ITEM 1. BUSINESS
Alliance Resources PLC (the "Company" or "Alliance") is organized as a public limited company under the laws of England and Wales. Alliance is a London-based holding company of a group ("the Group") whose principal activities are the acquisition, exploration, development and production of oil and gas properties.
All financial data (and, consequently, all oil and gas reserve information, descriptions of properties and business and all information associated with financial or reserve information ) prior to the Company's merger with LaTex Resources, Inc. ("LaTex") on May 1, 1997, described below, has been restated to reflect LaTex as the predecessor company to the Company. For financial, reserve and associated information concerning Alliance prior to its May 1, 1997 merger with LaTex, reference should be made to the Company's Registration Statement on Form (which was filed in its final form with the Securities Exchange Commission on April 9, 1997 and which contains information regarding Alliance through January 31, 1997) and to the Company's filing on Form 20-F (which was filed in its final form with the Securities and Exchange Commission on June 18, 1998).
Because for corporate law purposes (but not financial accounting purposes) Alliance is the surviving corporation of the May 1, 1997 merger, all references to the "Company" both prior and subsequent to May 1, 1997 refer to Alliance Resources PLC and its subsidiaries unless otherwise indicated. Unless the context requires otherwise, all references to "LaTex" include LaTex Resources, Inc., and its consolidated subsidiaries.
Alliance was incorporated and registered under the laws of England and Wales on August 20, 1990. Alliance's corporate headquarters are at 4200 East Skelly Drive, Suite 1000, Tulsa, Oklahoma 74135.
RECENT DEVELOPMENTS
On October 30, 1998, Alliance completed its acquisition (the "Acquisition") of Difco Limited ("Difco"). Alliance acquired all of the capital stock of Difco and, indirectly a contract to acquire 10% of Burlington Resources (Irish Sea) Limited's ("Burlington") interest in the East Irish Sea Properties ("U.K. Interests"). The Difco shareholders received approximately 8.7% of the outstanding shares of the Company and could receive up to 29.6% of the outstanding shares of the Company based upon the production from, or reserves attributable to, the U.K. Interests.
The Company acquired, through Difco, 10% of Burlington's interest in the East Irish Sea Properties for cash consideration of approximately $17,800,000. In addition, the Company issued to one of its lenders 15,000,000 ordinary shares and loan notes with a face value of $9,750,000 for a total consideration of $10,000,000 and 545,454 ordinary shares in payment of a fee of $292,000. The Company paid another lender a cash fee of $700,000 and granted the lender warrants to purchase 3,275,000 ordinary shares at a price of 1p per share and an overriding royalty interest in the U.K. Interests of 0.3% beginning January 1, 2001. The overriding royalty interest will entitle the lender to receive a payment equal to the specified percentage of the net revenues generated by the U.K. Interests. The overriding royalty interest would have the effect of reducing the Company's revenues from the U.K. Interests. The Company also issued to its financial advisors 615,385 ordinary shares in payment of a fee of $330,000.
On April 23, 1999, the Company announced the successful drilling and testing of the 110/2b - R1 well. The well was the first to be drilled on the Company's recently acquired East Irish Sea assets and is located in the Dalton Field. The well was spudded on February 26, 1999, drilled to 4,222 feet, and suspended on April 12, 1999. Log analysis estimates 605 feet of gross gas column to be present in the well. Production testing from gross perforations between 3,395 - 3,700 feet achieved flow rates up to 78 MMCFG/D at 730 psig flowing tubing pressure.
Also, on April 23, 1999 the Company announced that it had recommended its recompletion program on its U.S. properties, yielding early success. Notably, the Ernest Roberts No. 1 Gas Unit in Hinds County, Mississippi was recompleted in March 1999. The well is currently producing at a rate of 1,626 MCFG/D with 35 BOPD. In addition, the Millie 2-20 well located in Dewey County, Oklahoma, was recompleted in February, 1999 and is currently producing 560 MCFG/D and 2 BOPD.
On July 23, 1999 the Company announced that the Dalton R2 well has been successfully reentered and recompleted. The R2 well tested at a maximum flow rate of approximately 54 MMSCF/D on a 120/64 inch choke at 772 psig flowing tubing pressure. In the East Millom Field, the Millom Q1 well has been successfully reentered and recompleted. The Q1 well tested at a maximum flow rate of 18 MMSCF/D on a 68/64 inch choke at 725 psig flowing tubing pressure. The Dalton R1, R2 and Millom Q1 wells are in the process of being tied back to the North Morecambe Bay Platform. First production is anticipated in August, 1999.
Effective July 30, 1999, the Company and its principal lender agreed to amend the terms of its credit agreement to allow for additional immediate borrowings of $5,000,000, to defer the date of the borrowing base redetermination from July 31, 1999 to December 31, 1999, and to defer the repayment date of a portion of the indebtedness from January 31, 2001 to July 31, 2001.
American Rivers Oil Company ("AROC") and Alliance announced that on July 22, 1999, they entered into a preliminary agreement, under which subject to the satisfaction of certain of various pre-conditions a new subsidiary of AROC would make a share for share offer for Alliance. The principal conditions to the making of the offer are the filing of a registration statement with the Securities and Exchange Commission and due diligence conducted by both parties. If the share offer is completed, it is expected that the shares of the new company will be quoted on the U.S. OTC Bulletin Board and will not be listed on the London Stock Exchange. If the transaction is completed and all the Alliance shareholders accept the offer, the shareholders of Alliance would hold 98% and the shareholders of AROC would hold 2% of the enlarged group.
COMPETITION
The oil and natural gas industry is highly competitive in all its phases. Alliance encounters strong competition from many other energy companies in acquiring economically desirable producing properties and drilling prospects and in obtaining equipment and labor to operate and maintain its properties. In addition, many energy companies possess greater resources than Alliance.
GOVERNMENTAL AND ENVIRONMENTAL REGULATION
Oil and gas production is subject to regulation under many international and U.S. Federal and State statutes, rules, orders and regulation. Permits for drilling, reworking and recompletion operations, drilling bonds and reports concerning operations are required. Most jurisdictions have regulations governing conservation matters, establishing maximum rates of production and the regulation of the spacing, plugging and abandonment of wells.
Environmental laws and regulations may affect the Company's operations and costs. In particular, production and saltwater disposal operations and use of facilities from treating, processing or otherwise handling hydrocarbons and wastes therefrom are subject to stringent environmental regulations. Environmental regulations are subject to frequent change and the Company cannot predict ongoing costs of compliance or the future impact of such regulations on operations.
OPERATIONS HAZARDS AND INSURANCE
The operations of the Company are subject to all risks inherent in the exploration for and production of oil and gas, including such natural hazards as blowouts, cratering and fires, which could result in damage or injury to, or destruction of, drilling rigs and equipment, formation, producing facilities or other property, or could result in personal injury, loss of life or pollution of the environment. Any such event could result in substantial expense to the Company which could have a material adverse effect upon the financial condition of the Company to the extent it is not fully insured against such risks but, in accordance with standard industry practice, the Company is not fully insured for all risks, either because such insurance is unavailable or because the Company elects not to obtain insurance coverage because of cost. Although such operational risks and hazards may to some extent be minimized, no combination of experience, knowledge and scientific evaluation can eliminate the risk of investment or assure a profit to any company engaged in oil and gas operations.
EMPLOYEES
At April 30, 1999, Alliance had 15 management and administrative employees and 9 technical and operating employees, none of whom belonged to a union. The employees include 15 people located in its Tulsa, Oklahoma office, 8 people in the Tensaw, Alabama office who conduct lease operations in the Company's South Carlton Field, and 1 field person in Louisiana. The Company's other field activities are accomplished through independent contractors. The Company believes its relations with its employees and contractors are excellent.
MARKETING
Alliance's production is primarily from developed fields close to major pipelines or refineries and established infrastructure. As a result, Alliance has not experienced any difficulty in finding a market for its product as it becomes available or in transporting its product to those markets.
Oil Marketing
Alliance markets its oil to a variety of purchasers, most of which are large, established companies. The oil is generally sold under short-term contracts with the sales price based on an applicable posted price, plus a negotiated premium. This price is determined on a well-by-well basis and the purchaser generally takes delivery at the wellhead.
Gas Marketing
Virtually all of Alliance's gas production is close to existing pipelines and, consequently, Alliance generally has a variety of options to market its gas. Alliance sells the majority of its gas on the spot market, with prices fluctuating month-to-month based on published pipeline indices with slight premiums or discounts to the applicable index.
ITEM 2.
ITEM 2. PROPERTIES
PRODUCTION
Alliance owns producing properties located in 10 states in the U.S., with proved reserves located primarily in the states of Alabama, Louisiana, Mississippi, Oklahoma, and Texas. Alliance continuously evaluates the profitability of its oil, gas and related activities and has a policy of divesting itself of unprofitable oil and gas properties or areas of operation that are not consistent with its operating philosophy.
Alliance operates 144 producing wells (119.6 net) in these areas and also owns non-operated interests in a further 122 active producing wells and units (21.9 net). These properties produced at a gross average rate of 4,300.9 Bbls of oil per day and 59,749.8 Mcf of gas per day (802.6 BBls of oil per day and 4,353.2 Mcf of gas per day net to the Company's interest) for the year ended April 30, 1999. Oil and gas sales from Alliance's producing oil and gas properties accounted for substantially all of Alliance's revenues for the year ended April 30, 1999.
The following summarizes Alliance's principal areas of oil and gas production activity as of April 30, 1999.
South Carlton Field, Alabama. The South Carlton Field is located in Clarke and Baldwin Counties in southwest Alabama, approximately 50 miles north of Mobile, Alabama. The field is situated on the Alabama River, and all crude oil produced is exported from the field by barge. Alliance operates 56 active producing oil wells and three saltwater disposal wells. Production is from the Massive and Pilot Sands of the Tuscaloosa Formation at a depth of approximately 6,000 ft. The field produced at a gross average daily rate of 301.8 Bbls of oil per day (249.6 Bbls of oil per day net to the Company's interest) for the duration of the year ended April 30, 1999. Production from the field was allowed to fall during the course of 1998 in order to minimize the impact of low oil prices on the overall profitability of operations and reached a gross average daily low of 206 Bbls of oil per day in the month of December 1998. Workover activities which were kept to a minimum in 1998 were stepped up in early 1999, and many
temporarily shut-in wells were returned to production. The field is now producing consistently at gross daily rates in excess of 400 Bbls of oil per day and in July 1999 again reached gross production levels of over 500 Bbls of oil per day.
Additional infill drilling has been identified in the field, and the Company believes that the application of horizontal drilling techniques has the potential to significantly improve recovery per well in view of the heavy gravity of the oil (12-14/0/ API). Alliance's working interest in this field is 100%. Net proved reserves to Alliance as of April 30, 1999 were 5,864.6 MBbls of oil.
Bolton Field, Mississippi. The Bolton Field is located in Hinds County, Mississippi and approximately 18 miles west of Jackson, Mississippi. Alliance operates 1 active producing well in this field, the Ernest Roberts #1 Gas Unit. Production is from the Cotton Valley Sands at a depth of over 15,500 ft. This property produced at a gross average daily rate of 527 Mcf of gas per day and 14.2 Bbls of oil per day (372.1 Mcf of gas per day and 10.1 Bbls of oil per day net to the Company's interest) for the duration of the year ended April 30, 1999.
The well was recompleted in March 1999 in several Cotton Valley Sands at depths of between 15,590 and 15,916 ft. The well is currently producing at a stabilized gross rate of approximately 1,620 Mcf of gas per day and 40 Bbls of oil per day. Alliance's working interest in this field is currently 91%. Additional proved behind pipe potential has been identified in the well and net proved reserves to Alliance as of April 30, 1999 were 3,619 MMcf of gas and 132.3 MBbls of oil.
Black Warrior Basin, Mississippi and Alabama. Alliance owns operated and non-operated working interests in 51 wells (38 operated and 13 non-operated) in Lamar, Fayette and Pickens Counties, Alabama and Lee and Chickasaw Counties, Mississippi. Production from these wells and units is from multiple sandstones of Mississippian (Carter, Lewis and Millerella) and Pennsylvanian (Benton and Coats) age at depths of 1,900 to 4,600 ft. These properties produced at a gross average daily rate of 4,046.8 Mcf of gas per day and 318.4 Bbls of oil per day (1,450.5 Mcf of gas per day and 11.8 Bbls of oil per day net to the Company's interest) for the duration of the year ended April 30, 1999. Alliance's working interest in these properties varies from between 1.8% to 100%. Significant proved behind pipe reserves have been identified in the properties and the majority are scheduled for recompletion over the next few years with the potential to add significantly to net cash flow. Net proved reserves to Alliance as of April 30, 1999 were 14.2 MBbls of oil and 9,698.4 MMcf of gas.
