ITEM 1. BUSINESS
OVERVIEW
Harken Energy Corporation (together with its wholly-owned or controlled subsidiaries, "Harken") is engaged in oil and gas exploration, development and production operations both domestically and internationally through its various subsidiaries. Harken's domestic operations include oil and gas exploration, development and production operations in the Four Corners area of Utah, Arizona and New Mexico, in the onshore region of South Texas, in the Texas Panhandle region, in the Magnolia region of Arkansas, in the Carlsbad region of New Mexico, and beginning in May 1998, the onshore region of Southern Louisiana. Harken's international operations include six exclusive Association Contracts with the state-owned oil company in the Republic of Colombia and Harken's contract to participate in an Exploration and Production Contract to be signed with the Republic of Costa Rica.
Harken's corporate strategy is to expand its domestic reserve base through acquisitions and additional exploration and developmental drilling on its existing oil and gas properties and to reinvest a substantial portion of the cash flow generated from its domestic assets, along with funds generated from traditional and other sources of financing, towards developing its higher potential, and higher risk, international prospects.
Harken was incorporated in 1973 in the state of California and reincorporated in 1979 in the state of Delaware. Harken's principal offices are currently located at 5605 N. MacArthur Blvd., Suite 400, Irving, Texas 75038 and its telephone number is (972) 753-6900.
INTERNATIONAL EXPLORATION AND DEVELOPMENT OPERATIONS - COLOMBIA
Harken's international operations consist primarily of its exploration operations in the Republic of Colombia. Harken, through its wholly-owned subsidiary Harken de Colombia, Ltd. ("Harken Colombia"), currently holds six exclusive Association Contracts with Empresa Colombiana de Petroleos ("Ecopetrol"), the state-owned Colombian oil company.
Alcaravan Contract -- During the fourth quarter of 1992, Harken Colombia and Ecopetrol entered into an Association Contract covering the Alcaravan area (the "Alcaravan Contract"). The Alcaravan Contract grants Harken Colombia the exclusive right to explore for, develop and produce oil and gas throughout approximately 210,000 acres in the Alcaravan area of Colombia. The Alcaravan area is located in Colombia's Llanos Basin and is located approximately 140 miles east of Santafe De Bogota. Harken Colombia is required to conduct a seismic and exploratory drilling program during the initial six years of the Alcaravan Contract (the "Exploration Period"). At the end of each of the first six years of the Alcaravan Contract, Harken Colombia has the option to withdraw from the Alcaravan Contract or to commit to the next year's work requirements. If during the Exploration Period of the Alcaravan Contract, Harken Colombia discovers one or more fields capable of producing oil or gas in quantities that are economically exploitable and Ecopetrol agrees that such field is economically exploitable (a "commercial discovery"), the term of the Alcaravan Contract related to the areas of commerciality will be extended for a period of 22 years from the date of such commercial discovery.
Upon a discovery of a field capable of commercial production, and upon commencement of production from that commercial field, Ecopetrol will reimburse Harken Colombia for 50% of Harken Colombia's successful well costs expended up to the point of declaration of a commercial discovery out of Ecopetrol's share of production. Production from the field following a commercial discovery will be allocated as follows: Ecopetrol, on behalf of the Colombian government, will receive a 20% royalty interest in all production and all production (after royalty payments) will be allocated 50% to Ecopetrol and 50% to Harken Colombia until cumulative production in such field reaches 60 million barrels of oil, after which Ecopetrol's share of production will progressively increase and Harken Colombia's share will progressively decrease until cumulative production from the field reaches 150 million barrels of oil, and thereafter all production will be allocated 70% to Ecopetrol and 30% to Harken Colombia. If more than one commercially declared field is discovered on the Alcaravan area, the production sharing percentages applicable to the field with the greatest cumulative production will be applied to all fields within the Alcaravan area. After declaration of a commercial discovery, Harken Colombia and Ecopetrol will be responsible for all future development costs and operating expenses in direct proportion to their interest in production.
The Alcaravan Contract provides that at the end of the Exploration Period in June 1999, if a field capable of producing hydrocarbons in commercial quantities has been discovered, the Alcaravan Contract area will be reduced by 50%. Two years thereafter, the Alcaravan Contract area will be further reduced to 25% of the original area. Two years thereafter, the Alcaravan Contract area will be reduced to the area of the commercial field that is in production or development, plus a reserve zone of five kilometers in width around the productive boundary of such field. The commercial field plus the zone surrounding such field will become the area of exploitation. Harken Colombia will designate the acreage to be released.
Harken Colombia has completed all of the work requirements of the first five years of the Alcaravan Contract. Harken Colombia is required to drill an additional well by June 1999 in order to satisfy the work requirements for the sixth year of the contract. Harken Colombia does not currently have any plans to drill an additional well on the Alcaravan Contract area acreage during 1999. Harken Colombia is currently negotiating with Ecopetrol for a modification of the work obligations, and management believes that it will be successful in negotiating such a modification. Such negotiations could include the relinquishment of a portion of Alcaravan Contract area acreage. See "Negotiations with Ecopetrol" for further discussion. Prior to June 1999, Harken Colombia plans to submit a request to Ecopetrol for commerciality relating to the Palo Blanco Prospect Area following the completion of a long-term production test. The Alcaravan Contract provides that if Ecopetrol accepts the existence of the commercial field, Ecopetrol would begin to participate, upon the terms of the Alcaravan Contract, in the development of the commercial field. If Ecopetrol does not accept the existence of the commercial field, Harken Colombia would then have the choice to proceed with the development of the prospect area on a sole-risk basis or perform additional work as may be indicated by Ecopetrol, to demonstrate the existence of a commercial field. If Harken Colombia does proceed on a sole-risk basis, it will be entitled to receive Ecopetrol's share of production after royalty, until Harken Colombia has recovered 200% of its costs, after which time Ecopetrol would receive its share of production.
Harken Colombia has to date drilled three wells on the Alcaravan acreage. The first well, the Alcaravan #1, was drilled in February 1995, and did not find commercial quantities of oil or gas. In February 1997, Harken Colombia drilled the Estero #1 well located on the Palo Blanco prospect. The Estero #1 well was drilled to a depth of 8,608 feet to test the Carbonera, Mirador, Guadalupe, Gacheta and Ubaque formations. During initial production testing of the Ubaque formation, the Estero #1 well produced at the rate of 4,116 gross barrels of oil per day. Harken Colombia believes that the production rate was limited by
the capacity of the submersible pump and surface storage facilities at the location. In December 1997 and early 1998, Harken Colombia drilled and completed the Estero #3, also located on the Palo Blanco Prospect. Although the Estero #3 well initially produced oil from the Upper and Middle Ubaque during preliminary production testing, the well subsequently produced significant water from the Middle Ubaque. Harken is reviewing the production information from the Upper and Middle Ubaque to determine if, by performing additional work, these formations might be commercial. Harken also tested the Mirador, Guadalupe and the deeper Paleozoic formations and found them to be noncommercial. Through December 31, 1998, Harken Colombia has expended approximately $22.4 million of net oil and gas exploration and development costs related to the Alcaravan Association Contract.
During the third quarter of 1998, Harken Colombia initiated trucking operations of crude oil from its long-term production tests of the Estero #1 well on the Alcaravan Contract area. During the last half of 1998, Harken had periods where it has trucked up to 500 gross barrels of oil per day from the Estero wellsite to a pumping station approximately 20 miles away. In order to maximize the production and sales volume of oil which can be sold from the Estero wellsite, Harken Colombia has constructed and completed a 2.3 mile oil pipeline connecting the Palo Blanco field to an existing crude oil pipeline system. Initial plans for the 12-inch pipeline calls for the introduction of small amounts of crude into the new line, gradually increasing to pipeline capacity of up to 4,000 gross barrels of oil per day. Harken Colombia has received the environmental permit to tie-in to the existing pipeline and anticipates completing the tie-in during the first quarter of 1999. During late 1998, trucking operations have been suspended pending completion of the pipeline tie-in.
During the second quarter of 1998, Harken Colombia drilled and completed the Canacabare #1, the first exploratory well to be drilled on the Anteojos prospect. The Canacabare #1 was drilled vertically into the Paleozoic formation to a total depth of 8,410 feet. Due to the Colombian rainy season and resulting operating conditions in the Llanos Basin area in Colombia, the drilling rig was moved off the location prior to the production test on the well. Wireline log data analysis of the Cancabare #1 well indicated a net productive thickness of approximately 90 feet in the three formations to be tested in this well. Production tests are planned for late 1999 or early 2000 following the Colombian rainy season.
In 1996, Harken Colombia entered into two separate agreements with industry partners, whereby each industry partner paid 1/3 of the cost of the Estero #1 well, plus certain additional costs and fees and acquired a 25% beneficial interest in the Palo Blanco Prospect. In addition, the industry partners obtained certain rights to acquire a beneficial interest in any other prospect on the Alcaravan acreage by paying a portion of the costs associated with such prospect. Each industry partner also acquired a 25% beneficial interest in the Anteojos prospect. Effective December 31, 1998, Harken entered into an agreement with one of the industry partners pursuant to which Harken reacquired all of its beneficial interest in the Alcaravan and Miradores Contract areas.
Harken's net revenue interest in production from the Alcaravan Contract will depend upon whether or not Ecopetrol elects to participate. After payment of industry partner participation, and assuming that Ecopetrol elects to participate in the development of the Alcaravan Contract, Harken will initially receive 30% of the gross revenues from production from the Alcaravan Contract area. To the extent that a field produces in excess of 60 million barrels, Harken's net revenue interest will decrease as described above.
Bocachico Contract -- In January 1994, Harken Colombia signed its second Association Contract (the "Bocachico Contract") with Ecopetrol, covering the Bocachico Contract area. Under the Bocachico
Contract, Harken Colombia acquired the exclusive rights to conduct exploration and production activities and drilling on this area, which covers approximately 192,000 acres in the Middle Magdalena Valley of Central Colombia. During the exploratory period of the Bocachico Contract, if Harken Colombia makes a commercial discovery on one or more prospect areas in the contract area, the contract covering such prospect area(s) will be further extended for a period of 22 years from the date of any commercial discovery of oil and/or gas. The production sharing and acreage relinquishment arrangements under the Bocachico Contract are substantially similar to those under the Alcaravan Contract.
Harken Colombia has fulfilled all of the work requirements for the first four years of the Bocachico Contract. The work requirements for the fifth year require Harken Colombia to drill one exploratory well by May 6, 1999. Harken Colombia does not currently have any plans to drill an additional well on the Bocachico Contract area acreage during 1999. Harken Colombia is currently negotiating with Ecopetrol for a modification of the work obligations, and management believes that it will be successful in negotiating such a modification. Such negotiations could include the relinquishment of a portion of Bocachico Contract area acreage. See "Negotiations with Ecopetrol" for further discussion.
In October 1995, Harken Colombia entered into a Development Finance Agreement (the "Rio Negro Development Finance Agreement") with four institutional investors (the "Rio Negro Investors"), pursuant to which the Rio Negro Investors provided up to $3,500,000 to Harken Colombia to finance a portion of the drilling of two wells on the Rio Negro prospect in the Bocachico Contract area in exchange for the right to receive future payments from Harken Colombia equal to 40% of the net profits that Harken Colombia may derive from the sale of oil and gas produced from the Rio Negro prospect (the "Participation") if the planned drilling on that prospect is successful. In March 1997, Harken entered into an agreement with the Rio Negro Investors pursuant to which the Participation was reduced to 10% from 40% in exchange for 900,000 shares of Common Stock.
Harken Colombia has drilled three wells on the Bocachico Contract area in the Rio Negro Prospect. The Torcaz #2 well was drilled in 1996, and then recompleted in 1997, and the Torcaz #3 was spudded in April 1997. During the second quarter of 1998, Harken Colombia initiated sales of production from both the Torcaz #2 and Torcaz #3 wells to a local purchaser at the wellsites and for most of 1998 these wells produced in excess of 100 gross barrels of oil per day. Harken Colombia will study the production from the Torcaz #2 and Torcaz #3 wells in order to determine the optimum production method with which to further produce the heavy crude encountered in such wells. During the second half of 1998, Harken Colombia drilled the third exploratory well on the Rio Negro prospect, the Torcaz #5. The well tested with similar results to Torcaz #2 and Torcaz #3. Although still undergoing evaluation, the well initially tested at approximately 500 gross barrels of oil per day while maintaining high fluid level from the Lower Mugrosa "B" formation. Through December 31, 1998, Harken Colombia has expended approximately $29.7 million of net oil and gas exploration and development costs related to the Bocachico Association Contract.
In October and December 1997 and March 1998, Harken entered into three separate Development Finance Agreements with institutional investors (collectively the "Institutional Investors"), pursuant to which the Institutional Investors provided a total of $31.5 million of net proceeds to Harken to finance the drilling of the initial wells on three unexplored oil and gas prospects to be identified in the Middle Magdalena Basin of Colombia, including one prospect on the Bocachico acreage. In exchange, the Institutional Investors received the right to receive future payments from Harken equal to 7% of the net profits that Harken Colombia may derive from the sale of oil and gas produced from each of the three prospects if the planned drilling on the prospect is successful.
Harken's net revenue interest in production from the Bocachico Contract will depend upon whether or not Ecopetrol elects to participate. Assuming that Ecopetrol elects to participate in the development of the Bocachico Contract, Harken will initially receive 40% of the gross revenues from production from the Bocachico Contract area, except for production which is subject to the Development Finance Agreements, in which case Harken will initially receive approximately 33% of the gross revenues associated with such production. To the extent that a field produces in excess of 60 million barrels, Harken's net revenue interest will decrease as described above.
Cambulos Contract -- In September 1995, Harken Colombia signed an additional Association Contract (the "Cambulos Contract") with Ecopetrol, covering the Cambulos Contract area. Under the Cambulos Contract, Harken Colombia has acquired the exclusive rights to conduct exploration and production activities in the Cambulos Contract area, which covers approximately 300,000 acres in the Middle Magdalena Valley of Central Colombia.
During the first two years of the Cambulos Contract, Harken Colombia was required to conduct geologic studies on the lands covered by this contract, including reprocessing of at least 400 kilometers of existing seismic data and the acquisition of at least 90 kilometers of new seismic data. Harken Colombia has completed the work program for the first two years of the Cambulos Contract. The Cambulos Contract originally required that the Cambulos Contract acreage be reduced to 173,000 acres at the end of the second contract year. In May 1998, Ecopetrol agreed to defer relinquishment of the acreage until the fourth contract year in exchange for Harken Colombia drilling two exploratory wells within the third contract year.
If during the exploratory period of the Cambulos Contract, Harken Colombia discovers a field capable of commercial production of oil or gas, the term of the Cambulos Contract will be extended for a period of 22 years from the date of such commercial discovery. Upon a commercial discovery and at the initiation of production from the commercial field, Harken Colombia will be reimbursed by Ecopetrol for 50% of all seismic costs and direct exploratory well costs (including costs related to dry holes) incurred prior to the point at which a declaration of a commercial discovery is made. Production from a commercial discovery will be allocated as follows: Ecopetrol, on behalf of the Colombian government, will receive a 20% royalty interest in all production, and all production (after royalty payments) will be allocated 50% to Ecopetrol and 50% to Harken Colombia until cumulative production from all fields in the Cambulos acreage reaches 60 million barrels of oil, after which Ecopetrol's share of production will increase progressively to 75% and Harken Colombia's share will decrease progressively to 25%, determined by a formula based on Harken Colombia's recovery of its total expenditures under the Cambulos Contract. After a declaration of a commercial discovery, Harken Colombia and Ecopetrol will be responsible for all future development costs and operating expenses in direct proportion to their interest in production. The acreage relinquishment provisions of the Cambulos Contract are substantially similar to those contained in the Alcaravan Contract.
In August 1998, Harken Colombia spudded its first well on the Cambulos Contract area, the Islero #1, located in the Middle Magdalena Basin. During the drilling of the Islero #1, Harken Colombia encountered multiple highly fractured and faulted zones which led to various mechanical problems. Consequently, drilling proceeded at a reduced pace. Ultimately, the fourth sidetrack on the well was drilled into the Cimarrona formation at 7,726 feet and was drilled into the structure. Initially, the formation had good shows of high quality oil and gas throughout the Cimarrona, but the well subsequently produced large volumes of water and did not sustain oil production levels during the short-term testing. Harken Colombia has determined that the Cimarrona formation did not have adequate thickness or fracturing to economically produce. Preliminary analysis, however, indicates that the source of the oil and gas might be in the deeper
Olini (Villeta) formation that is located approximately 1,200 feet below the Cimarrona. Through December 31, 1998, Harken Colombia has expended approximately $21.3 million of net oil and gas exploration and development costs related to the Cambulos Association Contract.
