves, which consist of (i) reserves from wells that have been completed and tested but are not yet producing due to lack of market or minor completion problems that are expected to be corrected, and (ii) reserves currently behind the pipe in existing wells which are expected to be productive due to both the well log characteristics and analogous production in the immediate vicinity of the well.
"proved reserves" The estimated quantities of crude oil, natural gas and other hydrocarbon liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions.
"proved undeveloped reserves" Proved reserves that may be expected to be recovered from existing wells that will require a relatively major expenditure to develop or from undrilled acreage adjacent to productive units that are reasonably certain of production when drilled.
"royalty interest" An interest in an oil and gas lease that gives the owner of the interest the right to receive a portion of the production from the leased acreage for the proceeds of the sale thereof, but generally does not require the owner to pay any portion of the costs of drilling or operating the wells on the leased acreage. Royalty interests may be either landowner's royalty interests, which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalty interests, which are usually carved from the leasehold interest pursuant to an assignment to a third party or reserved by an owner of the leasehold in connection with a transfer of the leasehold to a subsequent owner.
"subsea tieback" A productive well that has its wellhead equipment located on the sea floor and is connected by control and flow lines to an existing production platform located in the vicinity.
"unitized" or "unitization" Terms used to denominate the joint operation of all or some portion of a producing reservoir, particularly where there is separate ownership of portions of the rights in a common producing pool in order that it may be economically feasible to carry on certain production techniques, maximize reservoir production and serve conservation interests.
"working interest" The interest in an oil and gas property (normally a leasehold interest) that gives the owner the right to drill, produce and conduct oil and gas operations on the property and to a share of production, subject to all royalties, overriding royalties and other burdens and to all costs of exploration, development and operations and all risks in connection therewith.
SIGNATURES
The registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
March 27, 1998
MARINER ENERGY, INC.
by: /s/ Robert E. Henderson ------------------------ Robert E. Henderson, Chairman of the Board, President and Chief Executive Officer
This report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT
No annual report covering the Registrant's last fiscal year or proxy statement, form of proxy or other proxy soliciting material with respect to any annual or other meeting of security holders has been sent to the Company's security holders.
EXHIBIT INDEX
3.1(a) Amended and Restated Certificate of Incorporation of the Registrant, as amended.
3.2(a) Bylaws of Registrant, as amended.
4.1(a) Indenture, dated as of August 1, 1996, between the Registrant and United States Trust Company of New York, as Trustee.
4.2(d) First Amendment to Indenture, dated as of January 31, 1997, between the Registrant and United States Trust Company of New York, as Trustee.
4.3(a) Credit Agreement, dated June 28, 1996, among the Registrant, NationsBank of Texas, N.A., as Agent, and the financial institutions listed on schedule 1 thereto, as amended by First Amendment to Credit Agreement, dated August 12, 1996, among the Registrant, NationsBank of Texas, N.A., as Agent, Toronto Dominion (Texas), Inc., as Co-agent, and the financial institutions listed on schedule 1 thereto.
4.4(a) Note, dated August 12, 1996, in the principal amount of up to $45,000,000, made by the Registrant in favor of NationsBank of Texas, N.A.
4.5(a) Note, dated August 12, 1996, in the principal amount of up to $45,000,000, made by the Registrant in favor of Toronto Dominion (Texas), Inc.
4.6(a) Note, dated August 12, 1996, in the principal amount of up to $30,000,000, made by the Registrant in favor of The Bank of Nova Scotia.
4.7(a) Note, dated 12, 1996, in the principal amount of up to $30,000.000, made by the Registrant in favor of ABN AMRO Bank, N.V., Houston Agency.
4.8(a) Form of the Registrant's 10 1/2% Senior Subordinated Note Due 2006, Series B.
10.2(a) Participation Agreement, dated as of May 16, 1996, between Hardy Oil & Gas plc. and Mariner Holdings, Inc.
10.3(c) Stockholders' Agreement, dated April 2, 1996, among Enron Capital & Trade Resources Corp., Mariner Holdings, Inc. (formerly Mystery Acquisition, Inc.), Joint Energy Development Investments Limited Partnership and the other stockholders of Mariner Holdings, Inc., as amended May 16, 1996, and as of May 31, 1996.
10.4(a)+ Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and Robert E. Henderson.
10.5(a)+ Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and Richard R. Clark.
10.6(a)+ Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and Michael W. Strickler.
10.7(a)+ Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and James M. Fitzpatrick.
10.8(a)+ Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and Gregory K. Harless.
10.9(b)+ Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and W. Hunt Hodge.
10.10(a)+Amended and Restated Employment Agreement, dated June 27, 1996, between the Registrant and Clinton D. Smith.
10.11(a)+Amended and Restated Consulting Services Agreement, dated June 27, 1996, between the Registrant and David S. Huber.
10.12(a)+Mariner Holdings, Inc. 1996 Stock Option Plan.
10.13(a)+Form of Incentive Stock Option Agreement (pursuant to the Mariner Holdings, Inc. 1996 Stock Option Plan).
10.14* List of executive officers who are parties to an Incentive Stock Option Agreement.
10.15(a)+Form of Nonstatutory Stock Option Agreement (pursuant to the Mariner Holdings, Inc. 1996 Stock Option Plan).
10.16* List of executive officers who are parties to a Nonstatutory Stock Option Agreement.
10.17(a)+Nonstatutory Stock Option Agreement, dated June 27, 1996, between the Registrant and David S. Huber.
10.19(d) Employment Agreement, dated as of December 2, 1996, between the Registrant and Frank A. Pici.
23.1* Consent of Ryder Scott Company.
27.1* Financial Data Schedule. - ---------------------------
(a) Incorporated by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-12707), filed September 25, 1996. (b) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement on Form S-4 (Registration No. 333-12707), filed December 6, 1996. (c) Incorporated by reference to Amendment No. 2 to the Company's Registration Statement on Form S-4 (Registration No. 333-12707), filed December 19, 1996. (d) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (Registration No. 333-12707) filed March 31, 1997.