War-Wink South/East Quito Fields, Texas. Alliance owns non-operated working interests in 41 active wells operated by Texaco and Chevron in the War- Wink South and East Quito Fields in Ward County, Texas. These fields currently produce from multiple reservoirs in the Fusselman dolomite (Middle Silurian), Atoka limestone (Middle Pennsylvanian), and the Wolfcamp and Cherry Canyon (Lower and Middle Permian) Sands at depths of 6,200 feet to 17,500 feet. These properties produced at a gross average daily rate of 9,253.7 Mcf of gas per day and 548.6 Bbls of oil per day (753.8 Mcf of gas per day and 46.1 Bbls of oil per day net to the Company's interest) for the duration of the year ended April 30, 1999. The University 10-18-1U well which was completed in the Fusselman dolomite produced at a gross average daily rate of 6,175 Mcf of gas per day throughout the year. This amounts to approximately 67% of the gross gas produced from the properties in which Alliance has an interest in these fields. A number of proved undeveloped drilling locations have been identified on these properties. Net proved reserves to Alliance as of April 30, 1999 were 94.7 MBbls of oil and 1,697.2 MMcf of gas.
Jefferson Island Field, Louisiana. The Jefferson Island field is located approximately 12 miles southwest of the town of New Iberia in Iberia Parish, Louisiana. Alliance has a working interest in a 525-acre lease on the south side of Lake Peigner, which is currently being maintained by production from the Will Drill Resources (Texaco) JISMC #4 well. This well is now owned by Continental Resources Limited ("Continental"). Production intervals are known to exist in the Siphoni Davisi and Discorbis B sandstone reservoirs at depths of approximately 8,000 to 9,000 ft. The reservoir traps are combination structural-stratigraphic traps in a piercement salt dome setting. However, Alliance has not yet established production from the property. A number of proved undeveloped drilling locations have been identified on the property and the Company's working interest in this property is currently 100%. Net proved reserves to Alliance as of April 30, 1999 were 431.7 MBbls of oil and 1,230.2 Mcf of gas.
The Company entered into a farm-out agreement with Continental on this property, whereby Continental, at its sole risk and expense, has conducted a 3D seismic survey and is to drill and complete two wells on the lease to earn a two-thirds working interest. Continental completed the 3-D seismic survey in late 1998 and spudded the first well under the farm-out agreement in June 1999. This well was drilled to a total depth of approximately 10,000 ft. and several potentially productive pay zones were identified on electric logs in Siphoni Davisi Sands at depths of 8,500 to 9,000 ft. Continental is currently attempting to complete the well in the lowermost potentially productive sand at a depth of approximately 9,000 ft.
Tinsley Field, Mississippi. The Tinsley Field is located in Yazoo County, Mississippi, and approximately 34 miles northwest of the town of Jackson, Mississippi. Alliance operates 5 active producing wells and 2 saltwater disposal wells. Production is from upper Cretaceous age Eutaw Sands at depths of around 4,500 ft. This property produced at a gross average daily rate of 55.4 Bbls of oil per day (45.4 Bbls of oil per day net to the Company's interest) for the duration of the year ended April 30, 1999. The Company has a working interest in the property of 100%. One proved undeveloped drilling location has been identified on the property. Net proved reserves to Alliance as of April 30, 1999 were 360.3 MBbls of oil.
South Elton Field, Louisiana. The South Elton Field is located approximately 19 miles north of the town of Jennings in Jefferson Davis Parish, Louisiana. Alliance operates 4 active producing oil and gas wells and 2 saltwater disposal wells. Production is primarily from the Oligocene age sands of the Homeseekers D Formation at a depth of approximately 9,000 ft. This property produced at a gross average daily rate of 140 Bbls of oil per day and 76.7 Mcf of gas per day (99.0 Bbls of oil per day and 45.6 Mcf of gas per day net to the Company's interest) for the duration of the year ended April 30, 1999. The Company has a working interest in the property of between 65.3% and 99.6%. Another operator is currently acquiring a 3-D seismic survey over the area and Alliance will receive copies of the data acquired over its property within two months of completion of processing of the data. One proved undeveloped drilling location has been identified on the property. Net proved reserves to Alliance as of April 30, 1999 were 259.8 MBbls of oil and 86.4 Mcf of gas.
Perkins Field, Louisiana. The Perkins Field is located approximately 4 miles south of the town of De Quincy in Calcasieu Parish, Louisiana. Alliance operates 7 active producing wells and 1 saltwater disposal well. Production is from various Miocene age sands at depths of 5,000 to 7,500 ft. The property produced at a gross average daily rate of 75.1 Bbls of oil per day (58.6 Bbls of oil per day net to the Company's interest) for the duration of the year ended April 30, 1999. The Company has a working interest in the property of 100%. Net proved reserves to Alliance as of April 30, 1999 were 221.7 MBbls of oil.
In addition to these properties, the Company has other producing oil and gas properties located in Alabama, Arkansas, Colorado, Kansas, Louisiana, Michigan, Mississippi, Montana, Oklahoma and Texas. These properties produced at a gross daily rate of 2,847.4 Bbls of oil per day and 45,845.7 Mcf of gas per day (281.9 Bbls of oil per day and 1,731.1 Mcf of gas per day net to the Company's interest) for the duration of the year ended April 30, 1999. Net proved reserves to Alliance, as of April 30, 1999, from these other properties were 1,328.0 MBbls of oil and 6,520.2 Mcf of gas.
RESERVES
Lee Keeling and Associates, Inc. ("LKA"), Alliance's independent petroleum engineering consulting firm, has made estimates of Alliance's oil and gas reserves at April 30, 1999. LKA's report covers the estimated present value of future net cash flows before income taxes (discounted at 10%) attributable to Alliance's estimated future net cash flows therefrom.
The quantities of Alliance's proved reserves of oil and natural gas presented below include only those amounts which Alliance reasonably expects to recover in the future from known oil and gas reservoirs under existing economic and operating conditions. Proved developed reserves are limited to those quantities which are recoverable commercially at current prices and costs, under existing regulatory practices and with existing technology. Accordingly, any changes in prices, operating and development costs, regulations, technology or other factors could significantly increase or decrease estimates of Alliance's proved developed reserves. Alliance's proved undeveloped reserves include only those quantities which Alliance reasonably expects to recover from the drilling of new wells
based on geological evidence from offsetting wells. The risks of recovering these reserves are higher from both geological and mechanical perspective than the risks of recovering proved developed reserves.
As required by the Securities and Exchange Commission, the estimates of net proved reserves and proved developed reserves and the estimated future net revenues from such reserves set forth below, have been made in accordance with the provisions of Statement of Financial Accounting Standards No. 69, "Disclosures about Oil and Gas Producing Activities." Estimated future net cash flows from proved reserves are determined by using estimated quantities of proved reserves and the periods in which they are expected to be developed and produced based on economic conditions at the date of the report. The estimated future production is priced at current prices at the date of the report. The resulting estimated future cash inflows are then reduced by estimated future costs to develop and produce reserves based on cost levels at the date of the report. No deduction has been made for depletion, depreciation or for indirect costs, such as general corporate overhead. The discounted value was computed by discounting future net revenues at 10% per annum, without deduction for income taxes.
The following table sets forth estimates of the proved oil and natural gas reserves of Alliance at April 30, 1999, as evaluated by LKA.
The following table sets forth amounts as of April 30, 1999 determined in accordance with the requirements of the applicable accounting standards pertaining to the estimated future net cash flows from production and sale of the proved reserves attributable to Alliance's oil and gas properties before income taxes and the present value thereof. Nymex benchmark prices used in determining the future U.S. net cash flow estimates at April 30, 1999 were $18.66 per barrel for oil and $2.35 per MMBtu for gas. A delivery price of 9.05 pence per therm, equivalent to $1.54 per MMBtu for gas was used in determining the future U.K. net cash flow estimates at April 30, 1999.
The estimation of oil and gas reserves is a complex and subjective process which is subject to continued revisions as additional information becomes available. Reserve estimates prepared by different engineers from the same data can vary widely. Assumptions have to be made regarding the timing of future production and the timing and amount of future development and production costs. The calculations assume that economic conditions existing at the end of the reporting period will continue. Other, but equally valid, assumptions might lead to a significantly different final result. Therefore, the reserve data presented herein should not be construed as being exact. Any reserve estimate presented herein should not be construed as being exact. Any reserve estimate depends in part on the quality of available data, engineering and geologic interpretation, and thus represents only an informed professional judgment. Subsequent reservoir performance may justify upward or downward revision of such estimate. The information provided, therefore, does not represent management's estimate of Alliance's expected future cash flows or value of proved reserves.
Alliance has filed estimates of proved reserves with the London Stock Exchange. These estimates do not differ materially from those contained in this document.
For further information on reserves, costs relating to oil and gas activities, and results of operations from producing activities, see Note 17 to the Consolidated Financial Statements--Supplementary Financial Information for Oil and Gas Producing Activities incorporated by reference herein.
The following table sets forth Alliance's producing wells at April 30, 1999.
Productive wells consist of producing wells and wells capable of production, including gas wells awaiting pipeline connections to commence deliveries and oil wells awaiting connection to production facilities. Wells that are completed in more than one producing horizon are counted as one well. Of the gross wells reported above, 12 had multiple completions.
Developed and Undeveloped Acreage
The following table sets forth the developed and undeveloped leasehold acreage held by Alliance at April 30, 1999. Developed acres are acres that are spaced or assignable to productive wells. Undeveloped acres are acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and gas, regardless of whether or not such acreage contains proved reserves. Gross acres are the total number of acres in which Alliance has a working interest. Net acres are the sum of Alliance's fractional interests owned in the gross acres.
States in which Alliance held developed and undeveloped acreage at April 30, 1999 include Alabama, Arkansas, Colorado, Kansas, Louisiana, Mississippi, Montana, New Mexico, North Dakota, Oklahoma, Texas and Wyoming.
PRODUCTION, UNIT PRICES AND COSTS
The following table sets forth information with respect to sales of production and average unit prices and costs for the periods indicated.
(1) After giving effect to the impact of Alliance's price hedging arrangements with Alliance's principal bank. Without such hedging arrangements, the average sales prices for the years ended April 30, 1999 and 1998 would have been $10.11 and $15.14 for oil and $1.92 and $2.34 for gas, respectively, and $19.15 for oil and $2.40 for gas for the nine months ended April 30, 1997.
(2) No figures are included for U.K. production activities since first production is not anticipated until mid-August 1999.
(3) The components of production costs may vary substantially among wells depending on the methods of recovery employed and other factors, but generally include production taxes, lease overhead, maintenance and repair, labor and utilities.
(4) DRILLING ACTIVITY
During the periods indicated, Alliance drilled or participated in the drilling of the following exploratory and development wells. The information excludes wells in which Alliance has only an overriding interest.
At April 30, 1999, Alliance was not participating in the drilling of any oil and gas wells.
All of Alliance's drilling activities are conducted with independent contractors. Alliance owns no drilling equipment.
TITLE TO PROPERTIES
As is customary in the oil and gas industry, Alliance conducts only a perfunctory title examination at the time properties believed to be suitable for drilling operations are first acquired. Prior to commencement of drilling operations, a thorough drill site title examination is normally conducted and curative work is performed with respect to significant defects. During acquisitions, title reviews are performed on all material properties being acquired.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Group is a named defendant in lawsuits, and is subject to claims of third parties from time to time arising in the ordinary course of business. While the outcome of lawsuits or other proceedings and claims against the Group cannot be predicted with certainty, management does not expect these additional matters to have material adverse effect on the financial position or results of operations or liquidity of the Group.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 30, 1998, Alliance held an Extraordinary General Meeting in which it adopted resolutions approving the following items:
(a) the acquisition by Alliance of all of the issued share capital of Difco Limited ("Difco") in exchange for 10 million newly created convertible restricted voting shares of 1p each (the "Convertible Restricted Voting Shares") and a contingent right to receive additional shares, subject to the sales of production actually achieved from the U.K. Interests (as defined below);
(b) the acquisition through Difco of an undivided ten percent (10%) of the interest of Burlington Resources (Irish Sea) Limited in and to 13 blocks in the East Irish Sea and Liverpool Bay areas off the West Coast of the United Kingdom (the "U.K. Interests") for a cash consideration of approximately $17.8 million;
(c) the creation of the Convertible Restricted Voting Shares and the allotment of the Convertible Restricted Voting Shares and the additional shares issuable under the terms of the acquisition agreement between Alliance and the Difco shareholders;
(d) the allotment of certain ordinary shares and warrants to the lenders of Alliance and the allotment of equity securities in other specified instances;
(e) the increase of the borrowing powers of the Directors;
(f) a reduction in the par value of the ordinary shares of the Company;
(g) the adoption of certain amendments to the Articles of Association of the Company; and
(h) other matters relating to the foregoing.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MARKET INFORMATION AND DIVIDENDS
The Company's Ordinary Shares are traded on the London Stock Exchange under the symbol "ARS."
The following table sets forth in pounds, for the calendar quarter indicated, the high and low sales prices for the Alliance Shares on the London Stock Exchange (in pence) for the periods indicated derived from the official list of the London Stock Exchange. Bid quotations represent quotations between dealers without adjustment for retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions.
As of April 30, 1999, the approximate number of record holders of the Alliance Ordinary Shares was 2,300.