Given the cost and time spent associated with the drilling of the Islero #1, Harken Colombia has submitted a request to Ecopetrol to allow the additional well depths drilled during Islero #1 to substitute for the obligation to drill a second exploratory well within the third contract year. Ecopetrol has granted an extension of the third contract year to April 16, 1999 to consider this request. Ecopetrol's approval of this requested substitution would allow Harken Colombia to satisfy its third year obligation with the drilling of Islero #1. Harken Colombia's proposal to Ecopetrol also contemplates the relinquishment of certain acreage in the Cambulos Contract area and its commitment to the fourth contract year work obligations. Should Ecopetrol not approve this request or an alternative proposal, Harken would have the obligation to drill an additional well, which would require obtaining an additional extension of time from Ecopetrol. Should Ecopetrol deny Harken Colombia's request to allow the Islero#1 to satisfy the third year work obligations and should Ecopetrol deny Harken Colombia's request for an extension to satisfy the third year work obligations, Harken Colombia would not be in compliance with the terms of the Cambulos Contract. See "Negotiations with Ecopetrol" for further discussion.
Harken's net revenue interest in production from the Cambulos Contract will depend upon whether or not Ecopetrol elects to participate. Assuming that Ecopetrol elects to participate in the development of the Cambulos Contract, Harken will initially receive 40% of the gross revenues from production from the Cambulos Contract area, except for production which is subject to the Development Finance Agreements, in which case Harken will initially receive approximately 37% of the gross revenues associated with such production. To the extent that a field produces in excess of 60 million barrels, Harken's net interest will decrease as described above.
Bolivar Contract -- In May 1996, Harken Colombia signed an additional Association Contract (the "Bolivar Contract") with Ecopetrol, covering the Bolivar Contract area. Under the Bolivar Contract, Harken Colombia has acquired the exclusive rights to conduct exploration and production activities in the Bolivar Contract area, which covers approximately 250,000 acres in the Northern Middle Magdalena Valley of Central Colombia.
Harken Colombia has completed all of the work obligations for the first three years of the Bolivar Contract. During each of the fourth through the sixth contract years, Harken Colombia may elect to continue the contract by committing to the drilling of at least one well during each contract year. The production sharing and acreage relinquishment arrangements under the Bolivar Contract are substantially similar to those under the Cambulos Contract.
In November 1997, Harken spudded its first well on the Bolivar Contract acreage, the Catalina #1. The Catalina #1 well was drilled as a horizontal well to test the Rosa Blanca formation. During initial production testing, the Catalina #1 well produced at rates averaging 7,073 barrels of oil per day and 11.5 million cubic feet of gas per day or 9,680 barrels of oil equivalent per day. Harken Colombia believes that production rates were limited by surface facilities, wellbore configurations and recovery of drilling fluids during the test. The well was designed to be drilled a horizontal distance of up to 6,000 feet. Harken Colombia elected to end the horizontal drilling at approximately 1,265 feet upon achieving significant production rates.
In March 1998, Harken Colombia spudded the Olivo #1. The Olivo #1 was drilled from the same surface location as the Catalina #1 to a total horizontal distance of approximately 6,000 feet using underbalanced horizontal drilling. Overall total length of the well bore is 10,215 feet. The well tested at a production rate of 10,800 gross barrels of oil per day with no water from the Middle Cretaceous naturally fractured Salada (Lower La Luna) formation. Harken believes the production rate was limited by the size of the pump and production equipment used.
During 1998, Harken Colombia began trucking sales of oil production generated during the production tests of the Catalina #1 and Olivo #1 wells. Harken Colombia is currently trucking approximately 2,500 gross barrels of oil per day from the entire field. Additionally, Harken Colombia has received the required construction and environmental permits for two five-mile pipelines for the Bolivar area. These two pipelines will have an initial capacity of up to 30,000 barrels of oil per day and 150 million cubic feet of gas per day, respectively. Through December 31, 1998, Harken Colombia has expended approximately $42.2 million of net oil and gas exploration and development costs related to the Bolivar Association Contract.
In March 1999, Harken Colombia filed a request with Ecopetrol to declare the Catalina field to be commercial. The commerciality process is similar to the process provided under the Alcaravan Contract, and within 90 days after the submission of the commerciality application, Ecopetrol is required to submit their response back to Harken Colombia. Ecopetrol may approve the commerciality request or require Harken Colombia to proceed on a sole-risk basis for its development plans. If Harken Colombia proceeds on a sole-risk basis, it will be entitled to receive Ecopetrol's share of production after royalty, until Harken Colombia has recovered 200% of its costs, after which time Ecopetrol would receive its share of production. Harken Colombia is currently in discussions with sources of project finance to provide debt funding for the development of the area, including the Bolivar area pipelines discussed above. Such a credit facility could enable Harken Colombia to accelerate its development of the field, while still preserving its working capital position for its exploration efforts. The results of a financing would affect the timing of the development of the area. Harken Colombia plans to drill approximately four wells on the Bolivar acreage during 1999 and early 2000.
Harken's net revenue interest in production from the Bolivar Contract will depend upon whether or not Ecopetrol elects to participate. Assuming that Ecopetrol elects to participate in the development of the Bolivar Contract, Harken will initially receive 40% of the gross revenues from production from the Bolivar Contract area. To the extent that a field produces in excess of 60 million barrels, Harken's net revenue interest will decrease as described above.
Miradores Contract -- In December 1997, Harken Colombia signed an additional Association Contract (the "Miradores Contract") with Ecopetrol, covering the Miradores Contract area. Under the Miradores Contract, Harken Colombia has acquired the exclusive rights to conduct exploration activities in the Miradores Contract area, which covers approximately 32,000 acres in the Llanos Basin which are contiguous with the Alcaravan acreage.
During the first year of the Miradores Contract, Harken Colombia was required to reprocess at least 165 kilometers of existing seismic data and acquire at least 25 kilometers of new seismic data, which it accomplished during 1998. During each of the second through the sixth contract years, Harken Colombia may elect to continue the contract by committing to the drilling of at least one well during each contract year. Harken Colombia has received from Ecopetrol a six-month extension (until August 22, 1999) to the first year of the Miradores Contract in order to consider whether to elect to continue the contract into its second year.
Harken Colombia is currently attempting to determine whether it will be necessary to drill a well on the Miradores Contract acreage, or if all of the reserves related to the Palo Blanco field can be recovered from wells drilled on the Alcaravan Contract acreage. The production sharing and acreage relinquishment provisions of the Miradores Contract are substantially similar to those contained in the Cambulos Contract. Through December 31, 1998, Harken Colombia has expended approximately $837,000 of net oil and gas exploration and development costs related to the Miradores Association Contract.
An industry partner who currently owns a beneficial interest in the Alcaravan Contract also acquired a similar 25% beneficial interest in the Miradores Contract.
Harken's net revenue interest in production from the Miradores Contract will depend upon whether or not Ecopetrol elects to participate. After payment of industry partner participation, and assuming that Ecopetrol elects to participate in the development of the Miradores Contract, Harken will initially receive 30% of the gross revenues from production from the Miradores Contract area. To the extent that a field produces in excess of 60 million barrels, Harken's net revenue interest will decrease as described above.
Los Olmos Contract -- In March 1998, Harken Colombia signed the Los Olmos Association Contract (the "Los Olmos Contract") with Ecopetrol, covering the Los Olmos Contract area. Under the Los Olmos Contract, Harken Colombia has acquired the exclusive rights to conduct exploration activities in the Los Olmos Contract area, which covers approximately 374,000 acres in the Lower Magdalena Valley.
During the first two years of the Los Olmos Contract, Harken Colombia is required to reprocess at least 500 kilometers of existing seismic data and acquire at least 120 kilometers of new seismic data and 2,000 kilometers of aeromagnetic data, and prepare an engineering study of the contract areas. During each of the third through the sixth contract years, Harken Colombia may elect to continue the contract by committing to the drilling of at least one well during each contract year. The production sharing and acreage relinquishment provisions of the Los Olmos Contract are substantially similar to those contained in the Cambulos Contract. Through December 31, 1998, Harken Colombia has expended approximately $632,000 of net oil and gas exploration and development costs related to the Los Olmos Association Contract.
Harken's net revenue interest in production from the Los Olmos Contract will depend upon whether or not Ecopetrol elects to participate. Assuming that Ecopetrol elects to participate in the development of the Los Olmos Contract, Harken will initially receive 40% of the gross revenues from production from the Los Olmos Contract area. To the extent that a field produces in excess of 60 million barrels, Harken's net revenue interest will decease as described above.
Negotiations with Ecopetrol - As discussed above, Harken Colombia is currently involved in discussions and negotiations with Ecopetrol on certain Association Contracts regarding certain contractual work requirements or the timing under which such requirements are to be performed. If Harken Colombia is unsuccessful in negotiating a modification of the existing work obligations prior to the specified date for a particular Association Contract, Harken Colombia will not be in compliance with the Association Contract terms. Failure to comply with the terms of an Association Contract could result in its termination, which could have a material adverse effect on Harken's business.
INTERNATIONAL EXPLORATION AND DEVELOPMENT OPERATIONS - COSTA RICA
In the fourth quarter of 1998, Harken announced that it signed an agreement to participate in an Exploration and Production Contract anticipated to be signed during the first half of 1999 with the Republic of Costa Rica ("Costa Rica Contract") covering approximately 1.4 million acres in the North and South Limon Back Arc Basin onshore and offshore Costa Rica, Central America.
The Costa Rican project is a logical extension of Harken's prior exploratory success in Colombia. Indicated source rocks for the Costa Rican structures are Middle Cretaceous black shales which are equivalent to the La Luna/Querecual/Villeta oil source rocks of Northern South America in the Magdalena, Llanos, Maracaibo and Maturin Basins. If the geological interpretation is confirmed, it is expected that similar source rock characteristics that Harken has encountered in its Colombian exploration program will also be found in Costa Rica.
The Costa Rica Contract area is comprised of Blocks 2, 3, 4 and 12 from Costa Rica's initial bidding round in October of 1997. Two of the Blocks are located onshore and two are located offshore within Costa Rica's Caribbean territorial waters. The issuance and execution of the Costa Rica Contract is subject only to the completion of environmental impact studies and final agreements including Harken's participation with the Costa Rican Ministry of Environment and Energy and is expected to be signed in the first half of 1999.
Harken's participation in Costa Rica is being structured whereby a wholly-owned Harken subsidiary owns 80% of the stock of a newly formed Nevada limited liability corporation, Harken Costa Rica Holdings LLC ("HCRH"). An affiliate of MKJ Xploration, Inc. ("MKJ") owns the remaining 20% of the stock of this subsidiary. Under the terms of the agreement between Harken and MKJ, Harken will pay $4.2 million to MKJ to purchase its share of the Costa Rica Contract rights from MKJ once an agreement and approval of the assignment is signed with the Republic of Costa Rica. Additionally, up to $8 million may be committed by Harken to fund the initial minimum work program obligations under the proposed Exploration and Production Contract.
DOMESTIC EXPLORATION AND PRODUCTION OPERATIONS
Harken operates or owns a non-operating working interest in 355 oil wells and 95 gas wells in the U.S. Harken's operations are located in the Paradox Basin in the Four Corners area of Arizona, Utah and New Mexico, the Texas Panhandle region, the onshore South Texas region, the Carlsbad region of New Mexico, the Magnolia region of Arkansas, and beginning in May 1998, the onshore region of Southern Louisiana. During 1997, domestic oil sales to Giant Refining, Inc. represented 15% of Harken's consolidated revenues. There was no customer during 1998 which individually represented 10% or more of Harken's consolidated revenues.
Four Corners Operations -- Harken operates a total of 34 oil wells and 6 gas wells in the Four Corners area of Arizona, Utah, and New Mexico. Harken also owns an interest in the Aneth Gas Plant, a gas processing plant located in the Paradox Basin (Harken's interest in the Aneth Gas Plant and the Four Corners area oil and gas wells are hereinafter referred to as the "Four Corners Properties"). Harken acquired its initial 50% interest in these properties as a result of the February 1993 acquisition of Chuska Resources Corporation ("Chuska"). Harken's activities in the Four Corners area are carried out primarily through Harken Southwest Corporation ("HSW"), a wholly-owned subsidiary.
HSW's operations in the Paradox Basin are primarily concentrated on the 16 million acre Navajo Indian Reservation, which comprises portions of Arizona, New Mexico and Utah. HSW currently has two operating agreements with the Navajo Tribe of Indians (the "Navajo Nation") allowing oil and gas exploration and development on an aggregate of 16,036 acres of Navajo tribal lands on the Reservation (the "Navajo Nation Lands"). HSW has the right to explore for, produce, and sell oil, natural gas, and other specified gases until July 20, 2012, under the Tribal Agreement effective July 20, 1987 (the "1987 Tribal Agreement") and until August 26, 2003, under the Tribal Agreement effective August 26, 1983 (the "1983 Tribal Agreement").
The Navajo Nation receives 30% of gross revenues from the sale of production of oil and gas under the 1983 Tribal Agreement and 20% under the 1987 Tribal Agreement (23% with respect to proceeds from oil production in excess of $22 per barrel). Under both Tribal Agreements, the Navajo Nation is entitled to receive 50% of all gross proceeds recovered over $35 per barrel of oil. Under the 1983 Tribal Agreement, the Navajo Nation receives 50% of all gross proceeds over $4 per Mcf of gas. Under the 1987 Tribal Agreement, the Navajo Nation receives 40% of all gross proceeds over $8 per Mcf of gas.
In order to develop the Navajo Nation Lands, in 1988, Chuska entered into an operating agreement pursuant to which a group of investors acquired an undivided 50% interest in the gross proceeds receivable by Chuska under the 1983 Tribal Agreement and the 1987 Tribal Agreement. Between 1994 and 1997, HSW reacquired the interests of all of these investors.
Texas Operations -- Harken operates or owns a non-operated interest in 219 oil wells and 88 gas wells in Texas. Harken operates 185 oil wells and 38 gas wells in Hutchinson and Gray Counties, owns non-operated interests in 34 oil wells in Hockley County, and owns non-operated interests in 50 gas wells in various counties of the Texas Gulf Coast region. Harken acquired its Texas properties as a result of four acquisitions.
On May 22, 1995, Harken acquired Search Exploration, Inc., a publicly-held oil and gas exploration and production company ("Search Exploration"), through a merger between Search Exploration and Search Acquisition Corp., a wholly-owned subsidiary of Harken ("Search Acquisition").
In October 1995, Harken Energy West Texas, Inc., a wholly-owned subsidiary of Harken, acquired certain non-operated interests in producing properties located in Hockley County, Texas (the "Yellowhouse Properties").
On December 21, 1995, pursuant to a Purchase and Sale Agreement (the "Panhandle Purchase and Sale Agreement"), Harken Exploration Company, a wholly-owned subsidiary of Harken ("Harken Exploration"), acquired working interests in certain producing oil and gas leases located on approximately 6,800 acres in Hutchinson County, Texas, a gas gathering system located thereon, property and equipment related thereto and the surface rights to a 161 acre tract of land (the "Panhandle Properties").
On August 29, 1997, Harken, along with Harken Exploration, purchased working interests in oil and gas properties located in the panhandle region of Texas (the "Cal-T Properties"). The purchase price of approximately $3,416,000 consisted primarily of 565,000 shares of Common Stock.
New Mexico Operations -- Harken, through Harken Exploration, owns non-operated interests in 20 oil wells in the Carlsbad region of New Mexico. These properties were acquired as a part of the acquisition of the EnerVest Properties described below.
Arkansas Operations -- Harken, through Harken Exploration, operates 26 oil wells and owns non-operated interests in 32 oil wells in Arkansas. On July 10, 1996, Harken Exploration purchased working interests in certain producing oil and gas properties located in the Magnolia area of Arkansas and in the Carlsbad area of New Mexico (the "EnerVest Properties") from EnerVest Acquisition-II Limited Partnership ("EnerVest"). The purchase price was approximately $15,200,000. Harken paid $5,000,000 cash at closing and issued 1,550,000 shares of Common Stock. Harken also issued to EnerVest warrants to purchase, over a period of three years from closing, 300,000 shares of Common Stock at an exercise price of $2.75 per share. Subsequently, Harken issued 1,400,000 shares of Common Stock in satisfaction of all remaining obligations to EnerVest.
Louisiana Operations - Harken, through Harken Exploration, owns non-operated interests in southern Louisiana (the "Bargo Properties"). These properties are located in St. Martin Parish and the South Bayou Boeuf area in LaFourche Parish. In the St. Martinville area, Harken has 17 oil wells, 1 gas well and 3 overriding royalty interests. In the South Bayou Boeuf area, Harken has 7 oil wells and 3 salt water disposal wells. On May 19, 1998, Harken, along with Harken Exploration purchased working interests in oil and gas properties from St. Martinville Partners, Ltd. and Bargo Energy Company. The purchase price consisted of 2,716,483 shares of Common Stock, having an approximate value of $16,250,000, which were issuable at closing. Pursuant to the Asset Purchase and Sale Agreement, additional consideration of up to $4,000,000 is payable by Harken to the sellers. The amount of the additional consideration that is payable under this transaction is currently being negotiated with the sellers and is payable at Harken's option in the form of additional shares of Common Stock or cash. The properties are operated by Bargo Energy Company, however, in the purchase and sale agreement, Harken has the option, for a period of one year from May 19, 1998, to purchase from the sellers all of the seller's remaining interests in the St. Martinville area and the South Bayou Boeuf area for a predetermined purchase price. This also includes the right to operate both areas.