Quotations for shares listed on the London Stock Exchange are not generally readily available in newspapers or other publication in the United States, but are available in the daily U.S. edition of the Financial Times. However, investors may place orders for the purchase or sale of shares traded on the London Stock Exchange through most licensed broker dealers in the United States. Under current U.K. law, the transfer of Alliance Shares will generally give rise to a liability to U.K. stamp duty, normally at the rate of 50p for every (Pounds)100 (or part thereof) of the actual consideration paid.
Alliance has not paid any cash dividends on the Alliance Shares for at lease the last two complete fiscal years. In addition, Alliance is now restricted from paying dividends under the Company's credit agreement with the Bank of America.
EXCHANGE RATES
The table below sets forth, for the periods and dates indicated, certain information regarding the US dollar/pound sterling exchange rate, based on the Noon Buying Rate, expressed in US dollars per (Pounds)1.00.
(1) 1999 exchange rates are for the period from January 1, 1999 to April 30, 1999 only.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
On May 1, 1997, Alliance completed its acquisition of LaTex. The acquisition resulted in the issuance of 21,448,747 shares to the former shareholders of LaTex compared to the 8,103,816 shares then outstanding. As a result, the former LaTex shareholders had a controlling interest in the combined group and so for accounting and financial reporting purposes, LaTex is treated as having acquired Alliance ("Reverse Acquisition"). The historical financial information for all financial periods to April 30, 1997 reflect the results of operations and assets and liabilities of LaTex. LaTex's fiscal year end was July 31, whereas that of Alliance is April 30.
On October 30, 1998, Alliance completed its acquisition of Difco and indirectly a contract to acquire an interest in the U.K. Interests. The results of operations and assets and liabilities of Difco have been included since the date of acquisition.
The selected financial information presented below should be read in conjunction with the Company's audited financial statements and the notes thereto included under Item 8 and Management's Discussion and Analysis of financial Condition and Results of Operations at item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's acquisition of LaTex on May 1, 1997 has been accounted for as a "reverse acquisition" of the Company by LaTex. As such, the historical financial statements and financial information as of and for each of the years in the two-year period ended July 31, 1996 and for the nine-month period ended April 30, 1997 are for the business of LaTex alone and include no information for the Company.
The information in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" refers to the Consolidated Financial Statements of Alliance included in this Form 10-K which are presented in accordance with U.S. GAAP.
Unless otherwise indicated, the financial information in this Form 10-K has been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). U.S. GAAP differs in certain respects from generally accepted accounting principles in the U.K. ("U.K. GAAP"). As a result of the Company's listing on the London Stock Exchange, the Company is required to file reports with the London Stock Exchange prepared in accordance with U.K. GAAP.
RESULTS OF OPERATIONS
The factors which most significantly affect results of operations are (i) the sale prices of crude oil and gas, (ii) the level of total sales volumes, (iii) the level of lease operating expenses and (iv) the level of and interest rates on borrowings. Total sales volumes and the level of borrowings are significantly impacted by the degree of success in efforts to acquire oil and gas properties and in the ability to maintain or increase production from existing oil and gas properties through development activities.
The following table reflects certain historical operating data for the periods presented.
YEAR ENDED APRIL 30, 1999 COMPARED TO THE YEAR ENDED APRIL 30, 1998
Total revenues for the year ended April 30, 1999 were $6,234,477 compared to $10,209,881 for the year ended April 30, 1998. This 39% decrease in total revenue can be attributed to a 30% decrease in oil sales volumes (primarily at the South Carlton Alabama field), and a 17% decrease in natural gas sales volumes. A portion of the decreased sales volumes is due to the sale of non- operated, non-strategic properties. Additionally there was a 16% decrease in the average sales price received for oil, and a 24% decrease in the average sales price received for natural gas. Crude oil contributed 56% and natural gas contributed 44% of oil and gas production revenues during the year ended April 30, 1999. For the year ended April 30, 1998, crude oil contributed 61% and natural gas contributed 39% of oil and gas production revenues, respectively.
Lease operating expenses decreased 44% to $3,096,468 for the year ended April 30, 1999, compared to $5,505,826 for the year ended April 30, 1998. The reduction in operating expenses is a result of a reduced property base, lower expenses in the Alabama operations, and the shutting-in of marginal operated wells. On an equivalent barrel basis, lease operating expenses decreased by $1.75 to $5.41 for the year ended April 30, 1999, compared to $7.16 for the year ended April 30, 1998.
Depreciation, depletion and amortization expense decreased 36% from $2,598,066 for the year ended April 30, 1998 to $1,670,711 for the year ended April 30, 1999. This was due primarily to lower production volumes and reserve revisions resulting from price declines. On an equivalent barrel basis depreciation, depletion, and amortization decreased $0.57 to $3.27 for the year ended April 30, 1999, compared to $3.84 for the year ended April 30, 1998.
Alliance limits, on a country-by-country basis, the net capitalized cost of proved oil and gas properties, to estimated future net cash flows from proved oil and gas reserves discounted at 10 percent, net of related tax effects, plus the lower of cost or fair value of unproved properties included in the costs being amortized. Since the acquisition of the U.K. Interests on October 30, 1998, developments plans have become firmer, drilling and well re-entry and recompletion result on 3 wells have been reviewed and significant progress has been made on the development of the Dalton and Millom Fields. This additional information indicates that, while the aggregate reserves estimates at the time of acquisition are confirmed, the reserves are likely to be produced at a slower rate than originally anticipated and that development costs are likely to be in excess of those originally anticipated. These factors have led to an impairment in value of the U.K. Interests. The Company intends to sell a significant portion of its production from the U.K. Interests
under a term contract which will achieve prices significantly greater than the spot price of gas at April 30, 1999 (9.05 pence per therm). The Directors are confident of achieving a price of between 13 and 15 pence per therm. (This is a forward-looking statement; refer to the Cautionary Statement Regarding Forward Looking Statements). However, as no contract is yet in place, the Group has utilized the spot price at April 30, 1999 in calculating the carrying cost limit resulting in an impairment charge of some $28 million. The charge has no impact on cash flows from operating activities.
Interest costs for 1999 increased $780,981, or 25%, from 1998 primarily due to the revised credit facility put in place to fund the East Irish Sea acquisition and development. In 1999, Alliance wrote off $869,906 in deferred loan costs related to the Company's previous credit facility.
General and administrative expenses for the year ended April 30, 1999 were $3,486,007 which represents an increase of 3.6% over the $3,363,885 incurred in the prior fiscal year. On an equivalent barrel basis general and administrative expenses rose by $1.84 to $6.81 for the year ended April 30, 1999 compared to $4.97 for the year ended April 30, 1998.
The net loss for the year ended April 30, 1999 was $34,463,502 ($0.82 per ordinary share) compared to a net loss of $4,728,923 ($0.15 per ordinary share) for the year ended April 30, 1998.
YEAR ENDED APRIL 30, 1998 COMPARED TO NINE MONTHS ENDED APRIL 30, 1997
Total revenues from the Company's operations for the year ended April 30, 1998 were $10,209,881 compared to $5,844,871 for the nine months ended April 30, 1997. Revenues increased proportionately over the comparable period a year earlier due principally to the beneficial effect of higher realized gas and higher oil volumes, offset partially by the absence of marketing margins in the revenue category. The higher oil volumes were partially attributable to the inclusion of Alliance's sales volumes and additional volumes attributable to the acquisition of the BoA ORRI in the 1998 period following the LaTex Merger. Although sales volumes for the year ended April 30, 1998, were adversely affected by a continuing decline in volumes from the LaTex properties during the initial three months of the period, the remedial work program had a beneficial impact on volumes from the LaTex properties (discussed below). In addition, the inclusion of Alliance's sales volumes from the start of the current reporting period more than compensated for the initial decline in the LaTex properties.
The Company concentrated its efforts immediately after the LaTex Merger on increasing production from eleven existing producing fields operated by LaTex in the states of Alabama, Mississippi, Oklahoma, Texas and Louisiana. Workover operations on these fields commenced in early May 1997 and comprised mainly returning shut-in wells to production. Gross production from these eleven fields was increased from an average of 244 BOE per day in April 1997 to an average of 980 BOE per day by October 1997. Most of the production increase came from remedial workover operations in the South Carlton field in Alabama. Gross production from this field alone increased from an average of 89 BOE per day in April 1997 to an average of 575 BOE per day in September 1997.
Total operating expenses increased proportionately to $12,595,777 for the year ended April 30, 1998 compared to $8,155,557 for the nine months ended April 30, 1997. On May 15, 1997, the existing commodity price hedging arrangements were bought out with a loss of $1,128,000 recognized in its entirety in the year ended April 30, 1998 as a result of new agreements being initiated on October 23, 1997. Lease operating expenses increased to $5,505,826 for the year ended April 30, 1998 compared to $3,117,341 for the nine months ended April 30, 1997. The year ended April 30, 1998 was impacted by the remedial work program mentioned above and the inclusion of the Alliance properties partially offset by lower operating costs due to the sale of non-operated, non-strategic wells. Depreciation, depletion and amortization increased to $2,598,066 for the 1998 period compared to $1,541,415 due to higher volumes resulting from the inclusion of Alliance. General and administrative expenses decreased marginally from $3,481,003 during the nine months ended April 30, 1997 to $3,363,885 for the year ended April 30, 1998 primarily due to an employee stock award of $528,125 in the 1997 period.
In addition to the marginal increase in the net operating loss to $2,385,896 for the year ended April 30, 1998 from $2,310,686 for the nine months ended April 30, 1997, there was also a proportionate decrease in other income/expense. This was the result of higher interest expense taking into account the additional quarterly payment.
In summary, due to the above factors, the net loss for the ordinary shareholders for the year ended April 30, 1998 decreased to $4,728,923 ($0.15 per ordinary share) compared to a net loss of $4,906,946 ($0.30 per ordinary share) for the nine months ended April 30, 1997.
CAPITAL RESOURCES AND LIQUIDITY
The Company's capital requirements relate primarily to the acquisition of developed oil and gas properties and undeveloped leasehold acreage and exploration and development activities, and the servicing of the Company's debt. In general, because the Company's oil and gas reserves are depleted by production, the success of its business strategy is dependent upon a continuous acquisition and exploration and development program and the acquisition of additional reserves.
CASH FLOWS AND LIQUIDITY
At April 30, 1999, Alliance reported current assets of $2,451,077 and current liabilities of $8,072,252, which resulted in a net current deficit of $5,621,175.
For the year ended April 30, 1999 and April 30, 1998, Alliance's operating activities resulted in negative cash flow of $3,991,251 and $5,184,000, respectively. The Company had a positive cash flow of $2,098,566 for the nine months ended April 30, 1997.
Investing activities of Alliance used $24,174,756 as compared to providing $3,084,970 in net cash flow for the years ended April 30, 1999 and April 30, 1998, respectively. The 1999 increase was a result of the acquisition of Difco and the U.K. Interests as well as the capital expenditures for oil and gas development activities.
Financing activities provided $28,043,726 for the year ended April 30, 1999, compared to $2,434,660 for the year ended April 30, 1998. The increase was due primarily to the issuance of long-term debt of $45,464,123, the issuance of common stock for $6,360,000, the refinancing of long-term debt of $22,566,762 and the payment of loan acquisition costs of $1,213,635, all in connection with the Difco and U.K. Interests acquisitions.
The domestic spot prices of oil and gas have traded, in a volatile manner over various periods in recent years. To the extent that oil and gas prices are volatile, material fluctuations in revenues from quarter to quarter can be expected which, in turn, could adversely affect the Company's ability to service its debt with its principal bank in a timely manner and to fund its ongoing operations and could, under certain circumstances, require a write-down of the book value of the Company's oil and gas reserves.
The Company continues to experience net losses and working capital deficits. These factors may indicate the Company will be unable to continue as a going concern for a reasonable period of time. Despite its negative cash flow, the Company has been able to secure financing to support its operations to date. The Company was not in compliance with certain covenants of its loan agreements at April 30, 1999, however, a waiver has been obtained for such violations. Agreement has been reached with the Company's principal lender to amend the terms of its credit agreement to allow for additional immediate borrowings of $5,000,000, to defer the date of the repayment of a portion of its indebtedness from January 31, 2001 to July 31, 2001 and to defer the date of the borrowing base redetermination from July 31, 1999 to December 31, 1999. The amendment does not change the scheduled repayment dates of other portions of its debt, the first payment of which is due July 31, 2000.
The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to continue to comply with the terms of its borrowing agreements, to obtain additional financing or refinancing as will be required and ultimately to attain profitability. Management believes it has a business plan that, if successfully executed, will achieve these objectives.
CAPITAL EXPENDITURES
The timing of most of the Company's U.S. capital expenditures is discretionary. Currently, there are no material long-term commitments associated with the Company's U.S. capital expenditure plans. Consequently, the Company has a significant degree of flexibility to adjust the level of such expenditures as circumstances warrant. The Company primarily uses funds available under its credit facility and proceeds from the sale of oil and gas properties to fund capital expenditures, other than significant acquisitions, and to fund its working capital deficit. If the Company's internally generated cash flows should be insufficient to meet its banking or other obligations, the Company may reduce the level of discretionary U.S. capital expenditures or increase the sale of non-strategic oil and gas properties in order to meet such obligations.
The timing of the Company's U.K. capital expenditures is determined annually by a budget prepared by Burlington and approved by Alliance. Currently, there are material commitments for the 2000 fiscal year. These commitments will be met by funds available under the Company's credit facility and internally generated cash flow.
The level of the Company's capital expenditures will vary in future periods depending on energy market conditions and other related economic factors. As a result, the Company will continue its current policy of funding capital expenditures with funds available under its credit facility and internally generated cash flow. (This is a forward-looking statement; refer to the Cautionary Statement Regarding Forward Looking Statements).
FINANCING ARRANGEMENTS
Alliance entered into a Credit Agreement (the "Alliance Credit Agreement") with the Bank of America effective May 1, 1997, amending and restating the Group's previous credit agreement. A portion of the borrowings under the Alliance Credit Agreement bore interest, payable monthly, at a rate equal to the higher of the Bank of America Reference Rate plus 1% and the Federal Funds Rate plus 1-1/4%. Another portion of the borrowings bore interest, payable monthly, at a rate equal to the London Interbank Offered Rate plus 2%. The rate at April 30, 1998 was 7.875%. Principal payments were scheduled to commence on October 31, 1998. The note was scheduled to mature on March 31, 2000. Amounts outstanding were secured by mortgages which cover the majority of the Group's oil and gas properties.
In connection with the Difco Acquisition, the Company entered into agreements with Bank of America National Trust & Savings Association ("BoA"), Alliance's principal lender and EnCap Equity 1996 Limited Partnership and EnCap Capital Investment Company PLC (collectively "EnCap") providing up to $64,750,000 in debt, as follows:
BoA: Tranche A $30,000,000 Tranche B 20,000,000 Tranche C 5,000,000 ----------- 55,000,000 EnCap 9,750,000 ----------- $64,750,000 ===========
Tranche A consists of a revolving credit facility secured by a first priority lien and security interest in all of the oil and gas properties of the Company. The Company's initial borrowing base is $18,500,000 and is redetermined semiannually on January 31 and July 31. Interest is at a rate determined by the Company from time to time, of either
(i) the greater of BoA's refernce rate and the federal funds effective rate plus 0.5%, or (ii) 2.0% above the current Interbank rate (7.5% at April 30, 1999). While any Tranche B loan is outstanding, the preceding margins will be increased by an additional 0.5% semi-annually on April 26 and on October 26 of each year. Interest is payable quarterly and principal is due in equal quarterly payments beginning October 30, 2000 and ending on October 30, 2003.
Tranche B consists of a credit facility secured by a first priority lien and security interest in all of the oil and gas properties of the Company. Interest is at a rate determined by the Company from time to time, of either (i) BoA's Tranche B reference rate plus 2.0%, or (ii) 4.0% above the current Interbank rate (9.0% at April 30, 1999). The margins for all Tranche B loans will be increased by an additional 0.5% semi-annually on April 26 and on October 26 of each year. Interest is payable quarterly and principal is due in full on January 31, 2001.
Tranche C consists of a credit facility secured by a first priority lien and security interest in all of the oil and gas properties of the Company. Interest is at a rate determined by the Company from time to time, of either (i) BoA's reference rate plus 5.0%, or (ii) 7.0% above the current Interbank rate (12.0% at April 30, 1999). Interest is payable quarterly and principal is due in equal quarterly payments beginning January 31, 2001 and ending on October 30, 2004. The BoA debt facility contains various covenants, including, but not limited to, maintenance of minimum current and interest coverage ratios, as defined in the agreement.
EnCap debt is unsecured and bears interest at 10%. Interest is payable quarterly and principal is due in full on October 30, 2005. Until October 30, 2001, the Company has the option, in lieu of paying cash, of increasing the principal amount of the debt by the interest due.
The Company paid BoA a cash fee of $700,000 and granted BoA warrants to purchase 3,275,000 ordinary shares at a price of 1p per share. The fair value of the warrants $1,335,000 attaching to the debt was treated as a discount. In addition, the Company will grant BoA an overriding royalty interest, valued at the value of the underlying oil and gas reserves, in the U.K. Interests of 0.3% beginning January 1, 2001. The overriding royalty interest will entitle BoA to receive payment equal to the specified percentage of the net revenues generated by the U.K. Interests and has the effect of reducing the Company's revenues from the U.K. Interests. In connection with obtaining the debt financing from BoA, the Company was required to enter into commodity price risk management contract on terms that are mutually agreeable to BoA and the Company for a period not less than two years with respect to at least 50% of the Company's estimated producing reserves as of October 31, 1998. BoA also required the Company to enter into interest rate risk management contracts providing for a maximum interest rate of 9.0% on the notional amount projected to be outstanding on the revolving credit facility.
The Company was not in compliance with certain covenants of the loan agreements, which included but were not limited to the maintenance of minimum levels of working capital and interest coverage. Prior to these violations causing an event of default, which would have resulted in an acceleration of the repayment of the loans, the Company obtained waivers from the lenders for all covenant violations. Effective July 30, 1999 the loan agreement was amended to revise the borrowing limit of Tranche B to $25,000,000 and reduce the limit of Tranche A to a similar amount. This enabled the Company to borrow an additional $5,000,000 as of July 30, 1999. The due date of Tranche B was extended from January 31, 2001 to July 31, 2001. In addition, the date of the borrowing base and collateral value redetermination scheduled to occur on July 31, 1999 was deferred until December 31, 1999.
SEASONALITY
The results of operations of the Company are somewhat seasonal due to fluctuations in the price for crude oil and natural gas. Recently, crude oil prices have been generally higher in the third calendar quarter, and natural gas prices have been generally higher in the first calendar quarter. Due to these seasonal fluctuations, results of operations for individual quarterly periods may not be indicative of results, which may be realized on an annual basis.
INFLATION AND PRICES
In recent years, inflation has not had a significant impact on the operations or financial condition of the Company. The generally downward pressure on oil and gas prices during most of such periods has been accompanied by a corresponding downward pressure on costs incurred to acquire, develop, and operate oil and gas properties as well as the costs of drilling and completing wells on properties.
Prices obtained for oil and gas production depend upon numerous factors that are beyond the control of the Company including the extent of domestic and foreign production, imports of foreign oil, market demand, domestic and world- wide economic and political conditions, and government regulations and tax laws. Prices for oil and gas have fluctuated significantly in recent years.
The following table sets forth the average price received by the Company.
Oil Gas --------- ---------- Year ended April 30, 1999 $13.20 $1.79 Year ended April 30, 1998 $15.75 $2.36 Nine months ended April 30, 1997 $15.34 $1.70
On October 31, 1998, the Company's commodity price hedge agreements expired. During February 1999 the Company completed a transaction to hedge approximately 65% of its existing monthly gas production by installing a floor of $1.60/MMBTU and a cap of $2.07/MMBTU. This will protect the Company from any severe declines in natural gas prices over the next six months and conversely limit the benefit of prices in excess of the cap. During April 1999 the Company completed a transaction to hedge approximately 40% of its existing monthly oil production by installing a floor of $12.00/barrel. This will protect the Company from any severe declines in oil prices over the next six months.
ISSUES RELATED TO THE YEAR 2000
GENERAL
The following Year 2000 statements constitute a Year 2000 Readiness Disclosure within the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998. The Year 2000 problem has arisen because many existing computer programs use only the last two digits to refer to a year. Therefore, these computer programs do not properly recognize and process date-sensitive information beyond 1999. In general, there are two areas where Year 2000 problems may exist for the Company: information technology such as computers, programs and related systems ("IT") and non-information technology systems such as embedded technology on a silicon chip ("Non IT").
THE PLAN
Alliance's Year 2000 Plan (the "Plan") has four phases: (i) assessment, (ii) inventory, (iii) remediation, testing and implementation and (iv) contingency plans. Approximately twelve months ago, the Company began its phase one assessment of its particular exposure to problems that might arise as a result of the new millennium. The assessment and inventory phases have been substantially completed and have identified Alliance's IT systems that must be updated or replaced in order to be Year 2000 compliant. Remediation, testing and implementation are scheduled to be completed by September 30, 1999, and the contingency plan phase of the Plan is scheduled to be completed by October 31, 1999. Alliance's assessment of the readiness of third parties whose IT systems might have an impact on Alliance's business has thus far not indicated any material problems.
With regard to Alliance's Non IT systems, the Company believes that most of these systems can be brought into compliance on schedule. Alliance's assessment of third party readiness is not yet completed. Because the potential problem with Non IT systems involves embedded chips, it is difficult to determine with complete accuracy where all such systems are located. As part of its Plan, the Company is making formal and informal inquiries of its vendors, customers and transporters in an effort to determine the third party systems that might have embedded technology requiring remediation.
ESTIMATED COSTS
Although it is difficult to estimate the total costs of implementing the Plan through January 1, 2000 and beyond, Alliance's preliminary estimate is that such costs will not be material. To date, the Company has determined that its IT systems are either compliant or can be made compliant for less than $50,000. However, although management believes that its estimates are reasonable, there can be no assurance, for the reasons stated in the next paragraph, that the actual cost of implementing the Plan would not differ materially from the estimated costs.
POTENTIAL RISKS
The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. This risk exists both as to Alliance's IT and Non IT systems, as well as to the systems of third parties. Such failures could materially and adversely affect Alliance's results of operations, cash flow and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third party suppliers, vendors and transporters, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on Alliance's results of operations, cash flow or financial condition. Although the Company is not currently able to determine the consequences of Year 2000 failures, its current assessment is that its area of greatest potential risk in its third party relationships is in connection with the transporting and marketing of the oil and gas produced by the Company. The Company is contacting the various purchasers and pipelines with which it regularly does business to determine their state of readiness for the Year 2000. Although the purchasers and pipelines will not guaranty their state of readiness, the responses received to date have indicated no material problems. The Company believes that in a worst case scenario, the failure of its purchasers and transporters to conduct business in a normal fashion could have a material adverse effect on cash flow for a period of six to nine months. Alliance's Year 2000 Plan is expected to significantly reduce Alliance's level of uncertainty about the compliance and readiness of these material third parties. The evaluation of third party readiness will be followed by Alliance's development of contingency plans.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
In addition, the dates for completion of the phases of the Year 2000 Plan are based on Alliance's best estimates, which were derived using numerous assumptions of future events. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-parties and the interconnection of computer systems, the Company cannot ensure its ability to timely and cost-effectively resolve problems associated with the Year 2000 issue that may affect its operations and business. Accordingly, shareholders and potential investors are cautioned that certain events or circumstances could cause actual results to differ materially from those projected, estimated or predicted.
QUANTITATIVE AND QUALITATIVE ANALYSIS ON MARKET RISK
The Company's primary market risks relate to changes in interest rates and in the prices received from sales of oil and natural gas. The Company's primary risk management strategy is to partially mitigate the risk of adverse changes in its cash flows caused by increases in interest rates on its variable rate debt, and decreases in oil and natural
gas prices, by entering into derivative financial and commodity instruments, including swaps, collars and participating commodity hedges. By hedging only a portion of its market risk exposures, the Company is able to participate in the increased earnings and cash flows associated with decreases in interest rates and increases in oil and natural gas prices; however, it is exposed to risk on the unhedged portion of its variable rate debt and oil and natural gas production.
Historically, the Company has attempted to hedge the exposure related to its variable rate debt and its forecasted oil and natural gas production in amounts which it believes are prudent based on the prices of available derivatives and, in the case of production hedges, the Company's deliverable volumes. The Company attempts to manage the exposure to adverse changes in the fair value of its fixed rate debt agreements by issuing fixed rate debt only when business conditions and market conditions are favorable.
The Company does not use or hold derivative instruments for trading purposes nor does it use derivative instruments with leveraged features. The Company's derivative instruments are designated and effective as hedges against its identified risks, and do not of themselves expose the Company to market risk because any adverse change in the cash flows associated with the derivative instrument is accompanied by an offsetting change in the cash flows of the hedged transaction.
Personnel who have appropriate skills, experience and supervision carry out all derivative activity. The personnel involved in derivative activity must follow prescribed trading limits and parameters that are regularly reviewed by senior management. The Company uses only well-known, conventional derivative instruments and attempts to manage its credit risk by entering into financial contracts with reputable financial institutions.
Following are disclosures regarding the Company's market risk sensitive instruments by major category. Investors and other users are cautioned to avoid simplistic use of these disclosures. Users should realize that the actual impact of future interest rate and commodity price movements will likely differ from the amounts disclosed below due to ongoing changes in risk exposure levels and concurrent adjustments to hedging positions. It is not possible to accurately predict future movements in interest rates and oil and natural gas prices.