EXECUTIVE OFFICERS OF HARKEN
The officers of Harken are elected annually by the Board of Directors following each Annual Meeting of Stockholders, or as soon thereafter as necessary and convenient. Each officer holds office until the earlier of such time as his or her successor is duly elected and qualified, his or her death or he or she resigns or is removed from office. Any officer elected or appointed by the Board of Directors may be removed by the Board of Directors whenever, in its judgement, the best interests of Harken will be served thereby, but such removal will be without prejudice to the contract rights, if any, of the person so removed.
The executive officers of Harken as of December 31, 1998, their ages and positions held with Harken and their business experience for the past five years are listed below.
Mikel D. Faulkner has served as Chairman of the Board of Harken since February 1991 and Chief Executive Officer of Harken since 1982. Mr. Faulkner previously served as President of Harken between 1982 and 1993.
Richard H. Schroeder has served as a Director of Harken since March 1994. Mr. Schroeder has served as Vice Chairman of the Board of Directors of Harken since April 1998. Mr. Schroeder previously served as President and Chief Operating Officer of Harken between March 1994 and May 1998. From November 1990 to March 1994, Mr. Schroeder was President and owner of RHS Management, a management consulting firm, and from January 1983 to November 1990, Mr. Schroeder was President of Rosewood Resources, Inc., a privately-owned oil and gas exploration and production company.
Bruce N. Huff has served as a Director of Harken since August 1996. Mr. Huff has served as President of Harken since April 1998. Mr. Huff had previously served as Senior Vice President and Chief Financial Officer since 1990.
Stephen C. Voss has served as a Director of Harken since July 1997. Mr. Voss has served as Executive Vice President and Chief Operating Officer of Harken since December 1998. Mr. Voss had previously served as Senior Vice President of Harken since 1990. Mr. Voss has also served since 1990 as President of Harken International, Ltd., a wholly-owned subsidiary of Harken.
Larry E. Cummings has served as Vice President, Secretary and General Counsel of Harken since 1983. Mr. Cummings previously served as Senior Legal Counsel and Vice President of Land for Harken from 1978 to 1983.
A. Wayne Hennecke has been employed with Harken since 1988. Mr. Hennecke has served as Vice President - Finance and Chief Financial Officer of Harken since April 1998. Mr. Hennecke had previously served as Vice President and Treasurer of Harken since June 1995. Mr. Hennecke also previously served as Vice President - Finance for Harken's subsidiaries.
Gregory S. Porter has served as Vice President - Legal and Assistant Secretary of Harken since September 1995. From April 1994 to September 1995, Mr. Porter was an attorney with the law firm of Baker & McKenzie and from September 1992 to April 1994, Mr. Porter was an attorney with the law firm of Johnson & Gibbs.
J. Marc Lewis has served as Vice President since August 1998. From November 1984 to August 1998, Mr. Lewis was President of Petrosource Capital Corporation, an investment banking group with activities in the U.S. and Latin America.
Rodger L. Ehrlish has served as Treasurer of Harken since April 1998. Mr. Ehrlish has been employed by Harken since 1996 and previously served as Tax Manager. Prior to 1996, Mr. Ehrlish was a C.P.A. in private practice.
Guillermo Sanchez has served as President of Harken de Colombia, Ltd. since November, 1994.
CAUTIONARY STATEMENTS
Certain statements contained in this Annual Report, including statements of Harken management's current expectations, intentions, plans and beliefs, and statements containing the words "believes," "anticipates," "estimates," "expects," or "may," are forward-looking statements, as defined in Section 21D of the Securities Exchange Act of 1934. Such forward-looking statements involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance, timing or achievements of Harken to be materially different from any results, performance, timing or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following:
Price Volatility -- The revenues generated by Harken are highly dependent upon the prices of crude oil and natural gas. Fluctuations in the energy market make it difficult to estimate future prices of crude oil and natural gas. Fluctuations in energy prices are caused by a number of factors, including regional, domestic and international demand, energy legislation, federal or state taxes (if any) on sales of crude oil and natural gas, production guidelines established by the Organization of Petroleum Exporting Countries ("OPEC"), and the relative abundance of supplies of alternative fuel such as coal. Additionally, changing international economic and political conditions may have a substantial impact upon crude oil and natural gas prices. All of these factors are beyond the control of Harken.
Business Risks -- Harken must continually acquire or explore for and develop new oil and gas reserves to replace those being depleted by production. Without successful drilling or acquisition ventures, Harken's oil and gas assets, properties and the revenues derived therefrom will decline over time. To the extent Harken engages in drilling activities, such activities carry the risk that no commercially viable oil or gas production will be obtained. The cost of drilling, completing and operating wells is often uncertain. Moreover, drilling may be curtailed, delayed or canceled as a result of many factors, including shortage of available working capital, title problems, weather conditions, environmental concerns, shortages of or delays in delivery of equipment, as well as the financial instability of well operators, major working interest owners
and drilling and well servicing companies. The availability of a ready market for Harken's oil and gas depends on numerous factors beyond its control, including the demand for and supply of oil and gas, the proximity of Harken's crude oil and natural gas reserves to pipelines, the capacity of such pipelines, fluctuations in seasonal demand, the effects of inclement weather, and government regulation. New oil and gas wells may be shut-in for lack of a market until a gas pipeline or gathering system with available capacity is extended into the area.
International Operations -- Harken presently conducts significant operations in Colombia and anticipates that it will continue to conduct operations in Colombia and other foreign countries in the future. Foreign properties, operations or investments may be adversely affected by local political and economic developments, exchange controls, currency fluctuations, royalty and tax increases, retroactive tax claims, renegotiation of contracts with governmental entities, expropriation, import and export regulations and other foreign laws or policies governing operations of foreign-based companies, as well as by laws and policies of the United States affecting foreign trade, taxation and investment. In addition, as certain of Harken's operations are governed by foreign laws, in the event of a dispute, Harken may be subject to the exclusive jurisdiction of foreign courts or may not be successful in subjecting foreign persons to the jurisdiction of courts in the United States. Harken may also be hindered or prevented from enforcing its rights with respect to a governmental instrumentality because of the doctrine of sovereign immunity. Exploration and production activities in areas outside the United States are also subject to the risks inherent in foreign operations, including loss of revenue, and property and equipment as a result of hazards such as expropriation, nationalization, war, insurrection, guerilla attack and other political risks, some of which types of losses may not be covered by insurance.
The terms of Harken Colombia's Association Contracts with Ecopetrol require Harken Colombia to complete certain activities by specified dates. See "International Exploration and Development Operations - Colombia" for additional details regarding Harken Colombia's contract obligations. If Harken Colombia failed to comply with the terms of Association Contracts, Harken Colombia could face termination of one or more Association Contracts by Ecopetrol, which could have a material adverse effect on the business of Harken.
Pursuant to the Foreign Assistance Act of 1961, the President of the United States is required to determine whether to certify that certain countries have cooperated with the United States, or taken adequate steps on their own, to achieve the goals of the United Nations Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances. In 1995, 1996, 1997 and 1998, the President did not certify Colombia. The 1995 and 1998 decertifications were subject to a so-called "national interest" waiver, effectively nullifying its statutory effects. Based on the 1996 and 1997 Presidential decertification, the United States imposed substantial economic sanctions on Colombia, including the withholding of bilateral economic assistance, the blocking of Export-Import Bank and Overseas Private Investment Corporation loans and political risk insurance, and the entry of the United States votes against multilateral assistance to Colombia in the World Bank and the InterAmerican Development Bank.
The consequences of continued and successive United States decertifications of Colombian activities are not fully known, but may include the imposition of additional economic sanctions on Colombia in 1999 and succeeding years. The President also has authority to impose far-reaching economic, trade and investment sanctions on Colombia pursuant to the International Emergency Economic Powers Act of 1978, which powers were exercised in 1988 and 1989 against Panama in a dispute over narcotics trafficking activities by the Panamanian government. The Colombian government's reaction to United States sanctions
could potentially include, among other things, restrictions on the repatriation of profits and the nationalization of Colombian assets owned by United States entities. Accordingly, imposition of the foregoing economic and trade sanctions on Colombia could materially affect the performance of the Common Stock and the Company's long-term financial results.
Operating Hazards and Uninsured Risks -- The operations of Harken are subject to the inherent risks normally associated with exploration for and production of oil and gas, including blowouts, cratering, pollution, environmental liabilities and fires, each of which could result in damage to or destruction of oil and gas wells or production facilities or damage to persons and property. As is common in the oil and gas industry, Harken is not fully insured against all of these risks, either because insurance is not available or because Harken has elected to self-insure due to high premium costs. The occurrence of a significant event that is not fully insured against could have a material adverse effect on Harken's financial condition.
Environmental Regulation -- Harken's domestic activities are subject to various Navajo Nation, federal, state, and local laws and regulations covering the discharge of material into the environment or otherwise relating to protection of the environment. In particular, Harken's oil and gas exploration, development, production, its activities in connection with storage and transportation of liquid hydrocarbons and its use of facilities for treating, processing, recovering, or otherwise handling hydrocarbons and wastes therefrom are subject to stringent environmental regulation by governmental authorities. In addition to these domestic laws and regulations, Harken's international operations are subject to the laws, regulations and governmental approvals of each foreign country in which it conducts activities including, but not limited to, environmental laws and regulations governing oil and gas operations. Such domestic and foreign laws and regulations have increased the costs of planning, designing, drilling, installing, operating and abandoning Harken's oil and gas wells and other facilities.
Harken has expended significant resources, both financial and managerial, to comply with environmental regulations and permitting requirements and anticipates that it will continue to do so in the future. Although Harken believes that its respective operations and facilities are in general compliance with applicable environmental laws and regulations, risks of substantial costs and liabilities are inherent in oil and gas operations, and there can be no assurance that significant costs and liabilities will not be incurred in the future. Moreover, it is possible that other developments, such as increasingly strict environmental laws, regulations and enforcement policies thereunder, and claims for damages to property, employees, other persons and the environment resulting from Harken's operations, could result in substantial costs and liabilities in the future.
Imprecise Nature of Reserve Estimates -- Reserve estimates are imprecise and may be expected to change as additional information becomes available. Furthermore, estimates of crude oil and natural gas reserves, of necessity, are projections based on engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Accordingly, there can be no assurance that the information regarding reserves set forth herein will ultimately be produced. Furthermore, the value of Harken's reserves are based on the prices Harken received for sales of oil and gas as of December 31, 1998. The prices at which Harken was able to sell its oil and gas on December 31, 1998, may not be reflective of the market price for oil and gas at the time Harken ultimately produces its reserves. The market price of oil and gas decreased substantially in 1998 and
could decrease further in 1999 and subsequent years. If the market price of oil and gas decreases from the prices Harken received on December 31, 1998, it could have a material adverse effect on the value of Harken's reserves.
Competitive Factors in the Oil and Gas Industry -- The oil and gas industry is highly competitive in all its phases. Competition is particularly intense with respect to the acquisition of desirable producing properties and the sale of crude oil and natural gas production. Harken's competitors in oil and gas exploration, development and production include major oil companies and numerous independent oil and gas companies, and individual producers and operators. Many of Harken's competitors possess and employ financial and personnel resources substantially greater than those which are available to Harken and may, therefore, be able to pay greater amounts for desirable leases and to define, evaluate, bid for and purchase a greater number of producing prospects than the financial or personnel resources of Harken will permit.
Extensive Regulation -- The production of oil and gas is subject to extensive Navajo, federal and state laws, rules, orders and regulations governing a wide variety of matters, including the drilling and spacing of wells, allowable rates of production, prevention of waste and pollution and protection of the environment. In addition to the direct costs borne in complying with such regulations, operations and revenues may be impacted to the extent that certain regulations increase the costs of oil and gas production to below economic levels. Although the particular regulations applicable in each state in which operations are conducted vary, such regulations are generally designed to ensure that oil and gas operations are carried out in a safe and efficient manner and to ensure that similarly-situated operators are provided with reasonable opportunities to produce their respective fair shares of available crude oil and natural gas reserves. However, since these regulations generally apply to all oil and gas producers, management of Harken believes that these regulations should not put Harken at a material disadvantage to other oil and gas producers.
Certain sales, transportation, and resales of natural gas by Harken are subject to Navajo, federal and state laws and regulations, including, but not limited to, the Natural Gas Act (the "NGA"), the Natural Gas Policy Act (the "NGPA") and regulations promulgated by the Federal Energy Regulatory Commission under the NGA, the NGPA and other statutes. The provisions of the NGA and NGPA, as well as the regulations thereunder, are complex, and can affect all who produce, resell, transport, purchase or consume natural gas.
PROPERTIES AND LOCATIONS
Production and Revenues -- The following table shows, for the periods indicated, operating information attributable to Harken's oil and gas interests:
DOMESTIC
INTERNATIONAL - COLOMBIA
Acreage and Wells -- At December 31, 1998, Harken owned interests in the following oil and gas wells and acreage.
DOMESTIC
INTERNATIONAL - COLOMBIA
Drilling Activity -- A well is considered "drilled" when it is completed. A productive well is completed when permanent equipment is installed for the production of oil or gas. A dry hole is completed when it has been plugged as required and its abandonment is reported to the appropriate government agency. International activity relates to Harken's Colombian operations. International net wells drilled information is reflected net of certain development finance and operating agreements, and does not consider any potential future participation by Ecopetrol. The following tables summarize certain information concerning Harken's drilling activity:
DOMESTIC
INTERNATIONAL - COLOMBIA
EMPLOYEES
As of December 31, 1998, Harken had 132 employees. Harken has experienced no work stoppages or strikes as a result of labor disputes and considers relations with its employees to be satisfactory. Harken maintains group life, medical, dental, surgical and hospital insurance plans for its employees.
ITEM 2.
ITEM 2. PROPERTIES
See "Item 1. Business" for discussion of oil and gas properties and locations.
Harken currently leases approximately 26,100 square feet of office space for use as its corporate headquarters in Irving Texas. The facilities are leased through February 2003.
Harken has two additional offices in Houston, Texas and Bogota Colombia. Harken leases approximately 16,900 square feet of office space in Houston, Texas, which lease runs through September 2001, and approximately 15,000 square feet of office space in Bogota, Colombia, which lease runs through April 2000.
Harken expects to move its corporate headquarters to Houston, Texas in May 1999. Harken has leased approximately 26,900 square feet of office space for use as its new corporate headquarters, which lease runs through July 2004.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In September 1997, Harken Exploration Company, a wholly-owned subsidiary of Harken, was served with a lawsuit filed in Amarillo, Texas in Federal District Court for the Northern District of Texas styled D. E. Rice and Karen Rice, as Trustees for the Rice Family Living Trust vs. Harken Exploration Company. The Rice Family Living Trust ("Rice") is a surface land owner in Hutchinson County, Texas. Rice has alleged that oil and saltwater spills from Harken Exploration Company's equipment and wells have polluted and otherwise damaged its property. Rice is seeking payment of costs to prevent, minimize and mitigate the alleged oil pollution, costs to restore and repair the land and vegetation, costs to decontaminate the ground and surface water, interest, attorneys' fees, and punitive damages. Furthermore, Rice has requested that Harken Exploration Company be enjoined from producing any oil or gas from its lands. Rice has alleged that remediation of all of the pollution on its land will cost approximately $40,000,000. Harken believes that this lawsuit is wholly without merit. Harken has asserted numerous defenses, all of which Harken believes are meritorious. Harken intends to defend itself vigorously. The lawsuit is expected to go to trial in 1999. In Harken management's opinion, the results of the lawsuit will not have a material adverse effect on Harken's financial position.
Harken and its subsidiaries currently are involved in various other lawsuits and other contingencies, which in management's opinion, will not have a material adverse effect on Harken's financial position.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Since March 18, 1991, the Common Stock has been listed on the American Stock Exchange and traded under the symbol HEC. At December 31, 1998, there were approximately 3,600 holders of record of Common Stock.
The following table sets forth, for the periods indicated, the reported high and low closing sales prices of the Common Stock on the American Stock Exchange Composite Tape.
DIVIDENDS
Harken has not paid any cash dividends on the Common Stock since its organization and it is not contemplated that any cash dividends will be paid on shares of Common Stock in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL INFORMATION AND OTHER DATA
(1) Harken has adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share", effective December 15, 1997, and as a result restated certain prior year weighted average shares outstanding calculations.