Interest Rate Risks (non-trading) - the Company uses both fixed and variable rate debts to partially finance operations and capital expenditures. As of April 30, 1999, the Company's debt consists of $39,830,348 in borrowings under its Credit Agreement which bear interest at a variable rate, and $10,243,775 in borrowings under its 10% Senior Subordinated Notes which bear interest at a fixed rate. The Company hedges a portion of the risk associated with its variable rate debt through derivative instruments which consist of interest rate swaps and collars. Under the swap contracts, the Company makes interest payments on its Credit Agreement as scheduled and receives or makes payments based on the differential between the fixed rate of the swap and a floating rate plus a defined differential. These instruments reduce the Company's exposure to increases in interest rates on the hedged portion of its debt by enabling it to effectively pay a fixed rate of interest or a rate, which only fluctuates within a predetermined ceiling and floor. A hypothetical increase in interest rates of two percentage points would cause a loss in income and cash flows of $800,000 during 1999, assuming that outstanding borrowings under the Credit Agreement remain at current levels. This loss in income and cash flows would be offset by a $0 increase in income and cash flows associated with the interest rate swap and collar agreements that are in effect for 1999. A hypothetical decrease in interest rates of two percentage points would cause an increase in the fair value of $0 in the Company's Senior Subordinated Notes from their fair value at April 30, 1999.
Commodity Price Risk (non trading) - The Company hedges a portion of the price risk associated with the sale of its oil and natural gas production through the use of derivative commodity instruments, which consist of collars and participating hedges. These instruments reduce the Company's exposure to decreases in oil and natural gas prices on the hedged portion of its production by enabling it to effectively receive a fixed price on its oil and natural gas sales or a price that only fluctuates between a predetermined floor and ceiling. As of July 1, 1999, the Company had entered into derivative commodity hedges covering an aggregate of 40,000 barrels of oil and 320,000 MMbtu's of
gas that extend through October 1999. Under these contracts, the Company sells its oil and natural gas production at spot market prices and receives or makes payments based on the differential between the contract price and a floating price which is based on spot market indices. The amount received or paid upon settlement of these contracts is recognized as oil or natural gas revenues at the time the hedged volumes are sold. A hypothetical decrease in oil and natural gas prices of 10% from the price in effect as of April 30, 1999, would cause a loss in income and cash flows of $383,250 during 1999, assuming that oil and gas production remain at current levels. This loss in income and cash flows would be offset by a $0 increase in income and cash flows associated with the oil and natural gas derivative contracts that are in effect.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page ----
Independent Auditors' Report..............................................
Consolidated Balance Sheets...............................................
Consolidated Statements of Operations.....................................
Consolidated Statements of Changes in Stockholders' Equity................
Consolidated Statements of Cash Flows.....................................
Notes to the Consolidated Financial Statements............................
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
John A. "Jak" Keenan, aged 45, is the Chairman and Managing Director of Alliance. He has worked in the oil industry since 1976 and was successively first vice president of corporate development, chief operating officer and director and president of the oil and gas division of Great Western Resources, Inc. He resigned his position at Great Western Resources, Inc. in August 1995 and accepted a position at the law firm of Jenkens & Gilchrist in Houston, Texas, where he specialized in oil and gas transactions. He joined the Board of Alliance in April 1996.
Michael E. Humphries, aged 42, is the Interim Finance Director of Alliance. Having begun his career at Britoil Plc, he has spent 16 years working in the international oil and gas arena and is currently Senior Vice President of Rothschild Natural Resources, LLC, based in Washington DC, where he has responsibility for Rothschild's oil and gas activities in North America. He joined the Board of Alliance in December 1997.
Paul R. Fenemore, aged 43, is the Operations and Business Development Director of Alliance. He has a B.Sc. degree in combined science obtained in 1975 and a M.Sc. degree in marine geotechnics. He has extensive experience in detailed technical and economic evaluations of exploration and oil field appraisal and development projects and project management and has held several technical and senior management positions with Gulf Oil Corporation, Amoco Europe and West Africa Limited, Amerada-Hess UK Limited, Hamilton Brothers (UK) Limited, CSX Oil and Gas Corporation, Cairn Energy PLC and Hunting Surveys Limited. From 1991 until 1995, he was managing director of Petroleum Ventures International and Spectron Petroleum Limited and became a fellow of the Geological Society in 1992. He joined the Board of Alliance in May 1996.
Phillip Douglas, aged 60, is a non-executive Director of Alliance. He was a director and head of international investment at Morgan Grenfell for 16 years and was a director of G T Management. He also has a number of other non- executive directorships in public and private companies. He joined the Board of Alliance in November 1993.
William J. A. Kennedy, aged 60, is a non-executive Director of Alliance. After 25 years experience in the investment industry, he became vice president of a major conglomerate, Crownx, Inc. For the past nine years, he has operated a management consulting service and sits on the board of two public Canadian companies. He joined the Board of Alliance in January 1994.
John R. Martinson, aged 63, is a non-executive Director of Alliance. He has a B.Sc. degree in engineering and a masters degree in business administration. He became a director of LaTex in May 1995, having served as a consultant to that company since 1994. He is Managing Director of Wood Roberts, LLC, where he has been engaged in financial consulting since January 1989. From 1973 to 1988, Mr. Martinson was an independent oil and gas entrepreneur. Previously, he was with Kidder Peabody & Co., Oppenheimer & Co. and Mobil Corporation. He joined the Board of Alliance in May 1997.
Other Key Employees and their Business Histories
In addition to the Executive Directors, the Company employs two senior executives. The names, current ages and positions of these other key employees are as follows:
Name Age Position ---- --- --------
Francis M. Munchinski 45 General Counsel
Robert E. Schulte 41 Controller
Francis M. Munchinski is the General Counsel of Alliance. He is a U.S. citizen and a doctor of law. Prior to joining the Company in June 1998, he was a shareholder at the law firm of Jenkens & Gilchrist in Dallas, Texas where he specialized in oil and gas law for over 13 years. Mr. Munchinski has been involved in the oil and gas business for over 18 years.
Robert E. Schulte is the Controller of Alliance. He is a U.S. citizen and has a B.S. degree in accounting. He has worked in the oil and gas industry since 1981 in both domestic and international arenas. He has held management positions with Bow Valley Petroleum, Kelt Energy, Great Western Resources and Apache Corporation before joining Alliance in September 1997.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information regarding compensation paid or accrued during each of the Company's last three fiscal years to the Company's Managing Director, John A. Keenan and each of the other most highly compensated executive officers who earned at least $100,000 in salary and bonus in fiscal 1999 (the "Named Executives"):
Summary Compensation Table
(1) Mr. Keenan assumed his position with Alliance on May 22, 1996. Amounts shown under All Other Compensation in 1999 represent pension and benefits. Amounts shown under All Other Compensation in 1998 represent relocation expenses.
(2) Mr. Fenemore assumed his position with Alliance on May 21, 1996. Amounts shown under All Other Compensation in 1999 represent pension.
(3) Mr. Munchinski assumed his position with Alliance on June 16, 1998. Amounts shown under All Other Compensation in 1999 represent relocation expenses and benefits.
(4) Mr. Schulte assumed his position with Alliance on September 17, 1997. Amounts shown under All Other Compensation in 1999 represent relocation expenses and benefits.
Options Grants in Last Fiscal Year
The following table sets forth all individual grants of options to the Named Executives of the Company during the fiscal year ended April 30, 1999.
(1) Represents the closing mid-market price of the ordinary shares on the London Stock Exchange on November 27, 1998.
Fiscal Year End Option Values
Shown below is information with respect to the Named Executives of the Company regarding option exercises during the fiscal year ended April 30, 1999, and the value of unexercised options held as of April 30, 1999.
Employment Agreements
Each of Messrs. Keenan, Fenemore, Munchinski, and Schulte have entered into Executive Service Agreements with Alliance providing for his employment in his current capacity for an initial fixed term of two years beginning October 15, 1996, September 20, 1996, January 1, 1999 and January 1, 1999, respectively, and having automatic extensions of the initial term for additional two-year periods unless written notice of either party's intention not to extend has been given to the other party at least three months prior to the expiration of the then effective two-year period of employment, provided that the executive may at any time terminate his employment by giving a minimum of three months notice. If the executive's employment terminates for any reason other than the executive's breach of the agreement, disability or malfeasance, Alliance must pay the executive an amount equal to twice the annual salary, bonuses and benefits paid to the executive. Upon the involuntary termination of the executive's employment without cause or voluntary termination by the executive after a change in his office location, his responsibilities or reduction in compensation following a change in control of Alliance, the executive is entitled to the payment of one lump sum of cash in an amount equal to two and a half times the annual salary, bonus and benefits paid to the executive.
The annual salary under each agreement is $180,000 for Mr. Keenan, (pounds)100,000 for Mr. Fenemore, $140,000 for Mr. Munchinski and $100,000 for Mr. Schulte, plus any bonuses or other compensation determined by Alliance's Board of Directors in its discretion.
Compensation of Directors
The compensation of the non-executive directors is reviewed by the Board of Directors from time to time to ensure that this compensation is in line with current market practice. Under Alliance's Articles of Association, shareholders determine the maximum aggregate amount payable by way of fees to directors and this maximum amount is currently fixed at (Pounds)100,000 per year. During the twelve months ended April 30, 1999, the following directors were paid the indicated fees for their services as directors: Mr. Douglas $16,000, Mr. Kennedy $16,000, Mr. Samuelson $12,000, Mr. Martinson $12,000 and Mr. Humphries $12,525.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of April 30, 1999, with respect to the beneficial ownership of Shares (i) by any person or "group," as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, known to the Company to own beneficially more than 5% of the outstanding Shares, (ii) by each director, including executive directors, and each other key employee of the Company named in the Summary Compensation Table, and (iii) by all directors, including executive directors, and all key employees of the Company as a group. Except as otherwise indicated, each of the persons named below is believed by the Company to possess sole voting and investment power with respect to the Shares beneficially owned by such person.
- -------------------------------- * Less than 1%
(1) All of the Company's directors may be contacted at 12 St. James's Square, London SW1Y 4RB.
(2) Includes options to purchase 1,290,000 Shares granted pursuant to the Company's executive share option plans.
(3) Consists of options to purchase 870,000 Shares granted pursuant to the Company's executive share option plans.
(4) Consists of options to purchase 520,000 Shares granted pursuant to the Company's executive share option plans.
(5) Consists of options to purchase 310,000 Shares granted pursuant to the Company's executive share option plans.
(6) Includes presently exercisable warrants to purchase 374,877 Shares held by Wood Roberts, Inc., a corporation under the control of Mr. Martinson and presently exercisable warrants to purchase 218,334 Shares held by Wood Roberts, LLC, a Texas limited liability company 50% owned by Mr. Martinson.
(7) The address of Enron Reserve Acquisition Corp. is 1400 Smith Street, Houston, Texas 77002. After April 30, 1999, Enron Reserve Acquisition Corp. advised the Company that it sold all of its shares.
(8) Consists of 1,500,000 Shares, convertible loan notes and immediately exercisable warrants convertible into or exercisable for 2,404,519 Shares issued to an affiliate of Bank of America and warrants to purchase 3,275,000 Shares at a price of 1p per share. The address of LaSalle Street Natural Resources is 231 S. LaSalle Street, Chicago, Illinois 60697.
(9) The address of EnCap Equity 1996 Limited Partnership is 1100 Louisiana, Suite 3150, Houston, Texas 77002. EnCap Equity 1996 Limited Partnership shares voting and dispositive power with EnCap Investments L.C., its general partner.
(10) The address of Energy Capital Investment Company PLC is c/o Aberdeen Asset Management, 1 Bow Churchyard, Cheapside, London EC4M 9HH, England. Energy Capital Investment Company PLC shares dispositive and voting power over these shares with EnCap Investments L.C.
(11) The address of EnCap Investments L.C. is 1100 Louisiana, Suite 3150, Houston, Texas 77002. EnCap Investments L.C. shares dispositive and voting power over 15,000,000 of these shares with EnCap Equity 1996 Limited Partnership and Energy Capital Investment Company PLC.
(12) In addition to the interests set out above, John A. Keenan is interested in 45,000 Shares held in the name of Diamond Securities Limited and 102,500 Shares held in the name of Havensworth Limited by virtue of having proxy over the voting rights attached to these Shares pending their sale, as required by a settlement of legal proceedings with the former Managing Director of the Company in August 1996.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements (included at Item 8. Financial Statements and Supplementary Data)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company with the Securities and Exchange Commission during the fourth quarter of the Company's fiscal year ended April 30, 1999.
(c) Exhibits.
Exhibit Description - ------- -----------
3.1(3) Memorandum of Association of Alliance Resources Plc (3.1) 3.2(3) Articles of Association of Alliance Resources Plc (3.7) 3.3(2) Form of Warrant Agreement relating to Warrants issued to Society National Bank as Warrant Agent for holders of certain LaTex Warrants (3.3) 3.4(2) Warrant Agreement and form of Warrant issued to all other holders of LaTex Warrants (3.4) 3.5(2) Form of Convertible Loan Note Instrument entered into between Alliance Resources Plc and Bank of America NT & SA (3.5) 3.6(2) Registration Rights Agreement between Alliance Resources Plc and affiliate of Bank of America NT & SA (3.6) 10.1(1)(2) Executive Service Agreement between Alliance Resources Plc and John A. Keenan dated October 15, 1996 as amended by Supplemental Agreement dated April 7, 1998 and Second Supplemental Agreement dated as of December 1, 1998 (10.1) 10.2(1)(2) Executive Service Agreement between Alliance Resources Plc and Paul R. Fenemore dated September 20, 1996 as amended by Supplemental Agreement dated April 16, 1998 and Second Supplemental Agreement dated as of December 1, 1998 (10.2) 10.3(1) Executive Service Agreement between Alliance Resources Plc and Francis M. Munchinski dated as of December 1, 1998.
10.4(1) Executive Service Agreement between Alliance Resources Plc and Robert E. Schulte dated as of December 1, 1998. 10.5(3) Purchase Agreement dated October 27, 1998, by and between Alliance Resources PLC and EnCap Equity 1996 Limited Partnership and Energy Capital Investment Company Plc. 10.6 First Amendment to the Purchase Agreement, dated effective as of July 30, 1999. 10.7(3) Registration Rights Agreement dated as of October 30, 1998 by and between Alliance Resources PLC, EnCap Equity 1996 Limited Partnership, Energy Capital Investment Company Plc and EnCap Investments, L.C. 10.8(3) Third Amended and Restated Credit Agreement dated as of October 27, 1998, among Alliance Resources PLC and certain of its subsidiaries and Bank of America National Trust and Savings Association. 10.9 First Amendment to the Third Amended and Restated Credit Agreement, dated effective as of July 30, 1999. 10.10(3) Registration Rights Agreement dated as of October 30, 1998 between the Company and LaSalle Street Natural Resources Corporation. 10.11(3) Registration Rights Agreement dated as of October 30, 1998, among Alliance Resources PLC and F. Fox Benton and certain members of his family. 10.12 Exchange and Merger Agreement by and among American Rivers Oil Company, a Wyoming corporation, American Rivers Oil Company, a Delaware corporation, and Alliance Resources Plc, dated July 22, 1999. 22.1 Subsidiaries
- -------------
(1) Constitutes compensation plan or arrangement (2) Incorporated by reference from the indicated exhibit filed with Alliance's Registration Statement on Form (No. 333-19013). (3) Incorporated by reference from the indicated exhibit filed with Alliance's Form 8-K filed November 16, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Alliance Resources PLC
Date: August 12, 1999 /s/ John A. Keenan --------------------- John A. Keenan, Chairman and Managing Director
Pursuant to the requirements of the Securities Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Title Date --------- ----- ----
/s/ John A. Keenan Chairman and Managing Director August 12, 1999 - ------------------------- John A. Keenan
/s/ Paul R Fenemore Operations and Business Development August 12, 1999 - ------------------------- Director Paul R Fenemore
/s/ Phillip Douglas Director August 12, 1999 - ------------------------- Phillip Douglas
/s/ William J A Kennedy Director August 12, 1999 - ------------------------- William J A Kennedy
/s/ Michael E Humphries Director August 12, 1999 - ------------------------- Michael E Humphries
/s/ John R Martinson Director August 12, 1999 - ------------------------- John R Martinson
Page ----
Independent Auditors' Report..............................................
Consolidated Balance Sheets...............................................
Consolidated Statements of Operations.....................................
Consolidated Statements of Changes in Stockholders' Equity................
Consolidated Statements of Cash Flows.....................................
Notes to the Consolidated Financial Statements............................
Independent Auditors' Report
Board of Directors Alliance Resources PLC and Subsidiaries
We have audited the consolidated balance sheets of Alliance Resources PLC and subsidiaries as of April 30, 1998 and 1999 and the related consolidated statements of operations, stockholders' equity, and cash flows for the nine months ended April 30, 1997 and the years ended April 30, 1998 and 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Alliance Resources PLC and subsidiaries as of April 30, 1998 and 1999, and the results of their operations and their cash flows for the nine months ended April 30, 1997 and the years ended April 30, 1998 and 1999, in conformity with generally accepted accounting principles in the United States.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency and is obliged to commence repayments on its borrowings on October 30, 2000. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
KPMG Audit Plc London, United Kingdom August 12, 1999
ALLIANCE RESOURCES PLC AND SUBSIDIARIES Consolidated Balance Sheets April 30, 1998 and 1999
See accompanying notes to consolidated financial statements.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES Consolidated Balance Sheets April 30, 1998 and 1999 (continued)
See accompanying notes to consolidated financial statements.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES Consolidated Statements of Operations Nine Months Ended April 30, 1997 and Years Ended April 30, 1998 and 1999
See accompanying notes to consolidated financial statements.
Alliance Resources PLC and Subsidiaries Consolidated Statements of Stockholders' Equity (Deficit) and Comprehensive Income Nine Months Ended April 30, 1997 and Years Ended April 30, 1998 and 1999
See accompanying notes to consolidated financial statements.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES Consolidated Statements of Cash Flows Nine Months Ended April 30, 1997 and Years Ended April 30, 1998 and 1999
See accompanying notes to consolidated financial statements.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Organization and Summary of Significant Accounting Policies
Organization and basis of presentation
Alliance Resources PLC ("Alliance" or "the Company") and its subsidiaries are engaged in the exploration, development and production of oil and gas and, until April 30, 1997, oil and gas marketing. Oil and gas production operations are currently conducted principally in Oklahoma, Texas, Louisiana, Mississippi and Alabama. The Company acquired proved undeveloped oil and gas interests in the East Irish Sea effective October 30, 1998 (See Note 2). Included in oil and gas revenue are sales from 10 significant producing properties which aggregated approximately $2,700,000, $2,210,000, and $2,155,000 for the nine months ended April 30, 1997, and years ended April 30, 1998 and 1999, respectively.
Alliance is a London-based public limited company organized under the laws of England and Wales and its shares are listed on the London Stock Exchange. The Company prepares its statutory financial statements in accordance with U.K. law and U.K. generally accepted accounting principles. These financial statements are prepared in accordance with generally accepted accounting principles in the United States.
On May 1, 1997, Alliance completed its acquisition of LaTex Resources, Inc. ("LaTex"), a US independent oil and gas exploration and production company. As the LaTex shareholders had a controlling interest in the combined group, LaTex was treated as having acquired Alliance ("Reverse Acquisition"). Accordingly, in the consolidated financial statements for the period beginning May 1, 1997, the assets and liabilities of Alliance are recorded at fair values while the assets and liabilities of LaTex and its subsidiaries are recorded at their historical costs. The consolidated financial statements of the Company for the nine months ended April 30, 1997, reflect the results of operations and assets and liabilities of LaTex and its subsidiaries. Adjustments have been made to reflect, in that period, the changes in the capital structure resulting from the acquisition. Earnings per share have been restated on the basis of the number of Alliance shares which, based on the exchange ratio used in the acquisition, represents the weighted average number of LaTex common shares outstanding in the relevant period.
In these financial statements the "Group" refers to Alliance and its subsidiaries for periods ending on or after May 1, 1997 and to LaTex Resources, Inc. and its subsidiaries for periods ending on or before April 30, 1997.
Financial Condition
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As shown in the financial statements during the nine months ended April 30, 1997 and the years ended April 30, 1998 and 1999, the Company incurred losses of $4,389,333; $4,728,923; and $34,463,502, respectively, continues to experience working capital deficits and is obliged to commence repayments on the borrowings on October 30, 2000. These factors among others may indicate the Company will be unable to continue as a going concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. Despite its negative cash flow, the Company has been able to secure financing to support its operations to date. As described in note 7, the Company was not in compliance with certain covenants of its loan agreements at April 30, 1999, but a waiver was obtained for such violations. The Company has also reached agreement with its principal bank to amend certain provisions of the loan agreement to allow for additional borrowing capacity under Tranche B, to defer the borrowing base redetermination date from July 31, 1999 to December 31, 1999 and extend the repayment due date to July 31, 2001. The amendment does not, however, change the scheduled repayment dates of Tranche A which commence on October 30, 2000.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet is obligations on a timely basis, to continue to comply with the terms of its borrowing agreements, to obtain additional financing or refinancing as will be required and ultimately to attain profitability. Management believes it has a business plan that, if successfully executed, will achieve these objectives.
Reporting Currency
The current operations are in the oil and gas industry in the United States and the United Kingdom and are conducted through subsidiaries, LaTex Petroleum Corporation, Alliance Resources (USA) Inc., Germany Oil Company, Difco Limited, and Source Petroleum Inc. Transactions are conducted primarily in U.K. Sterling and US dollars. The directors consider that the US dollar is the functional currency of the Group and the Group's consolidated financial statements have been prepared in US dollars.
Consolidation
The consolidated financial statements comprise the financial statements of the Company and all other companies in which the Group's holding exceeds 50 percent. Transactions and balances between group companies are eliminated on consolidation.
Earnings Per Share
Basic loss per share has been computed by dividing the net loss attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period.
The effect of potential common shares (warrants, options and convertible subordinated unsecured loan notes) is anti-dilutive. Accordingly, diluted loss per share is not presented.
Foreign Currency Translation
The financial statements of companies of the Group whose functional currency is not US dollars are translated for consolidation purposes at the rate of exchange ruling at the balance sheet date. Exchange differences arising on the retranslation of net assets are reported as a component of stockholders' equity(deficit) in accumulated other comprehensive loss. In the underlying financial statements, transactions with third parties are translated into the functional currency at the exchange rate prevailing at the date of each transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into US dollars at the exchange rate prevailing at the balance sheet date. Any exchange gain or loss is dealt with through the consolidated statement of operations.
The Group's share capital is denominated in sterling and for the purposes of the consolidated financial statements, is translated into US dollars at the rate of exchange at the time of its issue.
Revenues
Revenues represents income from production and delivery of oil and gas, recorded net of royalties in kind. The Group follows the sales method of accounting for gas imbalances. A liability is recorded only if the Group's excess takes of gas volumes exceed its estimated recoverable reserves from the relevant well and no receivable is recorded where the Group has taken less than its entitlement to gas production.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Oil and Gas Interests
The Group follows the full cost method of accounting for oil and gas operations whereby all costs of exploring for and developing oil and gas reserves are capitalized as tangible fixed assets. Such costs include lease acquisition costs, geological costs, the costs of drilling both productive and non-productive wells, capitalized interest, production equipment and related overhead costs. Capitalized costs, plus estimated future development costs, are accumulated in pools on a country-by-country basis and depleted using the unit-of-production method based upon estimated net proved reserve volumes. Reserve volumes are combined into equivalent units using approximate relative energy content.
Costs of acquiring and evaluating unproved properties and major development projects are excluded from the depletion calculation until it is determined whether or not proved reserves are attributable to the properties, the major development projects are completed, or impairment occurs, at which point such costs are transferred into the pool.
Proceeds from the sale or disposal of properties are deducted from the relevant cost pool except for sales involving significant reserves where a gain or loss is recognized.
The Group performs a "ceiling test" calculation in line with industry practice. Costs permitted to be accumulated in respect of each cost pool are limited to the future estimated net recoverable amount from estimated production of proved reserves. Future estimated net recoverable amounts are determined after income taxes, discounting and using prices and cost levels at the balance sheet date.
Provision is made for abandonment costs net of estimated salvage values, on a unit-of-production basis, where appropriate.
Depreciation of Other Fixed Assets
Other tangible fixed assets are stated at cost less accumulated depreciation. Depreciation is provided on a straight line basis to write off the cost of assets, net of estimated residual values, over their estimated useful lives as follows:
Fixtures and equipment - 3 to 7 years Buildings - 30 years
Deferred Taxation
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statement of operations in the period that includes the enactment date.
Joint Ventures
The Group's exploration, development and production activities are generally conducted in joint ventures with other companies. The consolidated financial statements reflect the relevant proportions of turnover, production, capital expenditure and operating costs applicable to the Group's interests.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The effects of redeterminations of equity interests in joint ventures are accounted for when the outcome of the redetermination is known.
Leases
Rentals under operating leases are charged to the consolidated statement of operations on a straight line basis over the lease term.
Debt Issuance Costs
Debt issuance costs are initially capitalized as intangible assets and are amortized over the term of the debt to which they relate.
Derivatives
Changes in value of financial instruments, utilized to hedge commodity price and interest rate risk are recognized in the consolidated statement of operations when the underlying transactions are recognized. Changes in value of financial instruments which do not meet the criteria to be treated as a hedge of an underlying risk are recognized in the consolidated statement of operations as they occur.
The Group's criteria for a derivative instrument to qualify for hedge accounting treatment are as follows: --the timing or duration, quantum and characteristics of the underlying exposure must have been identified with reasonable certainty; --changes in the value of the derivative must correlate to a high degree with changes in the present value of the exposure under a wide range of possible circumstances; --the derivative has been designated as a hedge or is a synthetic alteration of a specific asset, liability or anticipated transaction; and --the derivative instrument either: (a) reduces exposure of net income or cash flow to fluctuations caused by movements in commodity prices, currency exchange rates or interest rates, including fixing the cost of anticipated debt issuance; or (b) alters the profile of the group's interest rate or currency exposures, or changes the maturity profile of the investment portfolio, to achieve a resulting overall exposure in line with policy guidelines.