(2) These estimated reserve quantities, future net revenues and present value figures are related to proved reserves located in the United States and Colombia. No consideration has been given to probable or possible reserves. Oil and gas year end prices were held constant except where future price increases were fixed and determinable under existing contracts and government regulations. At December 31, 1998, Harken has included proved oil and gas reserve information related to its Colombian operations, specifically associated with a portion of its Alcaravan, Bocachico, Bolivar and Los Olmos Contract areas. (See "Notes to Consolidated Financial Statements, Note 5 - International Operations" contained in Part II, Item 8.)
(3) See "Notes to Consolidated Financial Statements, Note 8 -- Stockholders' Equity" contained in Part II, Item 8, for a discussion of Harken Series F Preferred Stock.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
During the three year period ended December 31, 1998, Harken has significantly expanded its exploration, development and production operations in both the United States and Colombia and now additionally has an agreement to initiate operations in Costa Rica. Despite recent downturns in crude oil and natural gas prices, Harken remains financially strong, with a growing asset base and significant cash reserves available for future investment opportunities. Harken has reflected an increase in total revenues, total assets, net working capital and stockholders' equity for each of the past four years. Harken's total assets have increased from approximately $71 million at December 31, 1995 to approximately $305 million at December 31, 1998, and its total net capital expenditures related to its Colombia oil and gas properties has totaled approximately $112 million over the past 3 years. Harken's proved oil and gas reserves have increased from a present value of $58.8 million at December 31, 1995 to $144.9 million at December 31, 1998, including approximately $120.2 million of proved reserves in Colombia. In May 1998, Harken placed $85 million of 5% European Notes, which mature in 2003. Largely as a result of the 5% European Notes issuance, as well as other financing efforts, Harken's working capital has increased during the year to approximately $123.7 million at December 31, 1998. Harken's strategy continues to focus on acquiring and producing proven domestic operations, while increasing its investment in higher potential international operations in Colombia, and beginning in 1999, Costa Rica.
Harken continues to manage and expand its diversified domestic oil and gas operations. With the May 1998 acquisition of the Bargo Properties, Harken now has operations in southern Louisiana in addition to its existing operations in Texas, New Mexico, Arkansas and the Four Corners area. Harken continues to pursue additional domestic acquisition opportunities, particularly during this period of depressed prices. Domestic oil and gas revenues decreased from $14.1 million to $10.4 million during the years ended December 31, 1997 and 1998, respectively, despite increases in equivalent barrel production volumes during each year, due to a sharp decline in oil and gas prices during 1998.
Harken reported a net loss of approximately $52.5 million for the year ended December 31, 1998, as Harken recorded a total non-cash valuation allowance of its U.S. domestic oil and gas properties of approximately $50.5 million during the year. The valuation allowance was caused by the decline in oil and gas prices in addition to downward reserve revisions. These factors together resulted in a reduction in the present value of Harken's net cash flows from U.S. domestic proved reserves causing a writedown of capitalized costs in excess of this value. Harken has reflected net losses in four of the last five years due to a number of factors, including the writedown or impairment of oil and gas properties or other assets, the fluctuating nature of crude oil and natural gas prices, and the administrative and executive expenses associated with Harken's emerging international operations. While Harken expects that oil and gas revenues from its Colombian operations will contribute to its total revenues, Harken's operating results will continue to remain dependent upon the prices of crude oil and natural gas. Accordingly, as Harken's future profitablilty cannot yet be assured, Harken has offset all of its deferred tax assets on its balance sheets with a valuation allowance.
Internationally, during 1998, Harken recorded its initial crude oil sales from its Colombia operations, consisting of oil revenues from Harken's Bolivar, Bocachico and Alcaravan Contract areas. During March 1998, Harken signed an additional Association Contract in Colombia with Ecopetrol, bringing the total
number of Association Contracts to six and increasing the total number of acres operated in Colombia by Harken as of December 31, 1998 to approximately 1,358,000.
RESULTS OF OPERATIONS
The following table presents certain data for Harken's continuing operations for the years ended December 31, 1996, 1997 and 1998. A discussion follows of certain significant factors which have affected Harken's operating results during such periods. This discussion should be read in conjunction with Harken's Consolidated Financial Statements and related footnotes contained in Part II, Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements appear on pages 39 through 76 in this report.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of Harken Energy Corporation:
We have audited the accompanying consolidated balance sheets of Harken Energy Corporation (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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 financial statements referred to above present fairly, in all material respects, the financial position of Harken Energy Corporation and subsidiaries as of December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Dallas, Texas, February 19, 1999
HARKEN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements.
HARKEN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements.
HARKEN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements.
HARKEN ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying Notes to Consolidated Financial Statements are an integral part of these Statements.
HARKEN ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996, 1997 AND 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Presentation -- The Consolidated Financial Statements include the accounts of Harken Energy Corporation (a Delaware corporation) and all of its wholly-owned subsidiaries ("Harken") after elimination of significant intercompany balances and transactions. Interests in oil and gas properties jointly owned and operated pursuant to a Joint Operations Agreement are proportionately consolidated. Data is as of December 31 of each year or for the year then ended and dollar amounts in tables are in thousands unless otherwise indicated.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform with the 1998 presentation.
Cash and Temporary Investments -- For purposes of the Consolidated Statements of Cash Flows, Harken considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Gross cash outflows for purchases of held-to-maturity investments during 1997 and 1998 totaled $446,328,000 and $2,656,105,000, respectively. Gross cash inflows for maturities of such investments during 1997 and 1998 totaled $365,124,000 and $2,615,072,000, respectively. Harken paid cash for interest in the amounts of $464,000, $0 and $2,138,000 during 1996, 1997 and 1998, respectively. All significant non-cash investing and financing activities are discussed in Notes 2, 6, 7, and 8 -- Acquisitions, Development Finance and Operating Agreements, European Convertible Notes Payable and Stockholders' Equity.
Harken includes in cash and temporary investments certain balances which are restricted to use for specific project expenditures, collateral or for distribution to outside interest owners and are not available for general working capital purposes. Such restricted cash amounts totaled approximately $6,861,000 and $2,891,000 at December 31, 1997 and 1998, respectively. In addition, Harken excludes from cash and temporary investments certain proceeds received from the issuance of European Convertible Notes Payable that remain in the Segregated Accounts. See Note 7 -- European Convertible Notes Payable for further discussion.
Accounts Receivable -- Harken maintains a reserve for potential losses in collection of its accounts receivable. The allowance for doubtful accounts was $327,000 and $380,000 as of December 31, 1997 and 1998, respectively.
Concentrations of Credit Risk -- Although Harken's cash and temporary investments and accounts receivables are exposed to credit loss, Harken does not believe such risk to be significant. Cash and temporary investments, including cash in Segregated Accounts, includes investments in high-grade, short-term securities, placed with highly rated financial institutions. Most of Harken's accounts receivable are
from a broad and diverse group of industry partners, many of which are major oil and gas companies and, as a whole, do not in total represent a significant credit risk.
Property and Equipment -- Harken follows the full cost accounting method to account for the costs incurred in the acquisition, exploration, development and production of oil and gas reserves. Facilities, gas plants and other property are depreciated on the straight-line method over their estimated useful lives ranging from four to twenty years.
Other Assets -- Harken includes in other assets certain deferred commissions and issuance costs associated with the issuance of European Convertible Notes Payable. See Note 7 -- European Convertible Notes Payable for further discussion. At December 31, 1997, such deferred costs totaled $4,088,000 net of $439,000 of accumulated amortization. At December 31, 1998, such deferred costs totaled $5,937,000 net of $515,000 of accumulated amortization. At December 31, 1998, other assets also included $2,800,000 of oilfield material and equipment inventory.
Accrued Liabilities and Other -- Accrued liabilities and other at December 31, 1997, includes an amount of $4,255,000 related to prepaid investor advances, $1,785,000 related to certain operational or regulatory contingent liabilities related to Harken's domestic operations and other accrued expense liabilities of $2,628,000. The December 31, 1998 balance includes an amount of $725,000 related to prepaid investor advances, $2,714,000 related to certain operational or regulatory contingent liabilities associated with Harken's domestic operations and other accrued expense liabilities of $3,911,000.
Deferred Revenue -- In connection with certain Development Finance Agreements, Harken has received approximately $35 million in exchange for net profits interests in three prospects to be drilled in Colombia. See Note 6 -- Development Finance and Operating Agreements for further discussion. Consistent with the provisions of Statement of Financial Accounting Standards #19, "Financial Accounting and Reporting by Oil and Gas Producing Companies", Harken has accounted for these transactions as conveyances of net profits interests and has recorded the sales proceeds as deferred revenue. As Harken drills these prospects, the cost capitalized in the depletion base is reduced by an applicable amount of deferred revenue.
Colombian Operations -- Harken's operations include oil and gas exploration and development efforts in Colombia pursuant to certain Colombian Association Contracts. See further discussion at Note 5 -- International Operations. Harken accounts for its activities in Colombia using the United States dollar as the functional currency. At December 31, 1997 and 1998, Harken reflects its exploration activities in Colombia primarily as a capitalized cost of oil and gas properties. See further discussion at Notes 4 and 13 -- Oil and Gas Properties and Oil and Gas Disclosures.
Capitalization of Interest -- Harken capitalizes interest on certain oil and gas exploration and development costs which are classified as unevaluated costs, or which have not yet begun production, and certain costs associated with facilities under construction. During 1996, Harken recorded interest expense of $1,673,000, net of $370,000 of interest which was capitalized to Harken's oil and gas properties. During 1997, Harken recorded interest expense of $1,530,000, net of $1,416,000 of interest which was capitalized to Harken's oil and gas properties. During 1998, Harken recorded interest expense of $963,000, net of $3,543,000 of interest which was capitalized to Harken's oil and gas properties.
General and Administrative Expenses -- Harken reflects general and administrative expenses net of operator overhead charges and other amounts billed to joint interest owners. General and administrative expenses are net of $61,000, $30,000 and $22,000 for such amounts during 1996, 1997 and 1998, respectively.
Valuation Allowance on Oil and Gas Properties -- The capitalized costs of proved oil and gas properties are subject to a "ceiling test", which limits such costs on a country-by-country basis to the estimated present value, discounted at a ten percent interest rate, of future net cash flows from related proved reserves, based on current economic and operating conditions. If capitalized costs exceed this limit, the excess is charged to depreciation, depletion and amortization. Application of these rules during periods of relatively low oil and gas prices, even if of short-term duration, may result in write-downs.
In the last half of 1998, Harken recorded a non-cash valuation allowance on its U.S. domestic oil and gas properties of $50,518,000 due to the significant decline in its estimated present value of future net cash flows as a result of low oil and gas prices and downward U.S. domestic reserve revisions during the last half of 1998.
(2) ACQUISITIONS
Acquisitions of Additional Four Corners Property Interests -- During the second quarter of 1996, Harken acquired additional interests in its oil and gas operations in the Four Corners area of Arizona, Utah and New Mexico (the "Four Corners Properties"). The acquisition of the seller's interest raised Harken's total interest in the Four Corners Properties from approximately 82% to approximately 94% of Harken's total operated interest. The purchase consideration paid by Harken to the sellers consisted of $338,000 cash plus the issuance of approximately 509,000 shares of restricted Harken common stock. Harken also assumed certain liabilities of the sellers relating to the property interests. On June 30, 1997, Harken acquired the remaining operating interest in the Four Corners Properties for approximately $450,000 cash. Harken also assumed certain liabilities of the seller relating to the property interests. All of the above acquisitions of the additional interests in the Four Corners Properties have been accounted for under the purchase method of accounting.
Acquisitions of Texas Properties -- On December 21, 1995, pursuant to a Purchase and Sale Agreement (the "Panhandle Purchase and Sale Agreement"), Harken Exploration Company ("Harken Exploration"), a wholly-owned subsidiary of Harken, acquired working interests in certain producing properties located in the panhandle region of Texas ("Panhandle Properties"). As consideration for the purchase of these interests, Harken issued, along with other consideration, 2.5 million shares of restricted Harken common stock (the "Purchase Shares"), $2.5 million in cash and a note payable by Harken Exploration to the seller for an initial face amount of $13 million. Harken had the option over the following two years to repay all or part of this $13 million note with restricted Harken common stock at conversion rates tied to future trading prices of Harken common stock. The $13 million note was to mature and become payable in two stages, with each maturity amount subject to certain adjustments. On July 11, 1996, Harken Exploration entered into an exchange agreement with the holder of the $13 million note, whereby it was exchanged for, among other consideration, the issuance of 5,150,000 restricted shares of Harken common stock. The acquisition of the Panhandle Properties has been accounted for under the purchase method of accounting. With the July 11, 1996 exchange agreement resulting in the issuance of 5,150,000 restricted shares of Harken common stock with a market value of approximately $10,429,000 in full payment of the
outstanding balance on the note, Harken adjusted the recording of the initial purchase price of the Panhandle Properties to give effect to the finalization of the consideration issued in the purchase.
On August 29, 1997, Harken, along with Harken Exploration, purchased working interests in oil and gas properties located in the panhandle region of Texas (the "Cal-T Properties"). The purchase price of approximately $3,416,000 consisted primarily of 565,000 shares of Harken common stock. The acquisition of the Cal-T Properties has been accounted for under the purchase method of accounting.
Acquisition of EnerVest Properties -- On July 10, 1996, Harken, along with Harken Exploration, purchased working interests in certain producing oil and gas properties located in the Magnolia region of Arkansas and in the Carlsbad region of New Mexico (the "EnerVest Properties") from EnerVest Acquisition-II Limited Partnership ("EnerVest"). The purchase price of approximately $15,200,000, plus the assumption of certain operational liabilities relating to these properties, was paid in the form of $5,000,000 cash paid at closing, 1,550,000 shares of Harken common stock which were issued following closing, and 1,400,000 shares of Harken common stock which were issued in March 1997 pursuant to a Resolution and Settlement Agreement, whereby the contingent issuance of additional shares of Harken common stock provided for in the Asset Purchase and Sale Agreement was eliminated. Harken also issued to EnerVest warrants to purchase, over a period of three years from closing, 300,000 restricted shares of Harken common stock at an exercise price of $2.75 per share.
Acquisition of Bargo Properties -- On May 19, 1998, Harken, along with Harken Exploration Company, purchased working interests in oil and gas properties located in southern Louisiana (the "Bargo Properties") from St. Martinville Partners, Ltd. and Bargo Energy Company. The purchase price consisted of 2,716,483 shares of Harken common stock, having an approximate value of $16,250,000 which were issuable at closing. Pursuant to the Asset Purchase and Sale Agreement, additional consideration having a value of $4,000,000 less certain adjustments, is payable by Harken to the sellers if the sellers are able to obtain new or renewal leases for certain of the Bargo Properties. Such adjustments may include unresolved title issues on certain leases and an allowance of up to a maximum of $750,000 for environmental and regulatory compliance. The amount of the additional consideration is currently being negotiated with the sellers and is payable at Harken's option in the form of additional shares of Harken common stock or cash. See Note 11 - Related Party Transactions for a discussion of the relationship between Harken and the sellers.
Pro Forma Information -- The following unaudited pro forma combined condensed statement of operations for the year ended December 31, 1997 gives effect to the acquisition of the Cal-T Properties and the Bargo Properties and the issuance of the European 5 1/2% Senior Convertible Notes Payable (See Note 7 -- European Convertible Notes Payable for further discussion) as if each had been consummated at January 1, 1997. The following unaudited pro forma combined condensed statement of operations for the year ended December 31, 1998 gives effect to the acquisition of the Bargo Properties and the issuance of the European 5% Senior Convertible Notes Payable as if each had been consummated at January 1, 1998.
The unaudited pro forma data is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred had the transactions been consummated at the dates indicated, nor are they indicative of future operating results. The unaudited pro forma data does not reflect the effect of the various conversions of European Notes, the capitalization of certain amounts of interest on the European Notes or the interest income earned from investment of the European Note proceeds.
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 (UNAUDITED)
PRO FORMA ADJUSTMENTS-PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS - YEAR ENDED DECEMBER 31, 1997
(1) Pro forma entry to adjust actual depreciation and amortization expense on oil and gas properties for the acquired interests to the depreciation and amortization expense calculated on a consolidated basis.
(2) Pro forma entry to reflect interest and amortization expense incurred on the 5 1/2% European Notes Payable.
(3) Pro forma entry to eliminate federal and state income tax expense.
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 (UNAUDITED)
PRO FORMA ADJUSTMENTS-PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS - YEAR ENDED DECEMBER 31, 1998
(1) Pro forma entry to adjust actual depreciation and amortization expense on oil and gas properties for the acquired interests to the depreciation and amortization expense calculated on a consolidated basis.
(2) Pro forma entry to reflect interest and amortization expense incurred on the 5% European Notes Payable.
(3) INVESTMENTS
Investments are classified by Harken management at the time of purchase as either held-to-maturity, available-for-sale or trading. Such classification is reevaluated as of each balance sheet date. Included within cash and temporary investments and cash in segregated accounts as of December 31, 1997 and 1998 are certain investments in marketable debt securities having maturities of sixty days or less. Such debt securities are classified as held-to-maturity as Harken has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest and other income. During 1997 and 1998, Harken held no securities which were classified as available-for-sale or trading.
Held-to-maturity securities -- The amortized cost and estimated fair value of the marketable debt securities are as follows:
Harken includes in cash and temporary investments and cash in segregated accounts other cash and cash equivalent amounts in addition to the above marketable debt securities.
(4) OIL AND GAS PROPERTIES
Harken follows the full cost accounting method to account for the costs incurred in the acquisition, exploration, development and production of oil and gas reserves. Under this method, all costs, including internal costs, directly related to acquisition, exploration and development activities are capitalizable as oil and gas property costs. Harken capitalized $2,167,000, $3,126,000 and $6,781,000 of internal costs, net of reimbursements from joint interest owners, directly related to these activities in 1996, 1997 and 1998, respectively. Such costs include office and personnel costs of Harken's international and domestic exploration field offices and does not include any corporate overhead. Harken also accrues costs of dismantlement, restoration and abandonment to the extent that such costs, in the aggregate, are anticipated to exceed the aggregate salvage value of equipment and facilities removed from producing wells and other facilities. See Note 13 -- Oil and Gas Disclosures for further discussion.
The capitalized costs of oil and gas properties, excluding unevaluated properties, are amortized on a country-by-country basis using a unit of production method (equivalent physical units of 6 mcf of gas to each barrel of oil) based on estimated proved recoverable oil and gas reserves. Such amortization of U.S. domestic oil and gas properties was $5.58, $6.60 and $6.03 per equivalent barrel of oil produced during 1996, 1997 and 1998, respectively.
Beginning in 1998, amortization of certain Colombia oil and gas properties was $1.04 per equivalent barrel of oil produced in 1998. The evaluated costs, net of accumulated depreciation, depletion and amortization, at December 31, 1997 and 1998 include $22,754,000 and $68,742,000, respectively, related to Colombia (see Note 5 -- International Operations for a discussion of Colombian operations).
The unevaluated property costs at December 31, 1997 and 1998 includes $21,413,000 and $43,844,000, respectively, related to Colombia and $5,780,000 and $4,372,000, respectively, related to U.S. domestic prospects. Amortization of unevaluated property costs will begin when the properties become proved or their values become impaired. Harken assesses realizability of unevaluated properties on at least an annual basis or when there has been an indication that an impairment in value may have occurred. Fair value of unevaluated prospects is determined based on management's intention with regard to future exploration and development of individually significant properties and the ability of Harken to obtain funds to finance such exploration and development.
Under full cost accounting rules for each cost center, capitalized costs, less accumulated amortization and related deferred income taxes, shall not exceed an amount ("the cost ceiling") equal to the sum of (a) the present value of future net revenues from estimated production of proved oil and gas reserves discounted at 10%, plus (b) the cost of properties not being amortized, plus (c) the lower of cost or estimated fair value of any unproved properties included in the costs being amortized, less (d) any income tax effects related to differences between the book and tax basis of the properties involved.
The capitalized costs of proved oil and gas properties are subject to a "ceiling test", which limits such costs, on a country-by-country basis, to the estimated present value, discounted at a ten percent interest rate, of future net cash flows from related proved reserves, based on current economic and operating conditions. If capitalized costs exceed this limit, the excess is charged to depreciation, depletion and amortization. Application of these rules during periods of relatively low oil and gas prices, even if of short-term duration, may result in write-downs.
In the last half of 1998, Harken recorded a non-cash valuation allowance on its U.S. domestic oil and gas properties of approximately $50,518,000 due to the significant decline in its estimated present value of future net cash flows as a result of low oil and gas prices at December 31, 1998 and downward U.S. domestic reserve revisions during the last half of 1998. Such valuation allowance on the U.S. domestic oil and gas properties was $65.03 per equivalent barrel of domestic oil produced during 1998.
(5) INTERNATIONAL OPERATIONS
Colombian Operations -- Harken's Colombian operations are conducted through Harken de Colombia, Ltd., a wholly-owned subsidiary of Harken, which held six exclusive Colombian Association Contracts with Empresa Colombiana de Petroleos ("Ecopetrol") as of December 31, 1998. These Association Contracts include the Alcaravan Contract, awarded in 1992, the Bocachico Contract, awarded in 1994, the Cambulos Contract, awarded in 1995, the Bolivar Contract, awarded in 1996, the Miradores Contract, awarded in December 1997, and the Los Olmos Contract, awarded in March 1998. The Alcaravan and Miradores Contracts currently cover a combined area of approximately 242,000 acres in the Llanos Basin of Eastern Colombia. The Bocachico and Cambulos Contracts cover a combined area of approximately 492,000 acres in the Middle Magdalena Valley of Central Colombia and the Bolivar Contract covers an area of approximately 250,000 acres in the Northern Middle Magdalena Valley of Central
Colombia. The Los Olmos Contract covers approximately 374,000 acres in the Lower Magdalena Valley of Northern Colombia.
Terms of each of the Association Contracts commit Harken to perform certain activities in accordance with a prescribed timetable. As of February 19, 1999, Harken was in compliance with the requirements of each of the Association Contracts, as amended. The Cambulos Association Contract requires Harken to have drilled two wells to a depth sufficient to test productive formations for oil and/or gas by April 16, 1999. Harken has submitted a request to Ecopetrol to allow for the additional well depth drilled during the Islero #1 well to substitute for the obligation to drill a second exploratory well within the third contract year. If Harken is unable to obtain such an extension, Harken may be required to select and relinquish a portion of the acreage within the Cambulos Contract area, which event, in the opinion of Harken management, would not have a material adverse effect on Harken's business.
Under the terms of the Association Contracts, if, during the first six years of each contract, Harken discovers one or more fields of producing oil or gas in quantities that are economically exploitable and Ecopetrol agrees that such field is economically exploitable (a "commercial discovery"), the term of that contract will be extended for a period of 22 years from the date of such commercial discovery. Upon discovery of a field capable of commercial production, and upon commencement of production from that commercial field, Ecopetrol will begin to reimburse Harken for 50% of Harken's successful well costs expended up to the point of declaration of a commercial discovery plus, in the case of the Cambulos, Bolivar, Miradores and Los Olmos Contracts, 50% of all seismic and dry well costs incurred prior to the point of declaration of a commercial discovery. Production from a commercial discovery will be allocated as follows: Ecopetrol, on behalf of the Colombian government, will receive a 20% royalty interest in all production, and all production (after royalty payments) will be allocated 50% to Ecopetrol and 50% to Harken until cumulative production from all fields (or the particular productive field under certain of the Association Contracts) in the Association Contract acreage reaches 60 million barrels of oil. As cumulative production increases in excess of 60 million barrels of oil, Ecopetrol's share of production will increase progressively (to a maximum of 75% under certain of the Association Contracts) with a corresponding decrease in Harken's share of production. After a declaration of a commercial discovery, Harken and Ecopetrol will be responsible for all future development costs and operating expenses in direct proportion to their interest in production. For any fields that are not declared by Ecopetrol to be a commercial discovery, Harken would retain the rights to all production after royalty.
Harken has entered into certain development finance and operating agreements with outside parties whereby such parties have received a beneficial interest in certain of Harken's Colombian operations. For further discussion, see Note 6 - Development Finance and Operating Agreements.
Costa Rica Operations -- In the fourth quarter of 1998, Harken announced that it signed an agreement to participate in approximately 1.4 million acres in the North and South Limon Back Arc Basin onshore and offshore Costa Rica, Central America covered by a bid awarded for an Exploration and Production Contract ("Costa Rica Contract"). The Costa Rica Contract area is comprised of Blocks 2, 3, 4 and 12 from Costa Rica's initial bidding round in October of 1997. Two of the Blocks are located onshore and two are located offshore within Costa Rica's Caribbean territorial waters. The Costa Rica Contract is subject only to the completion of environmental impact studies and final agreements including the assignment to Harken with the Republic of Costa Rica and is expected to be signed in the first half of 1999.
Harken's participation in Costa Rica is structured whereby a wholly-owned Harken subsidiary owns 80% of the stock of a Nevada limited liability corporation, Harken Costa Rica Holdings LLC ("HCRH). An affiliate of MKJ Xploration, Inc. ("MKJ") owns the remaining 20% of the subsidiary. Under the terms of the agreement between Harken and MKJ, Harken will pay $4.2 million to MKJ to purchase its share of the Costa Rica Contract rights from MKJ once an agreement and assignment are signed with the Republic of Costa Rica. Additionally, up to $8 million may be committed by Harken to fund the initial minimum work program obligations under the proposed Costa Rica Contract agreement. In connection with Harken's participation in the Costa Rica Contract rights, Harken issued to MKJ certain non-registered, non-transferrable stock purchase warrants to purchase 200,000 shares of Harken common stock which are currently exercisable by the holders thereof at any time after November 12, 1998 and on or before November 12, 2001 at an exercise price of $3.50 per share.
(6) DEVELOPMENT FINANCE AND OPERATING AGREEMENTS
Rio Negro Development Finance Agreement -- In October 1995, Harken entered into a Development Finance Agreement (the "Rio Negro Development Finance Agreement") with Arbco Associates L.P., Offense Group Associates L.P., Kayne Anderson Nontraditional Investments L.P. and Opportunity Associates L.P. (collectively, the "Rio Negro Investors"), pursuant to which the Rio Negro Investors provided $3,500,000 to Harken to finance drilling on the Rio Negro prospect in the Bocachico Contract area in exchange for the right to receive future payments from Harken equal to 40% of the net profits that Harken de Colombia, Ltd. may derive from the sale of oil and gas produced from the Rio Negro prospect (the "Rio Negro Participation").
In March 1997, Harken and the Rio Negro Investors entered into a Conversion Agreement whereby Harken purchased 75% of the Rio Negro Participation relating to the Rio Negro Development Finance Agreement in exchange for 900,000 restricted shares of Harken common stock which were issued within 30 days following closing. From the remaining 25% of the Rio Negro Participation retained, the Rio Negro Investors have the right to receive 10% of the net profits that Harken de Colombia, Ltd. may derive from the sale of oil and gas produced from the Rio Negro prospect.
Palo Blanco Development Finance Agreements -- In June 1996, Harken, along with Harken de Colombia, Ltd., entered into separate Development Finance Agreements with two investors. Under the terms of the agreements, the two investors provided an aggregate of $2,500,000 to finance the drilling of a well on the Palo Blanco prospect in the Alcaravan Association Contract area. In return for the $2,500,000, the investors were initially granted a beneficial interest in 40% of the net profits from the Palo Blanco prospect which might have been received by Harken de Colombia, Ltd. In 1996, the investors exercised their rights under the agreement to convert one-half of their beneficial interest into 599,988 shares of restricted Harken common stock. During the first quarter of 1997, the investors exercised their right to convert the remaining portion of their beneficial interest into an additional 599,988 shares of restricted Harken common stock.
Rochester Agreement -- Harken de Colombia, Ltd. has entered into an operating agreement (the "Rochester Agreement") with Rochester Energy Corporation ("Rochester", a Canadian corporation) pursuant to which Rochester has paid 33 1/3% of the aggregate costs of the Estero #1 well and related production facilities on the Palo Blanco prospect, 25% of the aggregate costs related to the Estero #3 well, and 25% of the aggregate costs of the initial well drilled on the Anteojos prospect, the Canacabare #1, all of which are located within the Alcaravan Contract area, along with 25% of the aggregate costs related to the Miradores
Association Contract. In exchange, Rochester acquired a beneficial interest equal to 25% of the interest held by Harken de Colombia, Ltd. in the Palo Blanco and Anteojos prospect operations. The Estero #1 well was drilled in the first half of 1997 and Estero #3 was spudded in December 1997. The Canacabare #1 well began drilling March 1998, and will be tested in late 1999 due to weather delays.
Parkcrest Financing Agreement - In January 1997, Harken de Colombia, Ltd. entered into a financing agreement ("the Parkcrest Financing Agreement") with Parkcrest Explorations, Ltd. ("Parkcrest", a Canadian corporation) pursuant to which Parkcrest paid 33 1/3% of the aggregate costs of the Estero #1 well and related production facilities on the Palo Blanco prospect, 33 1/3% of the aggregate costs of the initial well drilled on the Anteojos prospect, the Canacabare #1, and 25% of the aggregate costs related to the Estero #3 well, all of which are located within the Alcaravan Contract area. In addition, Parkcrest was to pay 33 1/3% of the aggregate costs of the initial well to be drilled under the Miradores Association Contract. Parkcrest was also responsible for their contracted percentage share of costs related to seismic on the Alcaravan and Miradores Contract areas. In exchange, Parkcrest, upon its full performance, was to acquire a beneficial interest equal to 25% of the interest held by Harken de Colombia, Ltd. in these prospects.
In April 1998, Harken and Parkcrest entered into a Loan and Security Agreement (the "Parkcrest Loan Agreement") whereby Harken agreed to provide up to $2,600,000 to Parkcrest to be used as needed by Parkcrest to finance its share of costs under the Parkcrest Financing Agreement. Under the terms of the Parkcrest Loan Agreement, any outstanding loans bear interest at 6% per annum in addition to a monthly management fee payable to Harken of $37,500 per month. Any outstanding balance pursuant to the Parkcrest Loan Agreement was due and payable by Parkcrest on November 30, 1998 secured by 50% of Parkcrest's beneficial interest in the Palo Blanco prospect. In December 1998, Harken purchased all of the interests held by Parkcrest in the Alcaravan and Miradores Association Contract areas. Under the terms of the purchase agreement entered into between Harken and Parkcrest, Harken forgave a loan balance of approximately $2,280,000 outstanding at the date of the purchase and issued 1,350,000 shares of Harken common stock.
EnCap Development Finance Agreement -- In October 1997, Harken entered into a Development Finance Agreement (the "EnCap Development Finance Agreement") with EnCap Energy Capital Fund III, L.P., EnCap Energy Capital Fund III-B, L.P., BOCP Energy Partners, L.P. and Energy Capital Investment Company PLC (collectively the "EnCap Investors"), pursuant to which the EnCap Investors provided $25 million (the "Payment Amount"), less a 2% investment banking fee, to Harken to finance the planned drilling of the initial wells on three unexplored oil and gas prospects in the Middle Magdalena Basin of Colombia. As part of the transaction, Harken issued 150,000 shares of Harken common stock to the EnCap Investors. The three well exploratory program contemplates the drilling of one prospect on Harken's Bocachico Contract area and the drilling of two prospects on Harken's Cambulos Contract area. In exchange, the EnCap Investors received the right to receive future payments from Harken equal to 5% of the net profits that Harken de Colombia, Ltd. may derive from the sale of oil and gas produced from each of the three prospects if the planned drilling on the prospect is successful (the "EnCap Participation"). Pursuant to the EnCap Development Finance Agreement, Harken is obligated to drill each of the three wells prior to October 2000.
Pursuant to the EnCap Development Finance Agreement, the EnCap Investors have the right, for a period of two years beginning in October 1998, to convert all or part of the EnCap Participation into shares of Harken common stock. The number of shares of Harken common stock to be issued upon conversion of
the EnCap Participation will be equal to the quotient of (i) the Payment Amount (less any distributions made in respect of the EnCap Participation) plus an amount equal to 15% interest per annum on the net Payment Amount compounded monthly (the "Invested Amount"), divided by (ii) the market price of Harken common stock at the time of conversion. During the same two year period, Harken also has the right to convert the EnCap Participation into shares of Harken common stock with the number of shares of Harken common stock to be issued to be equal to the quotient of (i) the Payment Amount (less any distribution made in respect of the EnCap Participation) plus an amount equal to 25% interest per annum on the net Payment Amount compounded monthly, divided by (ii) the market price of Harken common stock at the time of conversion. Harken can also elect to pay cash upon any conversion of the EnCap Participation in lieu of issuing Harken common stock. The EnCap Development Finance Agreement also provides for additional shares of Harken common stock to be issued by Harken in the event of a conversion to the extent that the EnCap Investors do not, under certain circumstances, realize the Invested Amount from the sale of shares of Harken common stock issued at the conversion. See Note 11 -- Related Party Transactions for a discussion of the relationship between Harken and the EnCap Investors.
European Development Finance Agreement -- In December 1997, Harken entered into a Development Finance Agreement and other related agreements (the "European Development Finance Agreement") whereby Sidro S.A., Lambertine Holdings, Ltd. and Rauscher Pierce and Clark (collectively the "European Investors") purchased all of the outstanding common stock of Harken Capital Corporation, ("HCC", a newly-formed U.S. corporation) for $7 million. Pursuant to the European Development Finance Agreement, HCC then provided the $7 million to Harken in January 1998 to finance a portion of the cost of the three-well exploratory program discussed above pursuant to the EnCap Development Finance Agreement. In exchange, HCC received the right to receive future payments from Harken equal to 1.4% of the net profits that Harken de Colombia, Ltd. may derive from the sale of oil and gas produced from each of the three prospects if the planned drilling on the prospect is successful. As part of the transaction, Harken issued 42,000 shares of Harken common stock to the European Investors and paid a cash fee of $175,000 to one of the European Investors.
In March 1998, Harken received directly an additional $3 million pursuant to a Development Finance Agreement with Faisal Finance ("Faisal"), which contains terms substantially identical to the EnCap Development Finance Agreement, including conversion provisions which begin in March 1999. In exchange, Faisal received the right to receive future payments from Harken equal to 0.6% of the net profits that Harken de Colombia, Ltd. may derive from the sale of oil and gas produced from each of the three prospects discussed above pursuant to the EnCap Development Finance Agreement if the planned drilling on the prospect is successful. As part of this transaction, Harken issued 18,000 shares of Harken common stock and paid a cash fee of $75,000 to a financial advisor.
Pursuant to the European Development Finance Agreement, the European Investors, Faisal and Harken each have the right to convert the interest into shares of common stock of Harken pursuant to conversion rights terms identical to those terms related to the EnCap Development Finance Agreement, for a period of two years beginning in December 1998. In December 1998, one of the Institutional Investors exercised their right to convert all their Institutional Participation into shares of Harken common stock. Harken elected by pay cash of approximately $2.3 million in lieu of issuing Harken common stock.
(7) EUROPEAN CONVERTIBLE NOTES PAYABLE
8% European Notes -- During the second quarter of 1995, Harken issued to qualified purchasers a total of $15 million in 8% Senior Convertible Notes (the "8% European Notes") which were to mature in May 1998. Interest on these notes was payable semi-annually in May and November of each year to maturity or until the 8% European Notes were converted. Such 8% European Notes were convertible at any time by the holders into shares of Harken common stock at a conversion price of $1.50 per share ("the 8% European Note Conversion Price"). Between September 30, 1995 and July 31, 1996, all holders of these 8% European Notes exercised their conversion options and Harken issued an aggregate total of 9,999,975 shares of Harken common stock pursuant to these conversions.
6 1/2% European Notes -- On July 30, 1996, Harken issued to qualified purchasers a total of $40 million in 6 1/2% Senior Convertible Notes (the "6 1/2% European Notes") which were to mature on July 30, 2000. Such 6 1/2% European Notes were convertible at any time by the holders into shares of Harken common stock at a conversion price of $2.50 per share ("the 6 1/2% European Note Conversion Price"). The 6 1/2% European Notes were also convertible by Harken into shares of Harken common stock after one year following issuance, if for any period of thirty consecutive days commencing on or after November 28, 1996, the closing price of Harken common stock for each trading day during such period shall have equaled or exceeded 135% of the 6 1/2% European Note Conversion Price (or $3.375 per share of Harken common stock).
During the last half of 1996, holders of 6 1/2% European Notes totaling $1,400,000 exercised their conversion option and such holders were issued 560,000 shares of Harken common stock. In February 1997, Harken gave notice as required under the Trust Indenture that it had met the market price criteria necessary to call for mandatory conversion of the 6 1/2% European Notes and on June 2, 1997 formally called the 6 1/2% European Notes for conversion on July 31, 1997. During the first six months of 1997, holders of 6 1/2% European Notes totaling $19,300,000 exercised their conversion option and such holders were issued 7,720,000 shares of Harken common stock. On July 31, 1997, Harken converted the remaining 6 1/2% European Notes into 7,720,000 shares of Harken common stock.
5 1/2% European Notes -- On June 11, 1997, Harken issued to qualified purchasers a total of $70 million in 5 1/2% Senior Convertible Notes (the "5 1/2% European Notes") which were to mature on June 10, 2002. In connection with the sale and issuance of the 5 1/2% European Notes, Harken paid approximately $5,174,000 from the 5 1/2% European Notes proceeds for commissions and issuance costs. Interest incurred on these notes was payable semi-annually in June and December of each year to maturity or until the 5 1/2% European Notes were converted. Such 5 1/2% European Notes were convertible into shares of Harken common stock at an initial conversion price of $5.00 per share, subject to adjustment in certain circumstances ("the 5 1/2% European Note Conversion Price"). The Trust Indenture provided for a five percent premium on the number of shares of Harken common stock issuable on conversion that was paid to holders converting the 5 1/2% European Notes prior to December 11, 1997. The 5 1/2% European Notes were also convertible by Harken into shares of Harken common stock after one year following issuance, if for any period of thirty consecutive days commencing on or after June 11, 1997, the average of the closing prices of Harken common stock for each trading day during such thirty-day period equaled or exceeded 130% of the 5 1/2% European Note Conversion Price (or $6.50 per share of Harken common stock). In October 1997, Harken met the market price criteria necessary to call for mandatory conversion of the 5 1/2% European Notes any time on or after June 11, 1998, and provided notice to the holders as required under the Trust Indenture. Harken formally called the 5 1/2% European Notes which remained outstanding on June 12, 1998. As of December 31, 1997, holders of 5 1/2% European Notes totaling $30,120,000 exercised their conversion option
and such holders were issued 6,325,200 shares of Harken common stock. During the first six months of 1998 additional holders of 5 1/2% European Notes totaling $610,000 exercised their conversion option and such holders were issued an additional 122,000 shares of Harken common stock. On June 12, 1998, Harken converted the remaining 5 1/2% European Notes into 7,854,000 shares of Harken common stock.
Upon closing, all proceeds from the sale of the 6 1/2% European Notes and 5 1/2% European Notes, net of commissions and issuance costs, were each initially paid to a Trustee under the terms of a Trust Indenture covering each issue and held in separate interest bearing Trust accounts (the "Segregated Accounts") to be maintained for Harken's benefit until the Trustee was presented with evidence of sufficient asset value, as defined in the Trust Indenture, held by Harken to permit an advance of a portion of the proceeds. Until all of the 5 1/2% European Notes were converted, Harken was to maintain an Asset Value Coverage Ratio as defined in the Trust Indenture. Upon the June 1998 conversion of the 5 1/2% European Notes which remained outstanding, Harken transferred the approximately $37.6 million in the Segregated Accounts to its main operating account.
All Segregated Account cash related to the 5 1/2% European Notes is reflected as a current asset at December 31, 1997 as all such cash was available according to the Trust Indenture. The initial cash proceeds received in 1997 from the issuance of the 5 1/2% European Notes are not included in the Statement of Cash Flows during that period because the proceeds are not considered to be cash equivalents due to the Segregated Account requirement of these notes. Transfers of proceeds from the Segregated Accounts are included in cash flows from financing activities in the accompanying consolidated statements of cash flows.
5% European Notes -- On May 26, 1998, Harken issued to qualified purchasers a total of $85 million in 5% Senior Convertible Notes (the "5% European Notes") which mature on May 26, 2003. In connection with the sale and issuance of the 5% European Notes, Harken paid approximately $4,256,000 from the 5% European Notes proceeds for commissions and issuance costs. Interest incurred on these notes is payable semi-annually in May and November of each year to maturity or until the 5% European Notes are converted. Such 5% European Notes are convertible into shares of Harken common stock at an initial conversion price of $6.50 per share, subject to adjustment in certain circumstances ("the 5% European Note Conversion Price"). The Trust Indenture provided for a 3% percent premium on the number of shares of Harken common stock issuable on conversion to holders of the 5% European Notes who converted prior to November 25, 1998. None of the bondholders have exercised their conversion option as of February 19, 1999. The 5% European Notes are also convertible by Harken into shares of Harken common stock after May 26, 1999, if for any period of thirty consecutive days commencing on or after May 26, 1998, the average of the closing prices of Harken common stock for each trading day during such thirty-day period shall have equaled or exceeded 125% of the 5% European Note Conversion Price (or $8.125 per share of Harken common stock). The 5% European Notes may be redeemed for cash, at Harken's option, at par, in whole or in part, at any time after May 26, 2002, upon not less than 30 days notice to the holders. In addition, beginning November 26, 2002, Harken may redeem up to 50% of the 5% European Notes in exchange for shares of Harken common stock at a defined conversion price based on an average market price of Harken common stock. Beginning May 26, 2003, Harken may similarly redeem all remaining 5% European Notes. The 5% European Notes are listed on the Luxembourg Stock Exchange.
Commissions and issuance costs associated with the European Notes are deferred and are included in Other Assets and are amortized to interest expense over the period until conversion or maturity of the
European Notes. As European Notes are converted to Harken common stock, a pro-rata portion of these deferred costs are charged to Additional Paid-In Capital.
(8) STOCKHOLDERS' EQUITY
Common Stock -- Harken currently has authorized 225,000,000 shares of $.01 par common stock. At December 31, 1997 and 1998, Harken had issued 121,811,534 shares and 134,758,830 shares, respectively.
Treasury Stock -- During the third quarter of 1998, Harken purchased 700,000 shares of Harken common stock in the open market at a cost of approximately $2,552,000. Such shares are held as treasury stock.
Issuance of European Convertible Notes Payable -- At December 31, 1995, $2,450,000 of the 8% European Notes had been converted into 1,633,327 shares of Harken common stock. In 1996, all of the remaining outstanding 8% European Notes were converted into 8,366,648 additional shares of Harken common stock. In connection with the issuance of the 8% European Notes, Harken issued to the placement agents for the 8% European Notes certain non-registered non-transferrable stock purchase warrants to purchase one million shares of Harken common stock which were exercisable by the holders thereof at any time on or before May 11, 1999 at an exercise price of $1.50 per share. As of December 31, 1997, only approximately 37,000 of such warrants remained outstanding and were subsequently exercised for shares of Harken common stock in February 1998.
In July 1996, Harken issued to qualified purchasers a total of $40 million in 6 1/2% European Notes which were to mature on July 30, 2000. The 6 1/2% European Notes were convertible under certain terms into approximately 16,000,000 shares of Harken common stock. During the last half of 1996, holders of 6 1/2% European Notes totaling $1,400,000 exercised their conversion option and such holders were issued 560,000 shares of Harken common stock. During the first six months of 1997, holders of 6 1/2% European Notes totaling an additional $19,300,000 exercised their conversion option and such holders were issued 7,720,000 shares of Harken common stock. On July 31, 1997, Harken converted the remaining 6 1/2% European Notes into 7,720,000 shares of Harken common stock. In connection with the issuance of the 6 1/2% European Notes, Harken issued to the placement agents for the 6 1/2% European Notes certain non-registered non-transferrable stock purchase warrants to purchase 1,280,000 shares of Harken common stock which are currently exercisable by the holders thereof at any time on or before July 31, 1999 at an exercise price of $2.50 per share. As of December 31, 1998, all but approximately 60,000 of such warrants had been exercised for shares of Harken common stock.
In June 1997, Harken issued to qualified purchasers a total of $70 million in 5 1/2% European Notes which were to mature on June 11, 2002. As of December 31, 1997, holders of 5 1/2% European Notes totaling $30,120,000 had exercised their conversion option and such holders were issued 6,325,200 shares of Harken common stock. Subsequent to December 31, 1997 and as of June 11, 1998, holders of 5 1/2% European Notes totaling an additional $610,000 exercised their conversion option and such holders were issued 122,000 shares of Harken common stock. On June 12, 1998, Harken formally called and converted the remaining 5 1/2% European Notes into 7,854,000 shares of Harken common stock. In connection with the issuance of the 5 1/2% European Notes, Harken issued to the placement agents for the 5 1/2% European Notes warrants to
purchase 1,120,000 shares of Harken common stock at any time after December 11, 1997 and on or before December 11, 1999 at an exercise price of $5.00 per share.
In May 1998, Harken issued to qualified purchasers a total of $85 million in 5% European Notes which mature on May 26, 2003. Such 5% European Notes are convertible into shares of Harken common stock at an initial conversion price of $6.50 per share, subject to adjustment in certain circumstances ("the 5% European Note Conversion Price"). The Trust Indenture provided for a three percent premium on the number of shares of Harken common stock issuable on conversion to holders of the 5% European Notes who convert prior to November 25, 1998. None of the bond holders have exercised their conversion option as of February 19, 1999. The 5% European Notes are also convertible by Harken into shares of Harken common stock after May 26, 1999, if for any period of thirty consecutive days commencing on or after May 26, 1998, the average of the closing prices of Harken common stock for each trading day during such thirty-day period shall have equaled or exceeded 125% of the 5% European Note Conversion Price (or $8.125 per share of Harken common stock). The 5% European Notes may be redeemed for cash, at Harken's option, at par, in whole or in part, at any time after May 26, 2002, upon not less than 30 days notice to the holders. In addition, beginning November 26, 2002, Harken may redeem up to 50% of the 5% European Notes in exchange for shares of Harken common stock at a defined conversion price based on an average market price of Harken common stock. Beginning May 26, 2003, Harken may similarly redeem all remaining 5% European Notes. In connection with the issuance of the 5% European Notes, Harken issued to the placement agents for the 5% European Notes warrants to purchase 200,000 shares of Harken common stock at any time after May 26, 1998 and on or before May 26, 2000 at an exercise price of $6.50 per share. The 5% European Notes are listed on the Luxembourg Stock Exchange.
Private Placements of Common Stock -- In March 1996, Harken received $1,289,000 related to the sale of 1,040,000 shares of Harken common stock previously held as treasury stock. In connection with certain of these placements, Harken issued to certain financial advisors warrants to purchase an aggregate total of 204,000 shares of Harken common stock at an average exercise price of $1.75 per share. During 1997, these warrants were exercised for shares of Harken common stock.
Acquisition of Texas Properties -- In December 1995, Harken Exploration acquired certain interests in producing properties located in the panhandle region of Texas ("Panhandle Properties") in exchange for, among other consideration, 2.5 million shares of Harken common stock and a $13 million note payable which was payable, at Harken's option, in shares of Harken common stock. In July 1996, Harken Exploration entered into an exchange agreement with the seller of the Panhandle Properties, pursuant to which Harken issued 5,150,000 restricted shares of Harken common stock in satisfaction of all obligations owed by the subsidiary to the seller under the terms of the Panhandle Note. On December 21, 1995, pursuant to a Purchase and Sale Agreement (the "Panhandle Purchase and Sale Agreement"), Harken Exploration Company ("Harken Exploration"), a wholly-owned subsidiary of Harken, acquired working interests in certain producing properties located in the panhandle region of Texas ("Panhandle Properties"). As consideration for the purchase of these interests, Harken issued, along with other consideration, 2.5 million shares of restricted Harken common stock (the "Purchase Shares"), $2.5 million in cash and a note payable by Harken Exploration to the seller for an initial face amount of $13 million. Harken had the option over the following two years to repay all or part of this $13 million note with restricted Harken common stock at conversion rates tied to future trading prices of Harken common stock. The $13 million note was to mature and become payable in two stages, with each maturity amount subject to certain adjustments. On July 11, 1996, Harken Exploration entered into an exchange agreement with the holder of the $13 million
note, whereby it was exchanged for, among other consideration, the issuance of 5,150,000 restricted shares of Harken common stock. The acquisition of the Panhandle Properties has been accounted for under the purchase method of accounting. With the July 11, 1996 exchange agreement resulting in the issuance of 5,150,000 restricted shares of Harken common stock with a market value of approximately $10,429,000 in full payment of the outstanding balance on the note, Harken adjusted the recording of the initial purchase price of the Panhandle Properties to give effect to the finalization of the consideration issued in the purchase. See Note 2 -- Acquisitions for further discussion.
In August, 1997, Harken acquired working interests in the Cal-T Properties in exchange for 565,000 shares of Harken common stock. See Note 2 - -Acquisitions for further discussion.
Acquisition of EnerVest Properties -- On July 10, 1996, Harken Exploration acquired the EnerVest Properties for a purchase price valued at approximately $15,200,000 and the assumption of certain operational liabilities relating to these properties. See Note 2 -- Acquisitions for further discussion. As partial consideration for the properties, Harken issued 1,550,000 in shares of Harken common stock issued after closing. Pursuant to a Resolution and Settlement Agreement in March 1997, Harken issued an additional 1,400,000 shares of common stock as final consideration for the properties. Harken also issued to EnerVest warrants to purchase, for a period of three years from closing, 300,000 restricted shares of Harken common stock at an exercise price of $2.75 per share. During the third quarter of 1997, the holder exercised warrants to purchase 100,000 shares of Harken common stock.
Acquisition of Bargo Properties -- In May 1998, Harken acquired working interests in the Bargo Properties in exchange for 2,716,483 shares issuable at closing. Additional consideration of up to $4,000,000 is payable by Harken to the Sellers in the form of additional shares of Harken common stock or cash under certain circumstances. See Note 2 Acquisitions for further discussion.
Development Finance Agreements -- Harken has entered into development finance agreements relating to certain of its Colombian operations. Pursuant to these development finance agreements, certain investors have the option, or have previously exercised their options, to convert their beneficial interest in a specific operating area into shares of Harken common stock. In addition, certain of these investors were issued shares of Harken common stock at the time of entering into a development finance agreement with Harken. For a complete discussion of each of the various development finance agreements, see Note 6 - Development Finance and Operating Agreements.
Series F Preferred Stock - On April 9, 1998, Harken entered into a Securities Purchase Agreement with RGC International Investors, LDC ("RGC"), pursuant to which Harken issued to RGC 15,000 shares of its Series F Convertible Preferred Stock (the "Series F Preferred") in exchange for $15,000,000. The Series F Preferred was convertible into shares of Harken common stock at a conversion price based upon the market price of Harken common stock at the time of conversion. The number of shares of Harken common stock issuable upon conversion of the Series F Preferred also included a premium amount equal to an increase calculated on the face value of the Series F Preferred at 5% per annum. Harken has reflected this 5% per annum increase throughout 1998 as accretion related to preferred stock in the accompanying Consolidated Statements of Operations. Such accretion amount is reflected in Harken's calculation of net income (loss) attributable to common stock. The Series F Preferred did not pay dividends.
During the first six months following the issuance of the Series F Preferred, RGC could have elected to convert the shares of the Series F Preferred into Harken common stock on any day that the closing sales price of the Harken common stock on the American Stock Exchange was equal to or greater than 115% of the "Market Price." The Market Price is equal to the lower of (a) the average of the closing bid prices of Harken common stock for any five consecutive trading days during the 22 trading days ending one trading day prior to the conversion date, or (b) the low closing bid price of Harken common stock over the five trading days ending one trading day prior to the conversion date.
During the first nine months following the issuance of the Series F Preferred, the conversion price was equal to 103% of the Market Price on the conversion date. On January 9, 1999, the conversion price would be fixed at 90% of the average of the closing bid prices of Harken common stock for the previous 22 trading days. Beginning February 9, 1999, the conversion price was to be fixed at 90% of the average of the closing bid prices of Harken common stock for the previous 22 trading days if it would result in a lower conversion price than that calculated on January 9, 1999. Any shares of Series F Preferred outstanding on April 9, 1999, would automatically be converted into shares of Harken common stock at the then applicable conversion price.
Harken had the option to redeem for cash any shares of Series F Preferred presented for conversion if (a) prior to January 9, 1999, the closing price of Harken common stock on the conversion date is less than $4.80, or (b) on or after January 9, 1999, the then applicable conversion price is less than $4.80, for an amount equal to the number of shares of Harken common stock that would otherwise be issuable upon conversion multiplied by the closing price of Harken common stock on the conversion date.
At each election to convert shares of Series F Preferred into Harken common stock, RGC would have the option to purchase from Harken for cash additional shares of Harken common stock equal to the number of shares issued on such conversion (less any shares issued in respect of the premium amount) at a purchase price equal to the then applicable conversion price.
On January 5, 1999, Harken reached an agreement with RGC to extend the fixed conversion price dates and mandatory conversion date by one year on Harken's $15 million Series F Preferred. Under the terms of the new agreement with RGC, Harken would have issued shares of a new Series G Convertible Preferred Stock (the "Series G Preferred") in exchange for the outstanding Series F Preferred. In January 1999, RGC elected to present its Series F Preferred for conversion and Harken elected to pay cash of approximately $25,273,000 to RGC in lieu of issuing shares of Harken common stock. Harken has reflected an additional amount of approximately $1,302,000 of accretion related to Series F Preferred which represents the portion of the ultimate redemption value generated in December 1998. Harken will reflect the additional accretion amount of approximately $8,427,000 in the calculation of net income (loss) attributed to common stock during the first quarter of 1999.
Stockholder Rights Plan -- In April 1998, Harken adopted a rights agreement (the "Rights Agreement") whereby a dividend of one preferred share purchase right (a "Right") was paid for each outstanding share of Harken common stock. The Rights will be exercisable only if a person acquires beneficial ownership of 15 percent or more of Harken common stock (an "Acquiring Person"), or commences a tender offer which would result in beneficial ownership of 15 percent or more of such stock. When they become exercisable, each Right entitles the registered holder to purchase from Harken one one-thousandth of one share of Series E Junior Participating Preferred Stock ("Series E Preferred Stock"), at a
price of $35.00 per one one-thousandth of a share of Series E Preferred Stock, subject to adjustment under certain circumstances.
Upon the occurrence of certain events specified in the Rights Agreement, each holder of a Right (other than an Acquiring Person) will have the right to purchase, at the Right's then current exercise price, shares of Harken common stock having a value of twice the Right's exercise price. In addition, if, after a person becomes an Acquiring Person, Harken is involved in a merger or other business combination transaction with another person in which Harken is not the surviving corporation, or under certain other circumstances, each Right will entitle its holder to purchase, at the Right's then current exercise price, shares of common stock of the other person having a value of twice the Right's exercise price.
Unless redeemed by Harken earlier, the Rights will expire on April 6, 2008. Harken will generally be entitled to redeem the Rights in whole, but not in part, at $.01 per Right, subject to adjustment. No Rights were exercisable under the Rights Agreement at December 31, 1998.
The terms of the Rights generally may be amended by Harken without the approval of the holders of the Rights prior to the public announcement by Harken or an Acquiring Person that a person has become an Acquiring Person.
Per Share Data -- Basic earnings per common share was computed by dividing net income or loss attributed to common stock by the weighted average number of shares of Harken common stock outstanding during the year. Diluted earnings per common share for 1997 was determined by including the effect of outstanding options and warrants using the treasury stock method to the extent that the average share price exceeds the exercise price. The impact of unconverted European Convertible Notes was not included in any of the years presented as their effect would have been antidilutive. The impact of the unconverted European Investors interest and the unconverted Series F Preferred were not included in December 31, 1998 as their effect would have been antidilutive. Harken has adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share", effective December 15, 1997, and as a result has restated certain prior year weighted average shares outstanding calculations, although there was no impact on prior year loss per share amounts. A reconciliation of the 1997 calculation of diluted earnings per common share is as follows (not in thousands):
Summary of Outstanding Warrants -- At December 31, 1998, Harken has the following outstanding warrants available to be exercised (not in thousands):
(9) STOCK OPTION PLAN
Harken has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", ("FAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of Harken's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Harken's 1993 Stock Option and Restricted Plan has authorized the grant of options to Harken employees and directors for up to 4,000,000 shares of Harken common stock. Harken's 1996 Stock Option and Restricted Stock Plan has authorized the grant of 8,290,000 shares of Harken common stock. All options granted have 10-year terms and vest and become fully exercisable at the end of 4 years of continued employment.
Pro forma information regarding net loss and loss per share is required by FAS 123, and has been determined as if Harken had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1996, 1997 and 1998, respectively: risk-free interest rates of 6%, 5 1/2% and 5%; dividend yields of 0%; volatility factors of the expected market price of Harken common stock of .614, .588 and .665; and a weighted-average expected life to the option of 4 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because Harken's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Harken's pro forma information follows (in thousands except for earnings per share information):
The weighted average fair value of the options issued in 1996, 1997 and 1998 was $1.30, $2.63 and $2.33 per share, respectively, underlying such option.
A summary of Harken's stock option activity, and related information for the years ended December 31, 1996, 1997 and 1998 follows (not in thousands):
Exercise prices for options outstanding as of December 31, 1996 ranged from $1.00 to $5.625. Exercise prices for options outstanding as of December 31, 1997 ranged from $1.00 to $6.00. Exercise prices for options outstanding as of December 31, 1998 ranged from $1.00 to $6.4375.
(10) INCOME TAXES
At December 31, 1998, Harken had available for federal income tax reporting purposes, net operating loss (NOL) carryforward for regular tax purposes of approximately $62,000,000 which expires in 1999 through 2019, alternative minimum tax NOL carryforward of approximately $49,000,000 which expires in 1999 through 2019, investment tax credit carryforward of approximately $809,000 which expires in 1999 through 2002, statutory depletion carryforward of approximately $2,400,000 which does not have an expiration date, and a net capital loss carryforward of approximately $6,300,000 which expires in 2000. Approximately $8,000,000 of the net operating loss carryforward has been acquired with the purchase of subsidiaries and must be used to offset future income from profitable operations within those subsidiaries.
The following is a reconciliation of the reported amount of income tax expense for the years ended December 31, 1997 and December 31, 1998 to the amount of income tax expense that would result from applying domestic federal statutory tax rates to pretax income:
At December 31, 1996, total deferred tax liabilities, relating primarily to property and equipment, decreased to approximately $3,216,000 while total deferred tax assets, primarily related to the net operating loss carryforward, increased to approximately $23,136,000. The resulting increase in net deferred tax assets was offset by a corresponding increase in the valuation allowance to approximately $19,920,000 at December 31, 1996, resulting in no impact to Harken's results of operations.
Total deferred tax liabilities, relating primarily to property and equipment as of December 31, 1997, were approximately $680,000. Total deferred tax assets, primarily related to the net operating loss carryforward, were approximately $20,538,000 at December 31, 1997. The total net deferred tax asset is offset by a valuation allowance of approximately $19,858,000 at December 31, 1997, resulting in no impact to Harken's results of operations.
Total deferred tax liabilities, relating primarily to property and equipment as of December 31, 1998, were approximately $753,000. Total deferred tax assets, primarily related to the net operating loss carryforward, were approximately $20,538,000 at December 31, 1998. The total net deferred tax asset is offset by a valuation allowance of approximately $19,785,000 at December 31, 1998, resulting in no impact to Harken's results of operations.
(11) RELATED PARTY TRANSACTIONS
In June 1997, Harken added to its Board of Directors a new director who is also a managing director of EnCap Investments L.C. ("EnCap"). EnCap has historically provided financial consulting and investment banking services to Harken. In connection with the June 1997 placement of the 5 1/2% European Notes, EnCap received as a financial consulting fee, $466,667 in cash, and a warrant to purchase 50,000 shares of Harken common stock at any time after December 11, 1997 and on or before December 11, 1999 at an exercise price of $5.00 per share. As described in Note 6 -- Development Finance and Operating Agreements, in October 1997, Harken entered into a Development Finance Agreement with the EnCap Investors. EnCap serves as the general partner of three of the EnCap Investors and the new Harken director serves as a director of the fourth EnCap Investor. In connection with the EnCap Development Finance Agreement, EnCap received an investment banking fee of $500,000. As described in Note 2 - Acquisitions, in May 1998 Harken acquired the Bargo Properties from St. Martinville Partners, Ltd. and Bargo Energy Company, which are affiliates of EnCap. Harken believes that the above transactions were made at terms at least as favorable to Harken as those that could have been secured with an unrelated party.
During 1997 and 1998, Harken made secured short-term loans to certain members of Harken's Board of Directors and Management. Such notes receivable are reflected in Harken's consolidated balance sheet at December 31, 1997 and December 31, 1998 as Related Party Notes Receivable.
During 1994, an agreement was reached with an officer whereby a certain note receivable from the officer for $520,000, together with accrued interest, was forgiven equally over three installments dated April 1994, July 1995 and December 1996 with each installment of such forgiveness contingent upon the officer's continued employment through the date of each such installment. Harken included an installment of this forgiveness totaling $232,000 per year in general and administrative expense during the year ended December 31, 1996.
(12) OTHER INFORMATION
Quarterly Data -- (Unaudited) -- The following tables summarize selected quarterly financial data for 1997 and 1998 expressed in thousands, except per share amounts:
Significant Customers -- In 1996, two oil purchasers and a gas purchaser represented 27%, 16% and 10%, respectively, of consolidated revenues. In 1997, one oil purchaser represented 15% of consolidated revenues. In 1998, no individual purchaser represented 10% or more of consolidated revenues. Harken has secured and maintains letters of credit with significant purchasers. In addition, management does not feel that the loss of a significant purchaser would significantly impact the operations of Harken due to the availability of other potential purchasers for its oil and gas production.
Operating Segment Information -- Harken divides its operations into two operating segments which are managed and evaluated by Harken as separate operations. Harken's North American operating segment currently relates to Harken's exploration, development, production and acquisition efforts in the United States whereby production cash flows are discovered or acquired, and operate primarily through traditional ownership of mineral interests in the various states in which it operates. Harken's North American production is sold to established purchasers and generally transported through an existing and well-developed pipeline infrastructure. Harken's South American operating segment currently relates to Harken's exploration, development, production and acquisition efforts in Colombia and Costa Rica. South American segment production cash flows are discovered through extensive drilling operations conducted under Association Contract arrangements with the state-owned oil and gas companies/ministries in the respective countries. Harken's South American production is currently sold to local purchasers with anticipated future production levels requiring export marketing operations to purchasers outside of the originating country. Harken's South American operations are heavily capital intensive in the exploration and development phases due to remote well locations and the general need for the construction of Harken's own pipeline connections and production facilities. During the three-year period ended December 31, 1998, none of Harken's South American segment operations related to Costa Rica.
Harken's accounting policies for each of its operating segments are the same as those described in Note 1 Summary of Significant Accounting Policies. There are no intersegment sales or transfers. Revenues and expenses not directly identifiable with either segment, such as certain general and administrative expenses, are allocated by Harken based on various internal and external criteria including an assessment of the relative benefit to each segment.
Harken's financial information for each of its operating segments is as follows for each of the three years in the period ended December 31, 1998:
(13) OIL AND GAS DISCLOSURES
Costs Incurred in Property Acquisition, Exploration and Development Activities:
International costs incurred during 1996, 1997 and 1998 relate to Harken's Colombian operations.
Capitalized Costs Relating to Oil and Gas Producing Activities:
Oil and Gas Reserve Data -- (Unaudited) -- The following information is presented with regard to Harken's proved oil and gas reserves. Such reserve information excludes Harken's share of the future cash flows from the Aneth Gas Plant, which is part of Harken's Four Corners Properties. The reserve values and cash flow amounts reflected in the following reserve disclosures are based on prices received as of year end. During 1996, 1997 and 1998, Harken consummated certain acquisition transactions resulting in additions to its domestic proved oil and gas reserves. (See Note 2 -- Acquisitions for further discussion). As of December 31, 1998, Harken has included no proved reserves related to its Cambulos or Miradores Association Contracts. As Harken identifies proved reserves associated with its Cambulos or Miradores Association Contracts, or identifies proved reserves from additional prospects within its Alcaravan, Bocachico, Bolivar or Los Olmos Association Contracts, such reserves will be added in the year of their discovery. Colombian reserves reflect Harken's net interest after consideration for certain development finance and operating agreements and additionally reflect the net Harken interest assuming full participation by Ecopetrol. If any of Harken's producing fields are considered by Ecopetrol not to be a commercial discovery, Harken's share of such reserves could be increased accordingly. As of December 31, 1998, Harken has not applied to Ecopetrol for a declaration of a commercial discovery relating to any of its proved Colombian reserves. For further discussion of Harken's Colombian operations, see Note 5 -- International Operations. Harken has reflected no reserves related to its Costa Rica operations.
Proved oil and gas reserves are defined as the 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. Reservoirs are considered proved if economic productivity is supported by either actual production or conclusive formation tests. The area of a reservoir considered proved includes that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. Reserves which can be produced economically through application of improved recovery techniques are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based.
The reliability of reserve information is considerably affected by several factors. Reserve information is imprecise due to the inherent uncertainties in, and the limited nature of, the data base upon which the estimating of reserve information is predicated. Moreover, the methods and data used in estimating reserve information are often necessarily indirect or analogical in character rather than direct or deductive. Furthermore, estimating reserve information, by applying generally accepted petroleum engineering and evaluation principles, involves numerous judgements based upon the engineer's educational background, professional training and professional experience. The extent and significance of the judgements to be made are, in themselves, sufficient to render reserve information inherently imprecise.
"Standardized measure" relates to the estimated discounted future net cash flows and major components of that calculation relating to proved reserves at the end of the year in the aggregate and by geographic area, based on year end prices, costs, and statutory tax rates and using a 10% annual discount rate.
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves:
Changes In Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves:
(14) COMMITMENTS AND CONTINGENCIES
Operating Leases -- Harken leases its corporate and certain other office space and certain field operating offices. Total office and operating lease expense during 1996, 1997 and 1998 was $359,000, $551,000, and $1,054,000 respectively. Future minimum rental payments required under all leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1998, net of sublease arrangements, are as follows:
Operational Contingencies -- The exploration, development and production of oil and gas are subject to various Navajo, federal and state laws and regulations designed to protect the environment. Compliance with these regulations is part of Harken's day-to-day operating procedures. Infrequently, accidental discharge of such materials as oil, natural gas or drilling fluids can occur and such accidents can require material expenditures to correct. Harken maintains levels of insurance customary in the industry to limit its financial exposure. Management is unaware of any material capital expenditures required for environmental control during the next fiscal year.
In September 1997, Harken Exploration Company, a wholly-owned subsidiary of Harken, was served with a lawsuit filed in Amarillo, Texas in Federal District Court for the Northern District of Texas styled D. E. Rice and Karen Rice, as Trustees for the Rice Family Living Trust vs. Harken Exploration Company. The Rice Family Living Trust ("Rice") is a surface land owner in Hutchinson County, Texas. Rice has alleged that oil and saltwater spills from Harken Exploration Company's equipment and wells have polluted and otherwise damaged its property. Rice is seeking payment of costs to prevent, minimize and mitigate the alleged oil pollution, costs to restore and repair the land and vegetation, costs to decontaminate the ground and surface water, interest, attorneys' fees, and punitive damages. Furthermore, Rice has requested that Harken Exploration Company be enjoined from producing any oil or gas from its lands. Rice has alleged that remediation of all of the pollution on its land will cost approximately $40,000,000. Harken believes that this lawsuit is wholly without merit. Harken has asserted numerous defenses, all of which Harken believes are meritorious. Harken intends to defend itself vigorously. The lawsuit is expected to go to trial in 1999. In Harken management's opinion, the results of the lawsuit will not have a material adverse effect on Harken's financial position.
Harken has accrued approximately $2,714,000 at December 31, 1998 relating to certain other operational or regulatory liabilities related to Harken's domestic operations. Harken and its subsidiaries currently are involved in various lawsuits and other contingencies, which in management's opinion, will not result in significant loss exposure to Harken.
Year 2000 issues -- Harken is currently working to resolve the potential impact of the Year 2000 on the processing of date-sensitive information by Harken's computer systems. The Year 2000 issue involves circumstances where a computerized system may not properly recognize or process date-sensitive information on or after January 1, 2000. The Year 2000 problem is the result of computer programs being written using two digits, rather than four, to define the applicable year. Any of Harken's programs that have time-sensitive software may recognize a date using "00" as the Year 1900 rather than the Year 2000, which could result in miscalculations or system failures. The problem is not limited to computer systems. Year 2000 issues will also potentially affect every non-information technology system that has an embedded microchip, such as elevators.
Harken began a formal process in 1998 to identify those internal computerized systems that are not Year 2000 compliant, prioritize those business-critical computerized systems that need remediation or replacement, test compliance once the appropriate corrective measures have been implemented, and develop any contingency plans where considered necessary. In addition, Harken is continuing to conduct a survey of purchasers, vendors and customers that Harken believes could have an impact on Harken's material business operations.
Harken's information technology infrastructure consists of desktop Pentium class Intel based PC systems, servers and UNIX based computers and off-the-shelf software packages. The systems are networked via Microsoft and other telecommunications equipment. Harken does not use mini or mainframe computer systems and uses only off-the-shelf software products.
Assessment. Based on Harken's internal review and discussions with third parties regarding the Year 2000 problem, Harken believes that its exposure to potential Year 2000 problems exists in two general areas: technological operations, including non-information technology systems, which are in the sole control of Harken, and technological operations which are dependent in some way on one or more third parties. Failure to achieve high levels of Year 2000 compliance in either area could have a material adverse impact on Harken.
Remediation and Implementation. In the area of technological operations which are under Harken's exclusive control, Harken is currently involved in the identification and remediation of affected technological functions, including non-information technology systems. Harken has completed its assessment of Year 2000 readiness of its internal computerized systems. Harken is in the process of installing upgrades to its off-the-shelf financial and operational software applications, hardware and telecommunications equipment. Harken expects that such remediation procedures will be completed by the second quarter of 1999. Harken is in the identification and assessment phase with respect to its non-information technology systems, which is projected to continue until the third quarter of 1999.
Testing. Harken will begin updating and testing of the newly upgraded systems for Year 2000 compliance, and expects that all testing will be completed by the third quarter of 1999. Upon completion, Harken will be able to identify any internal computer systems that remain non-compliant. At present, it is anticipated that Harken's action plan for addressing Year 2000 problems will be successfully completed in all material respects in advance of January 1, 2000.
Third Parties. Harken has assessed the level of Year 2000 issues associated with its most significant vendors, suppliers, partners and major customers. All of Harken's oil and gas sales revenues are derived from oil and gas production from its domestic and Colombian operations. Harken's domestic operations are dependent upon its various purchasers or pipeline operators who transport oil or gas for its purchasers. In addition, Harken's Colombian operations may also become dependent upon the transportation of oil through outside owned facilities or pipelines. Harken is monitoring progress of its various domestic purchasers and pipelines, as well as potential Colombian outside owned facilities on their activities related to the Year 2000. At this time, Harken expects that field operations will not be interrupted due to improper recognition of the Year 2000 by computerized systems of its various purchasers and pipelines.
Harken also relies on other oil and gas service providers, vendors, and financial institutions in its daily operations. Harken believes it has identified those third-party relationships that could have a material adverse effect on Harken's results of operations and financial position should their computerized systems not be compliant for the Year 2000. Harken continues with its efforts to survey the identified third parties on their readiness for the Year 2000 and establish appropriate alternatives, if needed, where noncompliance may pose a risk to Harken's operations.
Although Harken is making these efforts to ensure that the third parties on which it is heavily reliant are Year 2000 compliant, it cannot predict the likelihood of such compliance occurring nor the direct or indirect
costs to Harken of non-compliance by those third parties or of securing such services from compliant third parties. Harken has no control over these third parties' compliance and cannot give assurances that these third parties' representations to Harkens are accurate. Therefore, there can be no guarantee that Year 2000 problems originating with a third party will not occur and no absolute assurance that third parties will convent their systems in a timely manner. Assuming that such third parties are not or do not become Year 2000 compliant in a timely manner, to the extent Harken is unable to replace the goods, services or customers with alternate sources of supply and demand on a timely and economically equivalent basis, such failure would likely have a material adverse effect on Harken's business and results of operations.
Estimated Costs. The total financial effect that Year 2000 issues will have on Harken cannot be predicted with any certainty at this time. In fact, in spite of all efforts being made to rectify these problems, the success of Harken's efforts will not be known with certainty until the year 2000 actually arrives. Based on its assessment to date, Harken does not believe that the costs to resolve any Year 2000 issues will be material. To date, Harken has spent less than $100,000 on Year 2000 matters and it expects that the total cost, primarily consulting fees and software purchases, will not exceed $200,000.
Contingency Plan. Harken has not completed its implementation and testing of Year 2000 compliant systems. However, a reasonably likely worst case scenario is that Harken or certain of its purchasers or other vendors fail to correct a material Year 2000 problem, which results in an interruption of Harken's transportation and sale of Harken's crude oil and natural gas production sales revenues. Certain interruptions could result in a material adverse effect on Harken's results of operations, cash flows and financial condition. Due to the inherent uncertainties relating to the effect of the Year 2000 on Harken's operations, it is difficult to predict what impact, if any, noncompliance with the Year 2000 issue will have on Harken's results of operations, cash flows and financial condition. Based on the results of the implementation and testing of Harken's Year 2000 affected systems and ongoing assessment of the readiness of its vendors, suppliers, partners and major customers, Harken will develop appropriate contingency plans that address the most reasonably likely worst case scenarios. Harken expects to have such contingency plans in place by the end of the third quarter of 1999. A failure to address Year 2000 issues successfully could have a material adverse effect on Harken's business, financial condition or results of operations.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See "Item 1. Business" above for a discussion of the Executive Officers of Harken. Reference is made to the material under the caption "Election of Directors" in the Registrant's definitive Proxy Statement to be filed on or before April 30, 1999 pursuant to Regulation 14A in connection with its Annual Meeting of Stockholders to be held in June 1999, which is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to the material under the caption "Compensation of Executive Officers" in the Registrant's definitive Proxy Statement to be filed on or before April 30, 1999 pursuant to Regulation 14A in connection with its Annual Meeting of Stockholders to be held in June 1999, which is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Reference is made to the material under the caption "Ownership of Common Stock" in the Registrant's definitive Proxy Statement to be filed on or before April 30, 1999 pursuant to Regulation 14A in connection with its Annual Meeting of Stockholders to be held in June 1999, which is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the material under the caption "Certain Transactions" in the Registrant's definitive Proxy Statement to be filed on or before April 30, 1999 pursuant to Regulation 14A in connection with its Annual Meeting of Stockholders to be held in June 1999, which is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) Financial Statements included in PART II of this report:
(2) The information required by Schedule I is either provided in the related financial statements or in a note thereto, or is not applicable to the Company. The information required by all other Schedules is not applicable to the Company.
(3) Exhibits
3.1 Certificate of Incorporation of Harken Energy Corporation as amended (filed as Exhibit 3.1 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein).
3.2 Amendment to Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 28.8 to the Registration Statement on Form S-1 of Tejas Power Corporation, file No. 33-37141, and incorporated by reference herein).
3.3 Amendment to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3 to Harken's Quarterly Report on Form 10-Q for fiscal quarter ended March 31, 1991, File No. 0-9207, and incorporated by reference herein).
3.4 Amendments to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3 to Harken's Quarterly Report on Form 10-Q for fiscal quarter ended June 30, 1991, File No. 0-9207, and incorporated by reference herein).
3.5 Amendments to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.5 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, File No. 0-9207, and incorporated herein by reference).
3.6 Amendment to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.6 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, File No. 0-9207, and incorporated by reference herein).
3.7 Amendment to the Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.6 to Harken's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1998, File No. 0-9207, and incorporated by reference herein).
3.8 Bylaws of Harken Energy Corporation, as amended (filed as Exhibit 3.2 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein).
4.1 Form of certificate representing shares of Harken common stock, par value $.01 per share (filed as Exhibit 1 to Harken's Registration Statement on Form 8-A, File No. 0-9207, and incorporated by reference herein).
4.2 Certificate of Designations, Powers, Preferences and Rights of Series A Cumulative Convertible Preferred Stock, $1.00 par value, of Harken Energy Corporation (filed as Exhibit 4.1 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 0-9207, and incorporated herein by reference).
4.3 Certificate of Designations, Powers, Preferences and Rights of Series B Cumulative Convertible Preferred Stock, $1.00 par value, of Harken Energy Corporation (filed as Exhibit 4.2 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 0-9207, and incorporated herein by reference).
4.4 Certificate of the Designations, Powers, Preferences and Rights of Series C Cumulative Convertible Preferred Stock, $1.00 par value of Harken Energy Corporation (filed as Exhibit 4.3 to Harken's Annual Report on Form 10-K for fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein).
4.5 Certificate of the Designations of Series D Preferred Stock, $1.00 par value of Harken Energy Corporation (filed as Exhibit 4.3 to Harken's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1995, File No. 0-9207, and incorporated by reference herein).
4.6 Rights Agreement, dated as of April 6, 1998, by and between Harken Energy Corporation And ChaseMellon Shareholder Services L.L.C., as Rights Agent (filed as Exhibit 4 to Harken's Current Report on Form 8-K dated April 7, 1998, file No. 0-9207, and incorporated by reference herein).
4.7 Certificate of Designations of Series E Junior Participating Preferred Stock (filed as Exhibit B to Exhibit 4 to Harken's Current Report on Form 8-K dated April 7, 1998, file No. 0-9207, and incorporated by reference herein).
4.8 Certificate of Designations, Preferences and Rights of Series F Convertible Preferred Stock (filed as Exhibit 4.8 to Harken's Quarterly Report on Form 10-Q for the period ended March 31, 1998, File No. 0-9207, and incorporated by reference herein).
10.1 Seventh Amendment and Restatement of Harken's Amended Stock Option Plan (filed as Exhibit 10.1 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, File No. 0-9207, and incorporated by reference herein).
10.2 Amended and Restated Non-Qualified Incentive Stock Option Plan of Harken adopted by Harken's stockholders on February 18, 1991 (filed as Exhibit 10.2 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, File No. 0-9207, and incorporated by reference herein).
10.3 Form of Advancement Agreement dated September 13, 1990, between Harken and each director of Harken (filed as Exhibit 10.38 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 0-9207, and incorporated by reference herein).
10.4 Operating Agreement between Chuska Energy Corporation and the Navajo Tribe of Indians dated February 18, 1987, and effective July 20, 1987 (filed as Exhibit 10(b) to Chuska Energy Corporation's Form 10 - General Form for Registration of Securities (the "Chuska Form 10"), and incorporated by reference herein).
10.5 Operating Agreement between Chuska Energy Corporation and the Navajo Tribe of Indians dated July 28, 1983, and effective August 26, 1983 and First Addendum thereto (filed as Exhibit 10(a) to Chuska's Form 10, and incorporated by reference herein).
10.6 Association Contract (Cambulos), dated September 17, 1995, and effective as of November 17, 1995, by and between Harken de Colombia, Ltd., and Empresa Colombiana de Petroleos (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995, File No. 0-9207, and incorporated by reference herein).
10.7 Development Finance Agreement, dated October 12, 1995, by and among Harken Energy Corporation, Arbco Associates L.P., Offense Group Associates L.P., Kayne Anderson Nontraditional Investments L.P. and Opportunity Associates L.P. (filed as Exhibit 10.2 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995, File No. 0-9207, and incorporated by reference herein).
10.8 Harken Energy Corporation's 1993 Stock Option and Restricted Stock Plan (filed as Exhibit 4.3 to Harken's Registration Statement on Form S-8, and incorporated by reference herein).
10.9 Harken Energy Corporation's Directors Stock Option Plan (filed as Exhibit 4.3 to Harken's Registration Statement on Form S-8, and incorporated herein by reference).
10.10 Association Contract (Bolivar) by and between Harken de Colombia, Ltd. and Empresa Colombia de Petroleos (filed as Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996, and incorporated herein by reference).
10.11 Harken Energy Corporation 1996 Incentive and Nonstatutory Stock Option Plan (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996, and incorporated herein by reference).
10.12 Association Contract (Alcaravan) dated as of December 13, 1992, but effective as of February 13, 1993, by and between Empresa Colombia de Petroleos (filed as Exhibit 10.1 to Harken's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 0-9207, and incorporated herein by reference).
10.13 Association Contract (Bocachico) dated as of January 1994, but effective as of April 1994, by and between Empresa Colombia de Petroleos (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1994, File No. 0-9207, and incorporated herein by reference).
10.14 Association Contract (Miradores) dated as of December 1997, but effective as of February 1998, by and between Empresa Colombia de Petroleos (filed as Exhibit 10.14 to Harken's Annual Report on Form 10-K for the year ended December 31, 1997, File No. 0-9207, and incorporated herein by reference).
10.15 Development Finance Agreement dated as of October 17, 1997, by and among Harken, Harken Capital Corporation and the other signatories thereto (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997, File No. 0-9207, and incorporated herein by reference).
10.16 Development Finance Agreement dated as of December 24, 1997, by and among Harken and the other signatories thereto (filed as Exhibit 10.16 To Harken's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-9207, and incorporated herein by reference).
10.17 Exchange Agreement dated as of December 24, 1997, by and among Harken, Harken Capital Corporation and the other signatories thereto (filed as Exhibit 10.17 To Harken's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-9207, and incorporated herein by reference).
10.18 Trust Indenture dated June 11, 1997, by and between Harken and Marine Midland Bank plc (filed as Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, File No. 0-9207, and incorporated herein by reference).
10.19 Placing Agreement Dated June 3, 1997, by and among Harken and the other signatories thereto (filed as Exhibit 10.2 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, File No. 0-9207, and incorporated herein by reference).
10.20 Drilling Contract dated as of July 22, 1997, between Harken de Colombia, Ltd., and Parker Drilling Company International Ltd. (filed as Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, File No. 0-9207, and incorporated herein by reference).
10.21 Drilling Contract dated as of May 15, 1997, between Harken de Colombia, Ltd., and Marlin Colombia Drilling Company, Inc. (filed as Exhibit 10.5 to Harken's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997, File No. 0-9207, and incorporated herein by reference).
22 Subsidiaries of Harken.
24 Power of Attorney.
27 Financial Data Schedule.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the 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, in the City of Irving, State of Texas, on March 30, 1999.
HARKEN ENERGY CORPORATION
* ------------------------------------------------------ Mikel D. Faulkner, Chairman of the Board of Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
*Bruce N. Huff, by signing his name hereto, does hereby sign this Annual Report on Form 10-K for the year ended December 31, 1998 on behalf of Harken Energy Corporation and each of the above-named officers and directors of such Company pursuant to powers of attorney, executed on behalf of the Company and each officer and director.
/s/ Bruce N. Huff - ------------------------------ Bruce N. Huff, Attorney-in-Fact