For any termination of derivatives receiving hedge accounting treatment, gains and losses are deferred when the relating underlying exposures remain outstanding and are included in the measurement of the related transaction or balance. In addition, upon any termination of the underlying exposures, the derivative is marked-to-market and the resulting gain or loss is included with the gain or loss on the terminated transaction. The Group may re-designate the remaining derivative instruments to other underlying exposures provided the normal criteria are all met.
Cash Flow Statement
For the purposes of the consolidated statement of cash flows, the Group treats all investments with an original maturity of three months or less to be cash equivalents.
Stock Option Plan
The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock- based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock-Based
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Compensation, and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in future years if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
Accounting Estimates
In the course of preparing financial statements, management makes various assumptions and estimates to determine the reported amounts of assets, liabilities, revenue and expenses and in relation to the disclosure of commitments and contingencies. Changes in these assumptions and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, the actual results could differ from the amounts estimated.
Business Segments
The Group adopted Financial Accounting Standard (FAS) 131 "Segment Disclosures and Related Information" during the year ended April 30, 1998. Prior to April 30, 1997, the Group sold a portion of its oil and gas production volumes through its oil and gas marketing subsidiary although the operations and net assets of that subsidiary were not separately managed. The Group considers itself to be involved in one business activity and does not meet the criteria established by FAS 131. Accordingly, information regarding marketing activities has not been included for any periods presented.
Comprehensive Income (Loss)
The Company has adopted Financial Accounting Standards Board issued Statement of Financial Standards No. 130, "Reporting Comprehensive Income" (Statement No. 130). Statement No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The Company has reported accumulated other comprehensive loss as a separate line item in consolidated balance sheets. The components of total comprehensive income (loss) for the periods consist of net losses and foreign currency translation.
Significant Differences between U.S. and U.K. Accounting Principles
The accounting policies used in the preparation of these financial statements conform with U.S. generally accepted accounting principles ("U.S. GAAP") which differ in certain respects from U.K. generally accepted accounting principles ("U.K. GAAP"). Differences which may have a significant effect on net loss and shareholders' deficit are set out below.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(a) Under U.S. GAAP, ceiling tests are calculated using prices prevailing at the year end. Under U.K. GAAP, a reasonable assessment of future prices is used. At April 30, 1999, the spot price for gas in the U.K. was significantly below management's reasonable expectation of future prices resulting in a significantly greater charge under U.S. GAAP than under U.K. GAAP.
(b) Under U.S. GAAP, the convertible subordinated unsecured loan notes are treated as a liability. Under U.K. GAAP, the convertible subordinated unsecured loan notes are included as part of shareholders' equity as in substance their terms are economically equivalent to warrants with a zero strike price and Alliance has no obligation to transfer future economic benefit to the holder of the loan notes.
(c) Under U.S. GAAP, the shares issued to the vendors of Difco are recorded at the more readily determinable value. Under U.K. GAAP, the shares are recorded at the value of the underlying interest in the East Irish Sea Interests.
In addition there are a number of other classification and disclosure differences which do not impact net loss or shareholders' deficit.
(2) Acquisition of Difco Limited and U.K. Interests
On October 30, 1998, Alliance completed its acquisition of Difco Limited ("Difco"). Alliance acquired all of the capital stock of Difco and, indirectly, a contract to acquire 10% of Burlington Resources (Irish Sea) Limited's ("Burlington") interest in the East Irish Sea Properties ("U.K. Interests"). The Difco shareholders received 10,000,000 convertible shares valued at $7,208,000. Such value was derived based on the value of the underlying market value of the shares issued. The shares issued represented approximately 8.7% of the outstanding shares of the Company. The former Difco shareholders could receive up to 29.6% of the outstanding shares of the Company based upon the production from, or reserves attributable to, the U.K. Interests. The Company acquired, through Difco, 10% of Burlington's interest in the East Irish Sea Properties for cash consideration of approximately $17,800,000. The Company issued to its financial advisor 615,385 ordinary shares in payment of a fee of $330,000 incurred in connection with the transactions. The total acquisition cost, including transaction costs, was allocated to oil and gas properties.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following unaudited pro forma financial information presents the combined results of operations of the Company and Difco as if the acquisition had occurred as of the beginning of fiscal years 1998 and 1999, after giving effect to certain adjustments, including increased interest expense on debt related to the acquisition and amortization of deferred loan costs and debt discount. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Difco constituted a single entity during such periods.
(Unaudited) -------------------------------- Year ended April 30 -------------------------------- 1998 1999 ----------- ------------ Revenues $10,209,881 $ 6,234,477 =========== ============ Net loss $(7,760,657) $(36,497,108) =========== ============ Loss per share $ (0.15) $ (0.77) =========== ============
(3) Acquisition of LaTex
On May 1, 1997, Alliance, completed its acquisition of LaTex, whereby a newly formed wholly-owned subsidiary of Alliance merged with and into LaTex with LaTex being the surviving corporation for accounting purposes. In consideration the shareholders and warrant holders of LaTex received an aggregate of 21,448,787 shares of Alliance (the "New Alliance Shares") and warrants to purchase an additional 1,927,908 New Alliance Shares.
As a result, after giving effect to a 40-to-1 reverse stock split of the Alliance ordinary shares, each shareholder of LaTex on May 1, 1997, received 0.85981 ordinary shares for each share of LaTex common stock, 2.58201 ordinary shares for each share of the LaTex Series A preferred stock then held, 6.17632 ordinary shares for each share of LaTex Series B preferred stock then held, and a warrant to purchase 0.85981 share for each share of LaTex Common Stock subject to warrants.
The purchase price was arrived at as follows:
Value of 8,103,816 Alliance shares outstanding $4,039,339 Acquisition costs 871,000 ---------- $4,910,339 ==========
The value of the Alliance shares outstanding was arrived at by using the share price of LaTex at the time of announcement of the acquisition adjusted by the exchange ratio.
Transaction costs incurred by Alliance reduced the fair value of Alliance's monetary assets and liabilities at the date of the acquisition.
The fair value of the assets and liabilities of the acquired business at the effective date of acquisition is as follows:
Cash $ 1,460,555 Other current assets 480,045 Other assets 202,253 Oil and gas assets 5,268,929 Other fixed assets 253,386 Debt (85,420) Other liabilities and provisions (2,669,409) ----------- $ 4,910,339 ===========
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
In connection with the acquisition, Alliance issued to Bank of America, the Company's principal lender, 156,250 ordinary shares and convertible subordinated unsecured loan notes convertible into 115,456 ordinary shares to settle fees of $200,000 and $150,000 payable upon restructuring of LaTex's bank debt. In addition the Company agreed to issue 116,895 ordinary shares to Rothschild Natural Resources, LLC in settlement of outstanding fees of $150,000.
Alliance has also issued 1,343,750 ordinary shares, convertible subordinated unsecured loan notes convertible into 1,078,125 ordinary shares and 1,210,938 warrants to Bank of America in exchange for an overriding royalty interest in most of LaTex's properties held by Bank of America.
The purchase price was allocated to oil and gas properties and has been arrived at as follows:
Value of 1,343,750 ordinary shares and warrants issued $2,371,300 Value of convertible subordinated unsecured loan note issued 1,400,700 ---------- $3,772,000 ==========
(4) Impairment of U.K. Interests
As discussed in Note 1, the Company utilizes the full cost method of accounting for its oil and gas operations and performs a "ceiling test." The ceiling test limits the costs accumulated in respect of each cost pool to net amounts that can be recovered from the estimated production of proved reserves. The net amounts recovered are determined utilizing a 10% discount factor and pricing and cost levels at the balance sheet date.
The U.K. Interests consist of proven reserves and the current development program is being conducted to produce these reserves. Although the Company intends to enter into term gas delivery contracts which would be expected to be at prices above the spot price at April 30, 1999, the Group does not have contracts in place at April 30, 1999 with purchasers and, accordingly, has utilized the spot market price to value such interests. The utilization of these factors has resulted in a ceiling test write-down of approximately $28,000,000 for U.S. GAAP purposes.
(5) Financial Instruments
The carrying value of cash and cash equivalents, accounts receivables and accounts payable approximate the estimated fair value of those financial instruments due to their short maturities. The estimated fair value of the interest rate swap agreement, based on current market rates, approximated a net payable of $445,767 and $248,884 at April 30, 1998 and 1999, respectively. The estimated fair value of the commodity derivative instruments approximates a net receivable of $409,395 at April 30, 1998 and a net payable of $128,479 at April 30, 1999. The carrying value of long- term debt approximates to the fair value, as advised by the Group's bankers. See note 15.
Fair value is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Income Taxes
Income taxes different from the amounts computed by applying the U.S. federal tax rate of 34% as a result of the following (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below in thousands:
A valuation allowance is required when it is more likely than not that all or a portion of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon future profitability. Accordingly, a valuation allowance has been established to reduce the deferred tax assets to a level which, more likely than not, will be realized.
The Group has net operating loss carryovers to offset future taxable earnings of approximately $44,000,000, including approximately $36,000,000 of losses limited under Section 382 of the Internal Revenue Code. If not previously utilized or limited, the net operating losses will expire in varying amounts from 2004 to 2019.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Long-Term Debt
Long-term debt at April 30, 1998 and 1999 consists of the following:
Alliance entered into a Credit Agreement (the "Alliance Credit Agreement") with the Bank of America effective May 1, 1997, amending and restating the Group's previous credit agreement. A portion of the borrowings under the Alliance Credit Agreement bore interest, payable monthly, at a rate equal to the higher of the Bank of America Reference Rate plus 1% and the Federal Funds Rate plus 1-1/4%. Another portion of the borrowings bore interest, payable monthly, at a rate equal to the London Interbank Offered Rate plus 2%. The rate at April 30, 1998 was 7.875%. Principal payments were scheduled to commence on October 31, 1998. The note was scheduled to mature on March 31, 2000. Amounts outstanding were secured by mortgages which cover the majority of the Group's oil and gas properties.
In connection with the Difco Acquisition (See Note 2), the Company entered into agreements with Bank of America National Trust & Savings Association ("BoA"), Alliance's principal lender and EnCap Equity 1996 Limited Partnership and EnCap Capital Investment Company PLC (collectively "EnCap") providing up to $64,750,000 in debt, as follows:
BoA: Tranche A $30,000,000 Tranche B 20,000,000 Tranche C 5,000,000 ----------- 55,000,000 EnCap 9,750,000 ----------- $64,750,000 ===========
Tranche A consists of a revolving credit facility secured by a first priority lien and security interest in all of the oil and gas properties of the Company. The Company's initial borrowing base is $18,500,000 and is redetermined semiannually on January 31 and July 31. Interest is at a rate determined by the Company from time to time, of either (i) the greater of BoA's reference rate and the federal funds effective rate plus 0.5%, or (ii) 2.0% above the current Interbank rate (7.5% at April 30, 1999). While any Tranche B loan is outstanding, the preceding margins will be increased by an additional 0.5% semi-annually on April 26 and on October 26 of each year. Interest is payable quarterly and principal is due in equal quarterly payments beginning October 30, 2000 and ending on October 30, 2003.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Tranche B consists of a credit facility secured by a first priority lien and security interest in all of the oil and gas properties of the Company. Interest is at a rate determined by the Company from time to time, of either (i) BoA's Tranche B reference rate plus 2.0%, or (ii) 4.0% above the current Interbank rate (9.0% at April 30, 1999). The margins for all Tranche B loans will be increased by an additional 0.5% semi-annually on April 26 and on October 26 of each year. Interest is payable quarterly and principal is due in full on January 31, 2001.
Tranche C consists of a credit facility secured by a first priority lien and security interest in all of the oil and gas properties of the Company. Interest is at a rate determined by the Company from time to time, of either (i) BoA's reference rate plus 5.0%, or (ii) 7.0% above the current Interbank rate (12.0% at April 30, 1999). Interest is payable quarterly and principal is due in equal quarterly payments beginning January 31, 2001 and ending on October 30, 2004. The BoA debt facility contains various covenants, including, but not limited to, maintenance of minimum current and interest coverage ratios, as defined in the agreement.
EnCap debt is unsecured and bears interest at 10%. Interest is payable quarterly and principal is due in full on October 30, 2005. Until October 30, 2001, the Company has the option, in lieu of paying cash, of increasing the principal amount of the debt by the interest due.
The Company paid BoA a cash fee of $700,000 and granted BoA warrants to purchase 3,275,000 ordinary shares at a price of 1p per share. The fair value of the warrants, $1,335,000, attaching to the debt was treated as a discount. In addition, the Company granted BoA an overriding royalty interest, valued at the value of the underlying oil and gas reserves, in the U.K. Interests of 0.3% beginning January 1, 2001. The overriding royalty interest will entitle BoA to receive payment equal to the specified percentage of the net revenues generated by the U.K. Interests. In connection with obtaining the debt financing from BoA, the Company was required to enter into commodity price risk management contract on terms that are mutually agreeable to BoA and the Company for a period not less than two years with respect to at least 50% of the Company's estimated producing reserves as of October 31, 1998. BoA also required the Company to enter into interest rate risk management contracts providing for a maximum interest rate of 9.0% on the notional amount projected to be outstanding on the revolving credit facility (See Note 2).
In connection with the issuance of the EnCap debt, the Company sold EnCap 15,000,000 ordinary shares with a fair value of $6,360,000 for cash consideration. The difference was treated as a discount on the debt. The Company also issued EnCap Investments L.C. 545,454 shares in consideration of a fee of $292,000.
The Company was not in compliance with certain covenants of the loan agreements, which included but were not limited to the maintenance of minimum levels of working capital and interest coverage. Prior to these violations causing an event of default, which would have resulted in an acceleration of the repayment of the loans, the Company obtained waivers from the lenders for all covenant violations. Effective July 30, 1999, the loan agreement was amended to revise the borrowing limit of Tranche B to $25,000,000 and reduce the limit of Tranche A to a similar amount. The due date of Tranche B was extended from January 31, 2001 to July 31, 2001. In addition, the date of the borrowing base and collateral value redetermination, scheduled to occur on July 31, 1999, was deferred until December 31, 1999.
The revised schedule of contractual maturities of long-term debt at April 30, 1999 are as follows and do not include $5,000,000 borrowed under Tranche B subsequent to year end which is repayable during the year ending April 30, 2002:
Year ending April 30, 2000 $ - 2001 5,245,775 2002 23,740,348 2003 7,410,000 2004 2,810,000 Thereafter 10,868,000
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Group capitalizes interest cost as a component of the North Sea U.K. Interests development program. The following is a summary of interest cost incurred:
(8) Savings and Profit Sharing Plan
The Group maintains an employee savings and profit sharing plan (the Plan) which covers substantially all of its employees. The Plan is comprised of a 401(k) saving portion and a noncontributory defined contribution portion. Employees are qualified to participate after approximately one year of service. Participating in the 401(k) plan is voluntary, and the Group matches contributions up to six percent of the employees' salary at a rate of 50 percent of the employee's contribution. The Group contributed $8,481, $9,243, and $17,523 to the plan during the nine months ended April 30, 1997, and the years ended April 30, 1998 and 1999, respectively.
The noncontributory portion of the Plan allows the Group to share annual profits with employees. Annual payments to the Plan are elective. Management elected to make no contributions to the Plan for the nine months ended April 30, 1997 and the years ended April 30, 1998 and 1999. The Group is under no obligation to make contributions to the Plan in the future.
(9) Capital Stock
On May 1, 1997, the Company's share capital was consolidated such that every 40 ordinary shares of 1 pence each were consolidated into 1 ordinary share of 40 pence. All prior capital stock amounts have been restated to reflect this reverse stock split. At the same date, the Company issued 21,448,747 ordinary shares of 40 pence each to the holders of the issued ordinary shares and preference shares of LaTex outstanding at that date.
On October 30, 1998, the Company entered into a capital reorganization plan that subdivided each ordinary share into one new ordinary share with a par value of 1 pence and 39 deferred shares with a par value of 1 pence each. The resulting ordinary shares have the same rights as the ordinary shares at 40 pence each. The deferred shares have no substantive rights, are not represented by certificates issued to shareholders, and may be redeemed by the Company by the payment of a total of 1 pence for all of the deferred shares.
(10) Stock Option Plans
Effective October 21, 1996, each holder of options granted under the Group's 1993 Incentive Stock Plan agreed to terminate all options held and receive grants of 1,690,000 Restricted shares of LaTex Common Stock which, on May 1, 1997, was exchanged for Alliance shares. The Group recognized an employee bonus of $528,125 related to this transaction based on the market value of LaTex's stock on the date of grant. No tax gross up rights were granted in connection with the issue of the Restricted Stock.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Since May 1, 1997, the Group operates two employee share option schemes. Both schemes have similar terms, the principal terms being: -- any director or employee may be granted options over Shares; -- the subscription price will be no less than market price at the date of grant; -- options granted to an individual are limited such that the aggregate market value of shares subject to option taken together with the aggregate market value of shares which have been acquired under rights granted under the schemes in the previous ten years does not exceed four times cash salary; -- the exercise of options may be subject to performance tests. Long term options (exercisable after 5 years) may be subject to growth in earnings per share over the immediately preceding five years matching, exceeding growth in earnings per share of the companies ranked in the top 25 of the FTSE-100 share index, or growth in the Company's share price during the five year exercise period.
A summary of the status of the share option schemes is as follows:
Shares Weighted average service price --------- ---------------------- As at May 1, 1997 - - Granted 675,000 24.5 pence On acquisition of LaTex 237,500 80 pence --------- As at April 30, 1998 912,500 38.9 pence Granted 2,365,000 13.5 pence Cancelled (175,000) 80 pence --------- As at April 30, 1999 3,102,500 17.2 pence =========
Included in the options granted during the year ended April 30, 1999 were 1,700,000 long-term options which were subject to the Company's share price increasing three-fold during the five year exercise period of the options.
The Group's accounting policy for compensation cost is in line with Accounting Principles Board Opinion 25. Accordingly, compensation cost has not been recognized for share option plans except to deal with any discounts on option exercise prices, compared with market prices at the measurement date. For the year ended April 30, 1998, had compensation costs been charged against income based on the fair value at the grant- dates for awards under the share option plans, consistent with Statement of Financial Accounting Standards No. 123, the net loss and net loss per share would not have been materially different. This was determined using the Black Scholes option pricing model utilizing the following assumptions:
Risk free interest rate 5.3% Expected life 10 years Volatility 5.93%
At April 30, 1999, the Company also had outstanding 50,000 options to purchase shares at 300 pence per share which have been issued other than pursuant to the employee share options schemes.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(11) Warrants
On May 1, 1997 the Company issued warrants to subscribe for 1,927,908 ordinary shares of 40 pence each in exchange for the then outstanding warrants to subscribe for ordinary shares in LaTex. For periods ended on or before April 30, 1997, the warrants outstanding reflect the Alliance warrants issued on May 1, 1997, as though issued at the date of issue of the LaTex warrants for which the Alliance warrants were exchanged.
Warrants to subscribe for 1,210,938 ordinary shares were issued to Bank of America as part consideration for the acquisition of the overriding royalty interest (see note 3). At April 30, 1998, the Company had outstanding 2,916,527 warrants.
Warrants to subscribe to 3,275,000 common shares at a price of 1 pence per share were issued to Bank of America in connection with the Difco acquisition (see Note 7).
In November, 1998, warrants to purchase 1,112,378 Ordinary Shares at a price equal to the sterling equivalent of $4.94 expired.
(12) Convertible Subordinated Unsecured Loan Notes
At April 30, 1998 and 1999 the Group had outstanding loan notes convertible into 1,193,581 ordinary shares of which loan notes convertible into 1,078,125 ordinary shares were issued in part consideration for the acquisition of the overriding royalty interest amounting to $1,400,700 (see note 3) and loan notes convertible into 115,456 ordinary shares were issued to settle restructuring and arrangement fees of $150,000 in connection with the LaTex acquisition. The loan notes, which are non-interest bearing, are convertible by the holders (on the payment of a nominal cash consideration) any time up to ten years following their date of issue. They are convertible in the following six months on like terms at the option of the Company. Any loan notes not converted prior to the date ten years and six months from issue will be repaid on that date at an amount equal to twice the amount paid up on the notes.
(13) Contingencies and Commitments
The Group is a named defendant in lawsuits, and is subject to claims of third parties from time to time arising in the ordinary course of business. While the outcome of lawsuits or other proceedings and claims against the Group cannot be predicted with certainty, management does not expect these additional matters to have material adverse effect on the financial position or results of operations or liquidity of the Group.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Group leases office space and certain property and equipment under various lease agreements. As of April 30, 1999, future minimum lease commitments were approximately as follows:
Year Ending April 30 -------------------- 2000 $ 193,701 2001 196,905 2002 200,098 2003 203,301 2004 16,964
Rent expense under all operating leases was $160,780, $252,627, and $251,447 during the nine months ended April 30, 1997, and the years ended April 30, 1998 and 1999, respectively.
(14) Related Party Transactions
The Group, prior to May 1, 1997, has made loans to certain officers, directors and stockholders. During the nine months ended April 30, 1997, the board of directors forgave $391,218, of notes and accrued interest, due from directors and former officers of the Group. This amount is included in general and administrative expenses.
During the year ended April 30, 1998, the Company received $123,000 of proceeds from the sale of 10,351,966 shares in the Company which had previously been owned by the former Chief Executive of the Company. The right to receive the proceeds from the sale of the shares arose from a settlement agreed between the Company and Mr. O'Brien following the discovery that the Company had suffered a financial loss as a result of a number of transactions involving Mr. O'Brien or parties connected with him.
(15) Derivatives
Oil and Gas
Effective May 15, 1997, the Group terminated a previously existing oil and gas pricing derivative at a cost of $1,128,000 settled by an increase in the Bank of America loan. The loss relating to the buy-out was recognized in its entirety during the year ended April 30, 1998, consequent upon the Group entering into a new price protection agreement.
On October 23, 1997, the Group entered into commodity price hedge agreements to protect against price declines which may be associated with the volatility in oil and gas spot prices. The commodity price hedges were achieved through the purchase of put options (floors) by the Group, and the associated premium cost was funded by additional drawdowns under the current credit agreement. The commodity price hedges covered 32,000 bbls and 100,000 MMBTUs per month for the year to October 31, 1998, and covered in excess of 90% of the Group's current monthly sales volumes. The floors equated to approximately $18.50/bbl Nymex WTI contract and $2.20/MMBTU Nymex Natural Gas contract. On October 31, 1998, the Group's commodity price hedge agreements expired.
During February 1999, the Company completed a transaction to hedge approximately 65% of its existing monthly gas production by installing a floor of $1.60/MMBTU and a cap of $2.07/MMBTU (NYMEX Natural Gas). During April 1999, the Company completed a transaction to hedge approximately 40% of its existing monthly oil production by installing a floor of $12.00/barrel (NYMEX WTI). This commodity price hedge agreement will protect the Company from any severe declines in oil and gas prices until expiration on October 31, 1999.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Interest
The Group is required, by agreement with its primary lender (see Note 7) to participate in an interest rate protection program, for interest on the debt payable to the primary lender until March 31, 2000. Interest is hedged to achieve a fixed rate of 7.49% calculated on a monthly basis based on a fixed amortization schedule determined on loan origination. The notional principal is reduced each month by $365,000. The notional principal outstanding at April 30, 1999 was $13,784,000 and this will have reduced at termination to $9,769,000. The hedging gains/losses are included in interest expense.
(16) Disposition of Oil and Gas Properties
During the nine months ended April 30, 1997 and the years ended April 30, 1998 and 1999, the Group sold oil and gas properties for approximately $1,500,000, $5,600,000 and $1,742,000, respectively. Proceeds of such sales were credited to the full cost pool.
(17) Supplemental Financial Information for Oil and Gas Producing Activities (Unaudited)
Results of Operations from Oil and Gas Producing Activities
The following sets forth certain information with respect to the Group's results of operations from oil and gas producing activities for the nine months ended April 30, 1997 and the years ended April 30, 1998 and 1999. All of the Group's oil and gas producing activities are located within the United States.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Capitalized Costs and Cost Incurred Relating to Oil and Gas Activities
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Estimated Quantities of Proved Oil and Gas Reserves
The estimates of proved oil and gas reserves were prepared by independent petroleum engineers. The Group emphasizes that reserve estimates are inherently imprecise. Accordingly, the estimates are expected to change as more current information becomes available. In addition, a portion of the Group's proved reserves are undeveloped, which increases the imprecision inherent in estimating reserves which may ultimately be produced.
Proved reserves are estimated quantities of crude oil, natural gas, and natural gas 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 developed reserves are those which are expected to be recovered through existing wells with existing equipment and operating methods.
The following is an analysis of the Group's proved oil and gas reserves.
During the nine months ended April 30, 1997, the Group sold oil and gas properties for approximately $1,500,000. The Group chose not to include those properties in its reserve appraisal at July 31, 1996.
ALLIANCE RESOURCES PLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Discounted Future Net Cash Flows
In accordance with Statement of Financial Accounting Standards No. 69, estimates of the standardized measure of discounted future cash flows were determined by applying period-end prices, adjusted for fixed and determinable escalations, to the estimated future production of year-end proved reserves. Future cash inflows were reduced by the estimated future production and development costs based on period-end costs to determine pre-tax cash inflows over the Group's tax basis in the associated proved oil and gas properties. Net operating losses, credits and permanent differences were also considered in the future income tax calculation. Future net cash inflows after income taxes were discounted using a 10% annual discount rate to arrive at the Standardized Measure.
Future income tax expenses are estimated using the statutory tax rate of 34% and 30% in the United States and United Kingdom, respectively. Estimates for future general and administrative and interest expense have not been considered.
The estimated standardized measure of discounted future cash flows (in thousands) follows:
The changes in standardized measure of discounted future net cash flows (in thousands) follows: