SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934
FILED BY THE REGISTRANT [X]
FILED BY A PARTY OTHER THAN THE REGISTRANT [ ]
CHECK THE APPROPRIATE BOX:
[ ] Preliminary Proxy Statement [ ] Confidential, for Use of
the Commission Only (as
permitted by Rule
14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to
Rule 14a-12
ENERGY PARTNERS, LTD.
(Name of Registrant as Specified in Its Charter)
(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[ ] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and
0-11.
(1) Title of each class of securities to which transaction
applies:
o Energy Partners, Ltd. common stock, par value $.01
per share ("Common Stock");
o Warrants to purchase Common Stock at an exercise
price of $9 per share ("$9 Warrants");
o Warrants to purchase Common Stock at an exercise
price of $11 per share ("$11 Warrants");
o Energy Partners, Ltd. Series D exchangeable
convertible preferred stock ("Series D Preferred
Stock"); and
o Energy Partners, Ltd. 11% senior subordinated notes
due 2009 ("11% Notes").
(2) Aggregate number of securities to which transaction applies:
o 574,931 shares of Common Stock (not including any
shares of Common Stock issuable under the earnout
agreement described herein);
o 1,000,000 $9 Warrants;
o 3,000,000 $11 Warrants;
o $38,370,662.31 in liquidation preference of Series D
Preferred Stock;
o $38,370,662.31 in principal amount of 11% Notes; and
o Up to $50 million in cash or Common Stock issuable
under the earnout agreement described herein.
(3) Per unit price or other underlying value of transaction
computed pursuant to Exchange Act Rule 0-11 (set forth the
amount on which the filing fee is calculated and state how it
was determined):
o Common Stock: $4,656,941 in the aggregate, or $8.10
per share, the average of the high and low prices of
the Common Stock on April 22, 2002 on the New York
Stock Exchange;
o $9 Warrants and $11 Warrants: $2,900,000 in the
aggregate, the combined book value of the $9 Warrants
and $11 Warrants on April 26, 2002;
o Series D Preferred Stock: $34,909,790 in the
aggregate, the book value of the Series D Preferred
Stock on April 26, 2002; and
o 11% Notes: $38,370,662 in the aggregate, the book
value of the 11% Notes on April 26, 2002.
(4) Proposed maximum aggregate value of transaction, including
cash of $5.1 million paid as consideration in the transaction:
o $135,937,393.
(5) Total fee paid:
o $12,506.24.
[X] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange
Act Rule 0-11(a)(2) and identify the filing for which the offsetting
fee was paid previously. Identify the previous filing by registration
statement number, or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
(2) Form, Schedule or Registration Statement No.:
(3) Filing Party:
(4) Date Filed:
[ENERGY PARTNERS, LTD. LOGO]
201 ST. CHARLES AVENUE
SUITE 3400
NEW ORLEANS, LOUISIANA 70170
May 23, 2002
Dear Energy Partners Stockholder:
You are cordially invited to attend a special meeting of stockholders of
Energy Partners, Ltd. to be held on Tuesday, June 25, 2002 at 9:00 A.M., central
daylight saving time, at Energy Partners' principal executive offices at 201 St.
Charles Avenue, Suite 3400, New Orleans, Louisiana 70170. At the special meeting
you will be asked to vote upon a proposal to approve the merger of Hall-Houston
Oil Company with one of our subsidiaries and related transactions. The merger
and related transactions have already been completed and Hall-Houston became our
wholly-owned subsidiary on January 15, 2002.
As part of the acquisition of Hall-Houston, we issued our common stock, two
classes of warrants, a series of our preferred stock and a class of our senior
subordinated notes, and paid cash, in exchange for the outstanding common and
preferred stock and debt, as well as for overriding royalty interests in
specified oil and gas properties owned by some Hall-Houston affiliates. We also
agreed to pay up to $50 million, a minimum of 20% in cash and the remainder at
our option in cash or in shares of our common stock, to holders of earnout
interests in the future, depending on the net present value of proved reserves
above a specified threshold discovered through 2005 with respect to unproved
leases owned, in general, by Hall-Houston at the time of the merger. In total,
we issued 574,931 shares of our common stock, warrants exercisable for 4,000,000
shares of our common stock, $38,370,662.31 in liquidation preference of our
Series D preferred stock and $38,370,662.31 in principal amount of our 11% notes
due 2009 and we paid approximately $5.1 million in cash in connection with the
transactions, exclusive of the assumption of Hall-Houston's working capital
deficit and payments which may be required under the earnout agreement.
The holders of a majority of our common stock casting votes at the special
meeting must vote in favor of the proposal for it to be approved. Stockholders
holding 59.8% of the outstanding shares of our common stock have already agreed
to vote in favor of the proposal. Assuming these stockholders vote as they have
agreed, the necessary vote for approving the proposal is assured.
The merger with Hall-Houston and related transactions have already been
completed. Failure of our stockholders to approve the merger agreement and
related transactions will not have any effect on the validity of the merger. The
only consequence of a lack of stockholder approval is that the warrants issued
in the merger and related transactions will not be exercisable and we must pay
cash for amounts, if any, becoming due under the earnout agreement.
OUR BOARD OF DIRECTORS HAS CAREFULLY REVIEWED AND CONSIDERED THE TERMS OF
THE PROPOSAL AND HAS DETERMINED THAT IT IS IN THE BEST INTERESTS OF ENERGY
PARTNERS AND ITS STOCKHOLDERS. ACCORDINGLY, THE BOARD HAS UNANIMOUSLY APPROVED
THE PROPOSAL AND RECOMMENDS THAT YOU VOTE IN FAVOR OF IT.
A Notice of Special Meeting of Stockholders, Proxy Statement and proxy card
are included with this letter. The matter to be voted on is more fully described
in these documents. Please read them carefully.
Your participation in the special meeting, in person or by proxy, is very
important. Whether or not you plan to attend the special meeting in person, on
behalf of Energy Partners and your fellow stockholders, I urge you to complete,
date, sign and promptly return the enclosed proxy card in the postage-paid
return envelope to ensure that your shares will be represented at the special
meeting.
The board of directors and management look forward to seeing you at the
special meeting.
Sincerely,
/s/ RICHARD A. BACHMANN
RICHARD A. BACHMANN
Chairman, President and
Chief Executive Officer
[ENERGY PARTNERS, LTD. LOGO]
201 ST. CHARLES AVENUE
SUITE 3400
NEW ORLEANS, LOUISIANA 70170
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON JUNE 25, 2002
Notice is hereby given that a special meeting of stockholders of Energy
Partners, Ltd., a Delaware corporation, will be held at Energy Partners'
principal executive offices at 201 St. Charles Avenue, Suite 3400, New Orleans,
Louisiana 70170 on Tuesday, June 25, 2002, at 9:00 A.M., central daylight saving
time, for the following purposes:
(1) To consider and vote upon the merger of a subsidiary of Energy
Partners with Hall-Houston Oil Company, upon the exchange or repayment of
Hall-Houston's outstanding long-term debt and upon the purchase of
overriding royalty interests in specified oil and gas properties owned by
some affiliates of Hall-Houston.
(2) To consider and take action upon any other matter which may
properly come before the meeting and any adjournment or postponement
thereof.
Only stockholders of record at the close of business on May 20, 2002 are
entitled to notice of, and to vote at, the special meeting, or any adjournment
thereof, notwithstanding the transfer of any stock on the books of Energy
Partners after the record date. A list of such stockholders will be open for
examination by any stockholder for any purpose germane to the special meeting
for a period of ten (10) days prior to the meeting at Energy Partners' principal
executive offices at 201 St. Charles Avenue, Suite 3400, New Orleans, Louisiana
70170.
By Order of the Board of Directors,
/s/ JOHN H. PEPER
JOHN H. PEPER
Executive Vice President,
General Counsel and Corporate
Secretary
New Orleans, Louisiana
May 23, 2002
PLEASE FORWARD THE ENCLOSED PROXY CARD TODAY, WHETHER OR NOT YOU EXPECT TO
ATTEND THE SPECIAL MEETING IN PERSON. STOCKHOLDERS WHO ATTEND THE SPECIAL
MEETING MAY REVOKE THEIR PROXIES AND VOTE IN PERSON.
ENERGY PARTNERS, LTD.
201 ST. CHARLES AVENUE
SUITE 3400
NEW ORLEANS, LOUISIANA 70170
PROXY STATEMENT
FOR
SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON JUNE 25, 2002
This proxy statement is furnished to the stockholders of Energy Partners,
Ltd. in connection with the solicitation of proxies by the board of directors of
Energy Partners for use at the special meeting of stockholders of Energy
Partners to be held at its principal executive offices at 201 St. Charles
Avenue, Suite 3400, New Orleans, Louisiana 70170 on Tuesday, June 25, 2002 at
9:00 A.M., central daylight saving time, or at any adjournment or postponement
thereof, for the purposes set forth in the accompanying notice of special
meeting of stockholders.
ABOUT THE SPECIAL MEETING
PURPOSE OF THE SPECIAL MEETING
At the special meeting, holders of our common stock will consider and vote
upon the proposal to approve the merger and related transactions between us and
Hall-Houston and certain Hall-Houston affiliates. The merger and related
transactions were already approved by our board of directors and were completed
on January 15, 2002. We are required to seek shareholder approval for the
transactions by the rules of the New York Stock Exchange because, in the
transactions, the number of shares of common stock issued, together with the
number of shares of common stock underlying the warrants and Series D preferred
stock issued, is more than 20% of the number of shares of common stock
outstanding prior to the transactions. A failure to adopt the proposal will not
affect the validity of the merger or other related transactions in any way. The
only consequence if this proposal is not adopted is that the warrants issued in
the merger will not be exercisable and that we may not issue any common stock,
and must pay cash, for amounts, if any, becoming due under the earnout agreement
described in "Terms of the Merger and Related Transactions -- Other Agreements
Relating to the Merger -- Earnout Agreement."
VOTING PROCEDURES
Stockholders of record at the close of business on May 20, 2002 will be
entitled to vote at the special meeting. On the record date, there were
outstanding and entitled to vote 27,452,854 shares of our common stock. The
holders of a majority of the common stock issued and outstanding and entitled to
vote at the special meeting, present in person or represented by proxy, will
constitute a quorum. The person(s) whom we appoint to act as inspector(s) of
election will treat all common stock represented by a returned, properly
executed proxy as present for purposes of determining the existence of a quorum
at the special meeting. The common stock present at the special meeting, in
person or by proxy, that abstained from voting will be counted as present for
determining the existence of a quorum.
The board of directors is soliciting your proxy on the enclosed proxy card
to provide you with an opportunity to vote on all matters to come before the
special meeting, whether or not you attend in person. If you properly execute
and return the enclosed proxy card, your shares will be voted as you specify. If
you make no specifications, your shares will be voted FOR both proposals, in
accordance with the recommendations of the board. If you submit a proxy card,
you may subsequently revoke it by submitting a revised proxy or a written
revocation at any time before your original proxy is voted. You may also attend
the special meeting in person and vote in person by ballot, which would cancel
any proxy you previously gave.
VOTE REQUIRED; STOCKHOLDERS REPRESENTING MORE THAN A MAJORITY OF OUTSTANDING
STOCK HAVE AGREED TO VOTE FOR THE PROPOSAL
The proposal must be approved by a vote of holders, other than the holders
who received our common stock in the merger and related transactions,
representing a majority of the common stock present in person or represented by
proxy and entitled to vote at the special meeting. If the entities holding the
574,931 shares of common stock received in the transactions related to the
merger do not vote or vote against the proposal, a simple majority of the common
stock is sufficient. If such entities vote in favor, then the required vote is a
simple majority plus the amount voted in favor by such entities. An abstention
is counted as a vote against a matter to be presented at the special meeting. A
broker non-vote will not be counted for determining whether a quorum is present
or the number of votes cast and therefore will not affect the outcome on any
proposal in this proxy statement. A broker "non-vote" occurs when a nominee
holding shares for a beneficial owner does not vote on a particular proposal
because the nominee does not have discretionary voting power with respect to
that item and the broker has not received voting instructions from the
beneficial owner. Holders of 59.8% of our outstanding common stock, including
Richard A. Bachmann, our chairman, president and chief executive officer, have
agreed to vote their shares in favor of the proposal. These stockholders have
sufficient voting power to create a quorum at the special meeting, and, assuming
that they vote their shares at the special meeting as they have agreed, the
necessary votes for the approval of the proposal by our stockholders is assured.
See "Other Matters Relating to the Merger -- Energy Partners Principal
Shareholder Voting Agreement."
PROXY SOLICITATION
The enclosed proxy is being solicited by and on behalf of our board of
directors. The expense of preparing, printing and mailing proxy solicitation
materials will be borne by us. In addition to solicitation of proxies by mail,
certain directors, officers, our representatives and employees may solicit
proxies by telephone and personal interview. Such individuals will not receive
additional compensation from us for solicitation of proxies, but may be
reimbursed by us for reasonable out-of-pocket expenses in connection with such
solicitation. Banks, brokers and other custodians, nominees and fiduciaries also
will be reimbursed by us, as necessary, for their reasonable expenses for
sending proxy solicitation materials to the beneficial owners of our common
stock.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any reports, statements or other information we file at the Securities and
Exchange Commission's Public Reference Rooms at the following locations:
Public Reference Room New York Regional Office Chicago Regional Office
450 Fifth Street, N.W. 233 Broadway Citicorp Center
Room 1024 Woolworth Building 500 West Madison Street
Washington, DC 20549 New York, NY 10279 Suite 1400
Chicago, IL 60661-2511
Please call the Securities and Exchange Commission at 1-800-SEC-0330 for
further information on the operation of the public reference rooms. Our
Securities and Exchange Commission filings are also available to the public from
commercial document retrieval services and can also be found at the web site
maintained by the Securities and Exchange Commission at www.sec.gov.
In addition, our filings can be inspected at the offices of the New York
Stock Exchange.
You can request a free copy of all or any of the documents described in
this proxy statement relating to the merger and related transactions by writing
or calling our corporate secretary at: Energy Partners, Ltd., 201 St. Charles
Avenue, Suite 3400, New Orleans, Louisiana 70170, telephone: (504) 569-1875.
We also maintain a web site at www.eplweb.com which contains information
about us. Our web site and the information contained in it and connected to it
shall not be deemed incorporated by reference into this proxy statement.
ii
TABLE OF CONTENTS
PAGE
----
Questions and Answers About the Proposal.................... 1
Summary..................................................... 2
Comparative Per Share Data.................................. 6
Selected Historical Financial Data of Hall-Houston.......... 7
Selected Historical Financial Data of Energy Partners....... 8
Selected Unaudited Pro Forma Financial Data of Energy
Partners.................................................. 9
Terms of the Merger and Related Transactions................ 10
Other Matters Relating to the Merger........................ 19
Terms of the Energy Partners Securities Issued in the Merger
and Related Transactions.................................. 30
Hall-Houston's Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 34
The Companies............................................... 41
Unaudited Pro Forma Condensed Consolidated Financial
Statements of Energy Partners............................. 42
Audited Consolidated Financial Statements of Hall-Houston
Oil Company and Subsidiaries.............................. F-1
Annex A: Fairness Opinion of Merrill Lynch.................. A-1
iii
QUESTIONS AND ANSWERS ABOUT THE PROPOSAL
Q: WHAT DO I NEED TO DO NOW?
A: We urge you to read this proxy statement carefully and to consider how the
proposal may affect you as a stockholder. This proxy statement and
accompanying annexes, which was mailed to all holders of record as of May 20,
2002, contains important information regarding the transactions, as well as
information about us and Hall-Houston. You may also want to review the
documents referenced under "Where You Can Find More Information" on page ii.
For information about where to call to get answers to questions, see "What if
I have questions?" below.
Q: ON WHAT AM I VOTING?
A: You are being asked to approve the merger and related transactions, which
include the acquisition of Hall-Houston and the purchase of overriding
royalty interests in specified oil and gas properties owned by some
Hall-Houston affiliates.
Q: WHAT HAPPENS IF THE PROPOSAL FAILS?
A: The merger and related transactions were completed on January 15, 2002. If
the proposal fails, the validity of the merger and related transactions will
not be affected in any way. The validity of the common and Series D preferred
stock and the 11% notes issued in the merger will also not be affected. The
only consequence of a failure to approve the proposal is to prevent
exercisability of the warrants issued in the merger and related transactions
and to prohibit us from issuing our common stock in payment of amounts, if
any, becoming due under the earnout agreement described under "Terms of the
Merger and Related Transactions -- Other Agreements Relating to the
Merger -- Earnout Agreement."
Q: HOW DO I VOTE?
A: Just mail your completed, signed and dated proxy card in the enclosed
postage-paid return envelope as soon as possible so that your stock may be
represented at the special stockholders' meeting to vote on the proposal. You
may also attend the special meeting and vote your stock in person. The
special meeting will be held on Tuesday, June 25, 2002 at 9:00 A.M., central
daylight saving time, at our principal executive offices at 201 St. Charles
Avenue, Suite 3400, New Orleans, Louisiana 70170. Even if you plan to attend
the special meeting, we recommend that you complete, sign and date the
enclosed proxy card and return it promptly in the enclosed postage-paid
envelope. Our board of directors unanimously recommends that stockholders
vote in favor of the proposal.
Q: WHEN MUST I VOTE?
A: In order for your vote to be counted, we must receive your proxy at or prior
to the special meeting or you must attend the special meeting.
Q: IF MY SHARES ARE HELD BY MY BROKER, HOW DO I VOTE?
A: You should contact your broker for instructions. Your broker can tell you if
your shares are held in street name and, if they are, how you can instruct
him or her to vote your shares. Your broker may vote your shares only if you
provide instructions on how to vote your shares. Please tell you broker how
to vote your shares.
Q: WHAT IF I HAVE QUESTIONS?
A: If you have questions about the proposal or if you would like additional
copies of this proxy statement or a new proxy card, you should contact our
corporate secretary at: Energy Partners, Ltd., 201 St. Charles Avenue, Suite
3400, New Orleans, Louisiana 70170, telephone: (504) 569-1875.
SUMMARY
This summary highlights material information from this proxy statement
regarding the merger agreement and related transactions. You should read
carefully this entire proxy statement and not only this summary.
YOUR DECISION REGARDING THE MERGER AND RELATED TRANSACTIONS
You are being asked to approve the merger of one of our subsidiaries with
Hall-Houston and related transactions. Our board of directors has already
approved the merger and related transactions and, on January 15, 2002, one of
our subsidiaries was merged with Hall-Houston, whereby Hall-Houston became our
wholly-owned subsidiary. If the proposal fails, the warrants issued in the
merger and related transactions will not be exercisable and we will be
prohibited from issuing our common stock in payment of amounts, if any, becoming
due under the earnout agreement and will be required to make payment of any such
amounts in cash.
THE PARTIES
ENERGY PARTNERS, LTD.
201 St. Charles Avenue
Suite 3400
New Orleans, LA 70170
(504) 569-1875
We are an independent oil and natural gas exploration and production
company concentrated in the shallow to moderate depth waters of the central
region of the Gulf of Mexico Shelf. We have grown through a combination of
multi-year, multi-well drill-to-earn programs and strategic acquisitions. Under
our drill-to-earn programs, we use our personnel and capital to identify and
pursue additional drilling opportunities on properties previously developed by
our drill-to-earn partners and recover our investment through sharing revenue
from the new production we establish. After successful drilling of wells, we
earn an interest in the reserves we find and develop. We generally operate the
properties during the drilling phase of these programs and seek to reduce costs
and improve reservoir recovery efficiencies through our geophysical, technical
and operational expertise.
HALL-HOUSTON OIL COMPANY
700 Louisiana
Suite 2100
Houston, TX 77002
(713) 228-0711
Hall-Houston was a privately owned Houston-based oil and natural gas
exploration and production company which began actively drilling in the shallow
waters of the Gulf of Mexico Shelf in 1985. Since that time, Hall-Houston's
primary focus has been on the acquisition, exploration and development of oil
and natural gas prospects located off the coasts of Louisiana and Texas.
Hall-Houston is now our wholly-owned subsidiary.
2
TERMS OF THE MERGER AND RELATED TRANSACTIONS
(SEE PAGES 10-18)
THE MERGER AGREEMENT (SEE PAGES 10-12)
Hall-Houston common and preferred shareholders received the following
consideration from us:
- Common Stock: Hall-Houston's common shareholders received, in the
aggregate, warrants to purchase 250,000 shares of our common stock at $9
per share and 750,000 shares at $11 per share and $150,000 in cash.
- Redeemable Preferred Stock: Holders of Hall-Houston's redeemable
preferred stock received, in the aggregate, warrants to purchase 375,000
shares of our common stock at $9 per share and 1,125,000 shares at $11
per share, $225,000 in cash and the right to participate in 75% of the
earnout provided for in the earnout agreement described under "Terms of
Merger and Related Transactions -- Other Agreements Relating to the
Merger -- Earnout Agreement."
- 2002 Preferred Stock: Holders of Hall-Houston's 2002 preferred stock
received, in the aggregate, warrants to purchase 125,000 shares of our
common stock at $9 per share and 375,000 shares at $11 per share and the
right to participate in 25% of the earnout provided for in the earnout
agreement described under "Terms of Merger and Related
Transactions -- Other Agreements Relating to the Merger -- Earnout
Agreement."
DEBT EXCHANGE AGREEMENT (SEE PAGES 12-13)
Holders of Hall-Houston's outstanding long-term debt (approximately
$80,200,000 outstanding in the aggregate) received the following from us:
- Holders of approximately $76,800,000 in principal amount of Hall-Houston
debt exchanged their debt pursuant to the debt exchange agreement for our
Series D preferred stock and our 11% notes due 2009, each with
liquidation preference or principal amount, as the case may be, equal to
one-half of the outstanding principal amount of the Hall-Houston debt
exchanged. The holders of the remaining approximately $3,400,000 in
principal amount of Hall-Houston debt elected not to participate in the
debt exchange and their debt was redeemed for cash equal to the principal
amount of the debt.
- All holders of Hall-Houston long-term debt, regardless of whether they
participated in the debt exchange, also received cash from us in payment
of accrued interest on their debt (approximately $2,800,000 in the
aggregate). Holders of classes of debt with "nominal overriding royalty
interests" in Hall-Houston's oil and gas properties also received cash
from us of approximately $1,000,000 in the aggregate in payment of fees
due in connection with the early payment of the relevant Hall-Houston
debt.
AFFILIATE INTEREST PURCHASE AND SALE AGREEMENTS (SEE PAGES 13-17)
Before the merger, some affiliates of Hall-Houston owned "overriding
royalty interests" in oil and gas properties. We purchased substantially all of
these interests in connection with the merger.
- Overriding Royalty Interest Purchase and Sale Agreement. Under this
agreement, holders of overriding royalty interests, which were trusts
holding these overriding royalty interests for the benefit of some of the
classes of Hall-Houston's outstanding and previously retired debt, agreed
to sell these interests to us for 574,931 shares of our common stock and
approximately $1,100,000 in cash.
- Employee Royalty Trust Purchase and Sale and Debt Exchange
Agreement. Under this agreement, Hall-Houston's employee royalty trust,
which pays discretionary bonuses to Hall-Houston's employees, agreed to
sell overriding royalty interests and exchange approximately $5,800,000
in principal of Hall-Houston debt held by it and accrued interest thereon
for warrants to purchase 250,000 shares of our common stock at $9 per
share and 750,000 shares at $11 per share and $250,000 in cash.
3
OTHER AGREEMENTS RELATING TO THE MERGER (SEE PAGES 17-18)
- Earnout Agreement. We are obligated under this agreement to pay anywhere
from zero to $50 million, a minimum of 20% payable in cash and the
remainder payable at our option in cash or in shares of our common stock.
Under the merger agreement, as amended, 75% is to be distributed to
former Hall-Houston redeemable preferred shareholders and 25% is to be
distributed to former Hall-Houston 2002 preferred shareholders. The
amount of the earnout payment we are required to make is dependent on the
net present value of proved reserves above a specified threshold
discovered through 2005 with respect to the unproved leasehold interests
owned, in general, by Hall-Houston at the time of the merger.
- Registration Rights Agreement. Under this agreement, we are obligated to
file with the Securities and Exchange Commission and use reasonable
efforts to keep effective a shelf registration statement covering all of
our common stock issued or issuable in the merger and related
transactions, including common stock issuable upon exercise of the
warrants and conversion of our Series D preferred stock issued in the
merger.
- Hall-Houston Principal Shareholder Agreement. In this agreement, all of
Hall-Houston's senior management and entities controlled by certain of
them and some of its directors and principal shareholders committed to
vote in favor of and tender their Hall-Houston securities in the merger
and related transactions. Some of Hall-Houston's senior management and
entities controlled by certain of them also undertook in this agreement
to indemnify us for breaches of representations, warranties and covenants
in the merger agreement and other documents.
OTHER MATTERS RELATING TO THE MERGER AND RELATED TRANSACTIONS
(SEE PAGES 19-30)
BACKGROUND OF THE MERGER AND RELATED TRANSACTIONS (SEE PAGES 19-21)
Our board of directors carefully reviewed the terms of the merger and
related transactions, including the exchange of Hall-Houston's debt and the
purchase of overriding royalty interests and, based upon its conclusion that the
merger and related transactions are fair to and in the best interests of our
stockholders, unanimously recommends that our stockholders vote in favor of the
proposal.
REASONS FOR THE MERGER AND RELATED TRANSACTIONS (SEE PAGES 21-22)
Our board considered both material factors in favor of, and risks related
to, the merger and related transactions and concluded that the potential
benefits outweighed the risks. The following are some of the material factors
weighing in favor of the merger and related transactions:
- Hall-Houston's inventory of exploratory prospects;
- Hall-Houston's exploration expertise;
- the experience of Hall-Houston's management;
- the concentration of Hall-Houston's reserves in natural gas;
- the location of Hall-Houston's properties and prospects in the Gulf of
Mexico Shelf;
- Hall-Houston's flexibility in structuring the merger and related
transactions; and
- the financial presentations and fairness opinion of Merrill Lynch & Co.
OPINION OF MERRILL LYNCH (SEE PAGES 22-27)
In connection with the merger and related transactions, our board of
directors received a fairness opinion from Merrill Lynch, our financial advisor,
as to the fairness, from a financial point of view, of the merger and related
transactions to our stockholders. In arriving at its opinion, Merrill Lynch
reviewed various financial and
4
business information about us, Hall-Houston, and certain other relevant
companies. Merrill Lynch also conducted discussions with both us and
Hall-Houston and relied on other additional information that it deemed
necessary, including general economic, market and monetary conditions.
ENERGY PARTNERS PRINCIPAL SHAREHOLDER VOTING AGREEMENT (SEE PAGE 27)
Richard A. Bachmann, our chairman, president and chief executive officer,
Energy Income Fund, L.P. and Evercore Capital Partners L.P. and affiliated
entities, collectively owning 59.8% of our outstanding common stock, have agreed
to vote in favor of the merger and related transactions. Assuming that they vote
as they have agreed, approval of the proposal is assured.
INTERESTS OF DIRECTORS AND OFFICERS OF ENERGY PARTNERS AND HALL-HOUSTON IN THE
MERGER AND RELATED TRANSACTIONS (SEE PAGES 28-30)
Under the merger agreement and our liability insurance policies, our
directors and officers will be indemnified if the transactions give rise to
liabilities. We also agreed to pay Evercore Partners L.P., an affiliate of
Evercore Capital Partners L.P. and of two of our directors, a fee for advisory
services in connection with the transactions. Directors and officers of
Hall-Houston have the following interests in the merger and related
transactions:
- Hall-Houston directors, officers, their family members, entities
affiliated with them and trusts controlled by them have received
substantial consideration from us in exchange for Hall-Houston common
stock, redeemable preferred stock, 2002 preferred stock, debt and
overriding royalty interests held by them, either directly or
beneficially.
- Three of Hall-Houston's senior officers continued employment as our
officers and have entered into employment agreements with us.
TERMS OF THE ENERGY PARTNERS SECURITIES ISSUED IN THE MERGER AND RELATED
TRANSACTIONS
(SEE PAGES 30-33)
COMMON STOCK
(SEE PAGE 30)
Holders of our common stock are entitled to one vote per share with respect
to each matter on which common stockholders are entitled to vote and are
entitled to receive dividends as may be declared from time to time, subject to
prior rights of holders of preferred stock. Upon our liquidation, dissolution or
winding up, holders of our common stock are entitled to receive such assets
available for distribution after amounts have been paid or set aside to satisfy
any preferential rights of holders of our preferred stock.
$9 WARRANTS AND $11 WARRANTS
(SEE PAGES 30-31)
The $9 warrants are exercisable at a price of $9 per share and the $11
warrants are exercisable at a price of $11 per share. The warrants are not
exercisable until the later of January 15, 2003 or the date that our
stockholders approve the merger and related transactions. The warrants expire in
2007.
SERIES D EXCHANGEABLE CONVERTIBLE PREFERRED STOCK
(SEE PAGES 31-32)
The Series D preferred stock:
- pays semi-annual dividends at annual rates increasing over time from 7%
to 10%;
- pays dividends in cash from the issue date until December 31, 2005, in
cash or in additional shares of Series D preferred stock (at our option)
after December 31, 2005 and on or before December 31, 2008, and in cash
again from December 31, 2008 forward;
5
- is convertible into our common stock at a conversion price of $8.54 per
share;
- is redeemable at our option beginning in 2005;
- is exchangeable (at our option) for convertible subordinated debt
securities with similar economic terms and a seven year maturity in an
aggregate principal amount equal to the liquidation preference of such
preferred stock; and
- is not mandatorily redeemable.
11% SENIOR SUBORDINATED NOTES DUE 2009
(SEE PAGES 32-33)
The 11% notes:
- pay interest semi-annually at an annual rate of 11%;
- mature in 2009; and
- are subordinated to outstanding debt under our senior credit facility.
COMPARATIVE PER SHARE DATA
The following table sets forth our unaudited historical consolidated per
share data, our audited historical consolidated per share data, our unaudited
pro forma per share data giving effect to the merger with Hall-Houston, as set
forth in our unaudited pro forma condensed consolidated financial statements,
and the audited historical consolidated per share data of Hall-Houston, in each
case as of and for the year ended December 31, 2001 except for the unaudited
historical data which is as of and for the three months ended March 31, 2002.
The data should be read in conjunction with our consolidated financial
statements and accompanying notes thereto contained in our Form 10-K for the
year ended December 31, 2001 and our unaudited consolidated financial statements
and accompanying notes thereto for the three months ended March 31, 2002
contained in our Form 10-Q, both on file with the SEC, our unaudited pro forma
condensed consolidated financial statements and notes thereto and Hall-Houston's
audited consolidated financial statements and notes thereto, both included
elsewhere in this proxy statement. The unaudited pro forma financial data is not
necessarily indicative of the results that would have been achieved had the
transactions been in effect at the beginning of the period presented and should
not be considered indicative of future results.
AS OF AND
AS OF AND FOR THE FOR THE YEAR
THREE MONTHS ENDED
ENDED DECEMBER 31,
MARCH 31, 2002(1) 2001
----------------- ------------
HISTORICAL ENERGY PARTNERS PER SHARE
Earnings (loss)....................................... $(0.24) $ 0.44
Cash dividends........................................ -- --
Book value............................................ $ 7.14 $ 6.12
HISTORICAL HALL-HOUSTON PER SHARE
Loss..................................................................... $ (5.47)
Cash dividends........................................................... --
Book (deficit)........................................................... $(14.07)
UNAUDITED PRO FORMA ENERGY PARTNERS PER SHARE
Loss..................................................................... $ (0.24)
Cash dividends........................................................... --
Book value............................................................... $ 7.50
---------------
(1)Hall-Houston's financial data has been included in Energy Partners'
financial data since January 15, 2002, the date of Energy Partners'
acquisition of Hall-Houston. Accordingly, no pro forma or Hall-Houston
per share data as of and for the three months ended March 31, 2002 has
been set forth.
HALL-HOUSTON DIVIDEND HISTORY
Hall-Houston has never declared or paid any cash dividends on its common
stock.
6
SELECTED HISTORICAL FINANCIAL DATA OF HALL-HOUSTON
The following table sets forth Hall-Houston's selected consolidated
historical financial data as of and for each of the periods indicated, which
were derived from Hall-Houston's audited consolidated financial statements. The
following information should be read in conjunction with "Hall-Houston's
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Hall-Houston's audited consolidated financial statements and
accompanying notes thereto included elsewhere in this proxy statement.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Statement of Operations Data:
Revenue............................... $ 36,011 $ 47,477 $ 27,877 $ 46,461 $ 23,007
-------- -------- -------- -------- --------
Costs and expenses:
Lease operating.................... 8,760 6,023 7,160 9,480 7,826
Exploration expenditures and dry
hole costs....................... 14,283 3,070 11,999 7,721 8,981
Impairment of oil and natural gas
properties....................... 7,312 957 6,224 7,230 8,757
Depreciation, depletion and
amortization..................... 18,064 7,452 6,283 9,030 7,130
General and administrative......... 3,247 4,202 4,423 4,237 3,890
Merger-related costs............... 427 -- -- -- --
Other.............................. 600 825 4,326 665 128
-------- -------- -------- -------- --------
Total costs and expenses......... 52,693 22,529 40,415 38,363 36,712
-------- -------- -------- -------- --------
Income (loss) from operations......... (16,682) 24,948 (12,538) 8,098 (13,705)
-------- -------- -------- -------- --------
Interest income....................... 329 308 294 381 481
Interest expense...................... (9,406) (5,001) (4,054) (2,883) (1,885)
-------- -------- -------- -------- --------
Income (loss) before income taxes..... (25,759) 20,255 (16,298) 5,596 (15,109)
Income tax benefit (expense).......... 10,535 1,742 122 (253) (59)
-------- -------- -------- -------- --------
Net income (loss)..................... $(15,224) $ 21,997 $(16,176) $ 5,343 $(15,168)
======== ======== ======== ======== ========
Net income (loss) available to common
shareholders(1).................... $(17,362) $ 20,084 $(18,426) $ 3,543 $(16,973)
======== ======== ======== ======== ========
Basic earnings (loss) per share....... $ (5.47) $ 6.32 $ (5.80) $ 1.12 $ (5.35)
======== ======== ======== ======== ========
Diluted earnings (loss) per share..... $ (5.47) $ 3.65 $ (5.80) $ 0.89 $ (5.35)
======== ======== ======== ======== ========
AS OF DECEMBER 31,
----------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Balance Sheet Data:
Total assets.......................... $110,540 $ 70,324 $ 64,358 $ 22,110 $ 60,895
Long-term debt, excluding current
maturities......................... 80,156 36,000 48,497 9,591 16,400
Mandatorily redeemable preferred
stock.............................. 18,004 18,004 18,004 18,004 18,004
Stockholders' deficit................. (44,657) (27,295) (29,375) (10,949) (14,492)
---------------
(1) Earnings (loss) available to common shareholders is computed by subtracting
preferred stock dividends for the years ended December 31, 2001, 2000, 1999,
1998, and 1997 of $2.1 million, $1.9 million, $2.3 million, $1.8 million and
$1.8 million, respectively.
7
SELECTED HISTORICAL FINANCIAL DATA OF ENERGY PARTNERS
The following table sets forth our selected historical financial data as of
and for each of the periods indicated. The consolidated statement of operations
data for the period January 29, 1998 (inception) to December 31, 1998 and the
three years ended December 31, 2001 and the consolidated balance sheet data as
of December 31 of each year were derived from our audited consolidated financial
statements. The historical consolidated statement of operations data for the
three-month periods ended March 31, 2002 and 2001 and the consolidated balance
sheet data as of March 31, 2002 were derived from our unaudited consolidated
financial statements. The following information should be read in conjunction
with the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our audited consolidated financial
statements and accompanying notes, in each case, contained in our Form 10-K for
the year ended December 31, 2001 on file with the SEC and the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our unaudited consolidated financial statements and accompanying
notes, in each case, contained in our Form 10-Q for the three months ended March
31, 2002 on file with the SEC.
THREE MONTHS JANUARY 29,
ENDED 1998
MARCH 31, YEAR ENDED DECEMBER 31, (INCEPTION) TO
----------------- ----------------------------- DECEMBER 31,
2002 2001 2001 2000 1999 1998
------- ------- -------- -------- ------- --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Statement of Operations Data:
Revenue.............................. $29,078 $49,930 $145,927 $103,072 $ 9,509 $1,966
------- ------- -------- -------- ------- ------
Costs and expenses:
Lease operating.................... 8,753 8,992 36,269 24,077 1,640 359
Taxes, other than on earnings...... 1,550 1,808 7,190 6,327 -- --
Exploration expenditures and dry
hole costs...................... 2,322 1,368 15,141 1,703 1,570 --
Depreciation, depletion and
amortization.................... 16,383 10,746 46,870 25,595 4,525 1,303
General and administrative(1)...... 7,591 4,704 19,833 54,091 2,609 615
------- ------- -------- -------- ------- ------
Total costs and expenses........ 36,599 27,618 125,303 111,793 10,344 2,277
------- ------- -------- -------- ------- ------
Income (loss) from operations........ (7,521) 22,312 20,624 (8,721) (835) (311)
------- ------- -------- -------- ------- ------
Interest income...................... 22 128 329 596 312 49
Interest expense..................... (1,601) (429) (1,916) (7,438) (2,947) (802)
Gain on sale of oil and natural gas
properties......................... -- 41 39 7,781 -- --
------- ------- -------- -------- ------- ------
Income (loss) before income taxes.... (9,100) 22,052 19,076 (7,782) (3,470) (1,064)
Income taxes......................... 3,286 (8,015) (7,102) (10,902) 1,186 359
------- ------- -------- -------- ------- ------
Net income (loss).................... $(5,814) $14,037 $ 11,974 $(18,684) $(2,284) $ (705)
======= ======= ======== ======== ======= ======
Net income (loss) available to common
stockholders(2).................... $(6,538) $14,037 $ 11,974 $(25,387) $(3,120) $ (705)
======= ======= ======== ======== ======= ======
Basic earnings (loss) per share...... $ (0.24) $ 0.52 $ 0.45 $ (2.27) $ (0.22) $(0.09)
======= ======= ======== ======== ======= ======
Diluted earnings (loss) per share.... $ (0.24) $ 0.52 $ 0.44 $ (2.27) $ (0.22) $(0.09)
======= ======= ======== ======== ======= ======
AS OF AS OF DECEMBER 31,
MARCH 31, ---------------------------------------
2002 2001 2000 1999 1998
--------- -------- -------- ------- -------
Balance Sheet Data:
Total assets................................... $370,542 $242,777 $208,149 $69,276 $40,015
Long-term debt, excluding current maturities... 98,757 25,408 100 10,150 20,000
Redeemable preferred stock..................... -- -- -- 56,475 --
Stockholders' equity........................... 195,432 164,867 150,591 (3,815) (694)
---------------
(1) In 2000, general and administrative expense includes a one time non-cash
stock compensation charge for shares released from escrow to management and
director stockholders of $38.2 million and a non-cash charge of $2.1 million
for bonus shares awarded to employees at the time of the initial public
offering. The after-tax amount of these charges totaled $39.5 million.
Although these charges reduced our net income they increased
paid-in-capital, and thus did not result in a net reduction of total
stockholders' equity.
(2) Earnings (loss) available to common stockholders is computed by subtracting
preferred stock dividends and accretion of issuance costs for the years
ended December 31, 2001, 2000, 1999 and 1998 of $0, $6.7 million, $0.8
million and $0, respectively and by subtracting preferred stock dividends
and accretion of the discount for the three months ended March 31, 2002 and
2001 of $0.7 million and $0, respectively.
8
SELECTED UNAUDITED PRO FORMA FINANCIAL DATA OF ENERGY PARTNERS
The following table sets forth our selected unaudited pro forma financial
data as of and for the year ended December 31, 2001, pro forma for the merger
with Hall-Houston and related transactions. The pro forma adjustments are
described in the notes accompanying our unaudited pro forma condensed
consolidated financial statements included elsewhere in this proxy statement and
are based on preliminary estimates and certain assumptions that management of
the companies believes are reasonable under the circumstances. The unaudited pro
forma condensed consolidated financial information is for comparative purposes
only and does not purport to be indicative of the results which would actually
have been obtained had the merger occurred on January 1, 2001, or of results
which may be obtained in the future. The unaudited pro forma condensed
consolidated financial information in management's opinion reflects all
adjustments necessary to present fairly the data for the period presented. The
following information should be read in conjunction with our unaudited pro forma
condensed consolidated financial statements and accompanying notes and
Hall-Houston's audited consolidated financial statements and accompanying notes,
each included elsewhere in this proxy statement, as well as our audited
consolidated financial statements and accompanying notes contained in our Form
10-K for the year ended December 31, 2001, as filed with the SEC.
PRO FORMA
YEAR ENDED
DECEMBER 31, 2001
-----------------
Statement of Operations Data:
Revenue................................................... $175,481
--------
Costs and expenses:
Lease operating........................................ 43,081
Taxes, other than on earnings.......................... 7,190
Exploration expenditures and dry hole costs............ 29,424
Impairment of oil and natural gas properties........... 7,312
Depreciation, depletion and amortization............... 67,960
General and administrative............................. 26,055
--------
Total costs and expenses.......................... 181,022
--------
Loss from operations...................................... (5,541)
--------
Interest income........................................... 658
Interest expense.......................................... (6,525)
Gain on sale of oil and natural gas properties............ 6,496
--------
Loss before income taxes.................................. (4,912)
Income taxes.............................................. 1,768
--------
Net loss.................................................. $ (3,144)
========
Net loss available to common stockholders................. $ (6,619)
========
Basic loss per share...................................... $ (0.24)
========
Diluted loss per share.................................... $ (0.24)
========
PRO FORMA
AS OF
DECEMBER 31, 2001
------------------
Balance Sheet Data:
Total assets.............................................. $377,893
Long-term debt, excluding current maturities.............. 75,217
Stockholders' equity...................................... 205,853
9
TERMS OF THE MERGER AND RELATED TRANSACTIONS
The following is a summary of the agreements relating to the merger and
related transactions. To request a definitive copy of any of the agreements,
please contact our corporate secretary at: Energy Partners, Ltd., 201 St.
Charles Avenue, Suite 3400, New Orleans, Louisiana 70170, telephone: (504)
569-1875. These agreements are also all exhibits to filings we have made with
the SEC and you may obtain copies of such filings as described in "Where You Can
Find More Information."
MERGER AGREEMENT
GENERAL
On December 16, 2001, we, Hall-Houston and Saints Acquisition Subsidiary,
Inc., our subsidiary newly formed for the purpose of effecting the merger,
entered into the agreement and plan of merger, also referred to as the merger
agreement. On January 15, 2002, Saints Acquisition was merged with and into
Hall-Houston, with Hall-Houston being the surviving corporation. As a result of
the merger, Hall-Houston became our wholly-owned subsidiary.
CONVERSION OF STOCK
At the closing of the merger, all shares of Hall-Houston's outstanding
series A common stock, redeemable preferred stock and 2002 preferred stock were
converted into the merger consideration described below. These were the only
Hall-Houston equity securities outstanding at the time of the merger.
MERGER CONSIDERATION
In the merger, Hall-Houston shareholders received the following
consideration from us:
- Common Stock: Hall-Houston's common shareholders received in the merger,
in the aggregate, warrants to purchase 250,000 shares of our common stock
at $9 per share and 750,000 shares at $11 per share and $150,000 in cash.
- Redeemable Preferred Stock: Holders of Hall-Houston's redeemable
preferred stock received in the merger, in the aggregate, warrants to
purchase 375,000 shares of our common stock at $9 per share and 1,125,000
shares at $11 per share, $225,000 in cash and the right to participate in
75% of the earnout provided for in the earnout agreement described in
"-- Other Agreements Relating to the Merger -- Earnout Agreement." The
holders of redeemable preferred stock relinquished their rights to
receive dividends in arrears and redemption payments in excess of the
consideration received in the merger.
- 2002 Preferred Stock: Holders of Hall-Houston's 2002 preferred stock
received in the merger, in the aggregate, warrants to purchase 125,000
shares of our common stock at $9 per share and 375,000 shares at $11 per
share and the right to participate in 25% of the earnout provided for in
the earnout agreement described in "-- Other Agreements Relating to the
Merger -- Earnout Agreement."
REPRESENTATIONS AND WARRANTIES
The merger agreement contains customary representations from each of
Hall-Houston, Saints Acquisition and us regarding matters related to capacity to
enter into and legality of the transactions. Additionally, Hall-Houston made
representations to us and Saints Acquisition regarding the condition of its
business, including, but not limited to, regarding:
- compliance with laws and agreements;
- accuracy of financial statements;
- lack of changes to business;
- environmental compliance;
10
- outstanding litigation;
- condition of oil and natural gas and other properties;
- disclosure of agreements;
- possession of permits;
- absence of undisclosed liabilities; and
- payments to affiliates.
To the extent that Hall-Houston's representations are materially
inaccurate, we may have an indemnifiable claim against some members of
pre-merger senior management of Hall-Houston, as described under "-- Other
Agreements Relating to the Merger -- Hall-Houston Principal Shareholder
Agreement."
COVENANTS
The merger agreement contains customary covenants regarding, among other
things, cooperation among the parties, delivery of financial and other
information, conduct of Hall-Houston's business before the closing and employee
benefits matters. All of the material obligations under the covenants expired
with the closing of the merger.
CONDITIONS TO THE MERGER
The conditions to the merger were all met and the merger was completed on
January 15, 2002. Some of the conditions to both Hall-Houston's and our
obligation to complete the merger were:
- that the representations and warranties of the other party to the merger
agreement are true and correct as of the date of the merger agreement and
the closing date of the merger;
- that the other party shall have performed or complied with, in all
material respects, all covenants and agreements contemplated by the
merger agreement;
- that requisite consents for the merger and related transactions shall
have been obtained and there shall not have been any injunction
preventing those transactions; and
- that the other party shall not have experienced any changes which,
individually or in the aggregate, could reasonably be expected to have a
material adverse effect on that party.
Our obligations to complete the transactions contemplated by the merger
agreement were subject to the following additional conditions, among others:
- holders of at least 80% of the Hall-Houston long-term debt proposed to be
exchanged pursuant to the debt exchange agreement shall have entered into
that agreement and accepted the consideration provided in that agreement
in exchange for their debt;
- holders of no more than 10% of the Hall-Houston redeemable preferred
stock shall have indicated an intention to exercise appraisal rights
under Texas law instead of accepting the merger consideration;
- each of Gary L. Hall, Bruce R. Sidner and John H. Peper, Hall-Houston's
pre-merger chairman and chief executive officer, vice president,
exploration and senior vice president and general counsel, respectively,
shall have entered into an employment agreement with us on terms
previously agreed to between us and that person;
- we shall have entered into a new or amended credit facility providing for
a borrowing base of at least $100 million on the basis of all the proved
reserves of us and Hall-Houston after giving effect to the merger and
related transactions; and
- each of the other documents described in "Terms of the Merger and Related
Transactions" shall be in full force and effect.
11
The obligation of Hall-Houston to consummate the transactions contemplated
by the merger agreement was subject to the following additional conditions,
among others:
- our stockholder agreement shall have been amended to provide for the
right of specified pre-merger Hall-Houston directors to nominate one
member of our board of directors, as described under "Other Matters
Relating to the Merger -- Interests of Directors and Officers of Energy
Partners and Hall-Houston in the Merger and Related Transactions"; and
- holders of a majority of our common stock shall have executed an
agreement committing themselves to vote in favor of the merger and
related transactions at any meeting of our stockholders.
All of these conditions were satisfied by the closing date.
TERMINATION
The merger agreement could have been terminated:
- by mutual written consent of us, Saints Acquisition and Hall-Houston;
- by us and Saints Acquisition, if all conditions to closing in their favor
were not met by January 31, 2002; or
- by Hall-Houston, if all conditions to closing in its favor were not met
by January 31, 2002.
All of the other transactions related to the merger were conditioned on
consummation of the merger, so termination of the merger agreement would have
terminated all rights and obligations under the other related agreements.
TERMINATION FEE
In anticipation of the merger with Hall-Houston, we purchased an option to
acquire a swap of natural gas prices (called a "swaption," which is a
financially settled transaction which effectively provided us with a fixed price
for natural gas) for approximately $2.4 million. The put swaption provided us
with a financially settled natural gas swap at $2.95 on 30,000 million btu, or
MMbtu, per day of our production for the period of February 2002 through January
2003 and the option to cancel the contract on January 15, 2002. We exercised
this swaption on January 15, 2002. If the merger had not closed, Hall-Houston
would have had to repay us up to one-half of our cost relating to this swaption
(if not exercised), and such agreement was secured by our right to purchase
specified amounts of natural gas production from Hall-Houston.
DEBT EXCHANGE AGREEMENT
By way of the debt exchange agreement, we offered to exchange for the
consideration described below the following series of Hall-Houston long-term
debt (approximately $80.2 million outstanding in the aggregate):
- 2000 12% Senior Exploration and Development Facility Notes due 2004
($30.6 million outstanding principal amount);
- South Timbalier Block 185 12% Senior Secured Term Loan Facility Notes due
2003 (approximately $14.6 million outstanding principal amount);
- East Cameron Block 161 12% Senior Secured Term Loan Facility Notes due
2003 (approximately $13.8 million outstanding principal amount);
- East Cameron Block 263 12% Senior Secured Term Loan Facility Notes due
2004 (approximately $10.9 million outstanding principal amount); and
- West Cameron Block 431 12% Senior Secured Term Loan Facility Notes due
2004 ($10.2 million outstanding principal amount).
This represented substantially all of Hall-Houston's long-term debt.
Holders of approximately $76.7 million of Hall-Houston's long-term debt agreed
to tender their debt pursuant to the debt exchange agreement.
12
DEBT CONSIDERATION
Holders of Hall-Houston long-term debt received the following:
- debtholders who agreed to tender all or a portion of their debt, pursuant
to the debt exchange agreement, received for each $1,000 principal amount
of exchanged debt $500 liquidation preference of our Series D preferred
stock and $500 principal amount of our 11% notes due 2009;
- debtholders who did not agree to tender all of their debt pursuant to the
debt exchange agreement (approximately $3.4 million in principal amount)
had their debt not tendered redeemed by us for cash equal to the
principal amount of the debt;
- all debtholders, regardless of whether they participated in the debt
exchange agreement, received cash in an amount equal to all accrued
interest on the debt securities to the closing date (approximately $2.8
million); and
- all debtholders except the holders of 2000 Senior Exploration and
Development Facility Notes received cash (approximately $1.0 million) in
payment of fees due in conjunction with their "nominal overriding royalty
interests" (holders of 2000 Senior Exploration and Development Facility
Notes had overriding royalty interests held by a trust for their benefit,
which were purchased by us as described under "-- Affiliate Interest
Purchase and Sale Agreements -- Overriding Royalty Interest Purchase and
Sale Agreement").
REPRESENTATIONS AND WARRANTIES
The debt exchange agreement contains customary representations and
warranties from the debtholders regarding such matters as title to the debt
being exchanged and qualification for accepting the securities offered by us in
exchange in a private placement under the federal and state securities laws. We
made the same representations to the debtholders as we made to Hall-Houston in
the merger agreement.
COVENANTS
The debt exchange agreement contains customary covenants.
CONDITIONS TO THE DEBT EXCHANGE
The only condition to closing of the debt exchange was the contemporaneous
closing of the merger.
AFFILIATE INTEREST PURCHASE AND SALE AGREEMENTS
WORKING INTEREST PURCHASE AND SALE AGREEMENT
On January 15, 2002, Mr. Sidner, Wayne P. Hall, Mr. Peper and several
entities controlled by Gary L. Hall agreed to contribute to Hall-Houston working
interests in specified federal offshore oil and gas leases in which Hall-Houston
separately owned a working interest and served as operator. The working
interests were contributed to Hall-Houston in exchange for shares of a class of
newly issued Hall-Houston 2002 preferred stock. Working interests entitle the
owners to a share of oil and natural gas production under the terms of the
relevant leases and obligate the owners thereof to bear a pro rata share of
expenses incurred in discovering, developing, producing and marketing oil or
natural gas. The purchase and sale agreement dated December 16, 2001 originally
provided for direct purchase by us of the working interests from the holders,
and upon amendment of the purchase and sale agreement to provide for the
exchange of the working interests for Hall-Houston 2002 preferred stock, we
assigned all our rights under the purchase and sale agreement to Hall-Houston.
Accordingly, the merger agreement was also amended on January 15, 2002 to
provide for the exchange of Hall-Houston 2002 preferred stock, received for
contributing the working interests to Hall-Houston, for merger consideration. As
a result, in the merger, the holders of this new class of preferred stock
received the consideration described in "-- Merger Agreement -- Merger
Consideration." The purchase and
13
sale agreement contains customary representations, warranties, covenants and
indemnities, including but not limited to, the following:
Representations and warranties by sellers:
- title to the interests being sold;
- capacity to enter into the agreement;
- legality of the transactions subject to the agreement;
- condition of the oil and gas leases;
- liabilities associated with the oil and gas leases; and
- suitability of each seller to acquire the consideration being provided by
the purchaser in a transaction not registered under federal or state
securities laws.
Representations and warranties by us or Hall-Houston:
- capacity to enter into the agreement;
- legality of the transactions subject to the agreement;
- capitalization of the purchaser;
- certain matters associated with the consideration to be provided to the
sellers; and
- financial condition of the purchaser.
Covenants of sellers:
- operation of oil and gas leases prior to closing; and
- incurring of obligations prior to closing.
Indemnity by sellers against:
- breach of the sellers' representations and warranties, other than as to
environmental matters and abandonment and clean-up liabilities; and
- liabilities arising from operation of the oil and gas leases prior to
closing, excluding environmental and abandonment and clean-up
liabilities.
Indemnity by purchaser against:
- breach of the purchaser's representations and warranties;
- liabilities arising from operation of the oil and gas leases following
closing; and
- environmental and abandonment and clean-up liabilities arising from
operation of the oil and gas leases prior to closing.
The individuals and entities party to the working interest purchase
agreement as sellers were all officers of Hall-Houston or entities controlled by
an officer of Hall-Houston and each bore its working interest share of the cost
of establishing oil and/or natural gas production from the relevant oil and gas
leases.
Following the closing under the working interest purchase agreement and the
closing of the merger, our wholly owned subsidiary, Hall-Houston, owns the
working interests and is entitled to the benefits and subject to the obligations
associated with such ownership.
OVERRIDING ROYALTY INTEREST PURCHASE AND SALE AGREEMENT
By way of the purchase and sale agreement dated December 16, 2001, referred
to as the override purchase agreement, the Hall-Houston 1996 Exploration and
Development Facility Overriding Royalty Trust, referred to as the 1996 override
trust, and the Hall-Houston Oil Company 2000 Exploration and Development
14
Facility Overriding Royalty Trust, referred to as the 2000 override trust,
agreed to sell to us interests (overriding royalty interests) in oil and natural
gas production under the terms of certain federal offshore oil and gas leases.
Overriding royalty interests entitle the owners thereof to a share of oil and
natural gas production under the terms of the relevant leases or proceeds from
the sale of such production without obligation to bear any expenses incurred in
discovering, developing, producing or marketing such oil and natural gas. The
aggregate consideration paid and issued by us pursuant to the override purchase
agreement was approximately $1.1 million in cash and 574,931 shares of our
common stock. The agreement contains customary representations, warranties,
covenants and indemnities, including, but not limited to, the following:
Representations and warranties by sellers:
- title to the interests being sold;
- capacity to enter into the agreement;
- legality of the transactions subject to the agreement; and
- suitability of each seller to acquire the consideration being provided by
the purchaser in a transaction not registered under federal or state
securities laws.
Representations and warranties by us:
- capacity to enter into the agreement;
- legality of the transactions subject to the agreement;
- capitalization of the purchaser;
- certain matters associated with the consideration to be provided to the
seller; and
- financial condition of the purchaser.
Covenants of seller:
- actions prior to closing with respect to the interests being sold; and
- obtaining releases of existing encumbrances against interests being sold.
Indemnity by sellers against:
- breach of the seller's representations and warranties; and
- liabilities arising from ownership of the interests being sold prior to
closing.
Indemnity by purchaser against:
- breach of the purchaser's representations and warranties; and
- liabilities arising from ownership of the interests being sold following
closing.
The 1996 override trust is a trust established under Texas law to hold
overriding royalty interests conveyed to it by Hall-Houston pursuant to the Note
Purchase and Sale Agreement dated November 1, 1996 governing the Hall-Houston
credit facility pursuant to which Hall-Houston issued its 1996 12% Senior
Secured Exploration and Development Facility Notes, all of which were repaid in
full in June 2000. The beneficiaries of the 1996 override trust are those
parties formerly holding those notes or their respective successors or assigns.
Gary L. Hall and Wayne P. Hall serve as the trustees of the 1996 override trust.
The 2000 override trust is a trust established under Texas law to hold
overriding royalty interest conveyed to it by Hall-Houston pursuant to the Note
Purchase and Sale Agreement dated September 1, 2000 governing the Hall-Houston
credit facility pursuant to which Hall-Houston issued its 2000 12% Senior
Exploration and Development Facility Notes. The beneficiaries of the 2000
override trust are those parties holding those notes. Gary L. Hall and Wayne P.
Hall serve as the trustees of the 2000 override trust. The holders of those
notes were asked to exchange the notes held by them pursuant to the debt
exchange agreement discussed above.
15
We now own the overriding royalty interests subject to the override
purchase agreement and are entitled to the rights of such ownership. The 1996
override trust and the 2000 override trust have made cash distributions to their
respective beneficiaries and will hold, for the benefit of their respective
beneficiaries, the shares of our common stock received in the sale of the
overriding royalty interests which will be distributed to the respective
beneficiaries at a date that has yet to be determined.
EMPLOYEE ROYALTY TRUST PURCHASE AND SALE AND DEBT EXCHANGE AGREEMENT
By way of the purchase and sale and debt exchange agreement dated December
16, 2001, referred to as the employee royalty trust purchase agreement, the
Hall-Houston Oil Company employee royalty trust, referred to as the employee
royalty trust, agreed to sell to us overriding royalty interests in oil and
natural gas production under the terms of certain federal offshore oil and gas
leases and agreed to exchange three promissory notes payable by Hall-Houston to
the employee royalty trust with an aggregate outstanding principal balance, as
of December 16, 2001, of $5.8 million. The consideration paid and issued by us
pursuant to the employee royalty trust purchase agreement was 750,000 $11
warrants, 250,000 $9 warrants and $250,000 in cash. The agreement contains
customary representations, warranties, covenants and indemnities, including, but
not limited to, the following:
Representations and warranties by seller:
- title to the interests being sold;
- capacity to enter into the agreement;
- legality of the transactions subject to the agreement; and
- suitability of the seller to acquire the consideration provided by the
purchaser in a transaction not registered under federal or state
securities laws.
Representations and warranties by us:
- capacity to enter into the agreement;
- legality of the transactions subject to the agreement;
- capitalization of the purchaser;
- certain matters associated with the consideration to be provided to the
sellers; and
- financial condition of the purchaser.
Covenants of sellers:
- actions prior to closing with respect to the interests being sold; and
- obtaining releases of existing encumbrances against interests being sold.
Indemnity by sellers against:
- breach of the seller's representations and warranties; and
- liabilities arising from ownership of the interests being sold prior to
closing.
Indemnity by purchaser against:
- breach of the purchaser's representations and warranties; and
- liabilities arising from ownership of the interests being sold following
closing.
The employee royalty trust is a trust established under Texas law and its
beneficiaries are those employees of Hall-Houston as may be designated from time
to time in connection with trust distributions. Gary L. Hall and Wayne P. Hall
serve as the trustees of the employee royalty trust. For federal income tax and
financial reporting purposes, the assets, liabilities and results of operations
of the employee royalty trust are consolidated with those of Hall-Houston.
16
We now own the overriding royalty interests subject to the employee royalty
trust purchase agreement and are entitled to the rights of such ownership. The
notes owned by the employee royalty trust have been canceled and the amount
owing thereunder now represents a portion of the equity investment by us in
Hall-Houston. In February 2002, the employee royalty trust distributed the $9
warrants, the $11 warrants and the cash it received in the merger and related
transactions to its beneficiaries, as well as the cash it received as a
beneficiary of the 1996 override trust. Upon receipt of shares of our common
stock held for its benefit by the 1996 override trust, the employee royalty
trust will distribute our common stock, or the proceeds from the sale of our
common stock, to its beneficiaries.
OTHER AGREEMENTS RELATING TO THE MERGER
EARNOUT AGREEMENT
In connection with the closing of the merger, we and Hall-Houston entered
into an earnout agreement. Hall-Houston entered into the earnout agreement for
the benefit of the former holders of its redeemable preferred stock and 2002
preferred stock.
The earnout agreement is intended to allow the earnout participants to
participate in the value, in general, of Hall-Houston's inventory of undrilled
prospects owned as of the closing of the merger once such value is established
through drilling subsequent to the consummation of the merger and through 2005.
We are committed to spend $13 million for the drilling of four identified
Hall-Houston prospects. After satisfying such commitment, further capital
expenditures with respect to the relevant Hall-Houston prospects will be
determined by our investment advisory committee which is now required to include
one of our employees to be designated by Gary L. Hall.
Calculations of the reserves valuation (reserves valuation) under the
earnout agreement are to be made each March 1 (or the first business day
thereafter) of each year commencing in 2003 through 2007 (the earnout
calculation date). Each reserves valuation is to be determined using the earnout
reserves as defined in the earnout agreement during the period from January 1,
2002 through December 31 of the calendar year immediately preceding the
respective earnout calculation date and the pre tax income attributable to such
reserves from January 1, 2002 forward to be estimated by an independent
reservoir engineering firm using, except as otherwise provided in the agreement,
the same criteria and methodology as are used in preparing such reserve
estimates for SEC reporting purposes combined with price and cost escalations as
specified in the earnout agreement. The portion of the earn out reserves
attributable to each well included in the reserves valuation will be discounted
back to January 1 of the year in which the initial capital expenditures for such
well were recorded in our accounting records. The before tax net present value
attributable to each such well will be calculated using mid-year discounting and
a 30% per annum discount rate. All historical revenue and expense information
attributable to such properties through December 31 of the calendar year
preceding the earnout calculation date, as recorded in our accounting records,
will be used in the respective year's reserves valuation.
Earnout payments will be made 10 business days following each earnout
calculation date based on the percentages below, applied only to the amount by
which the before tax net present value on the calculation date exceeds the net
present value discounted at 30%. This amount will then be paid less amounts, if
any, of all prior earnout payments made.
EARNOUT
CALCULATION EARNOUT
DATE PERCENTAGE
------------------------------------------------------------ ----------
March 3, 2003............................................... 20%
March 1, 2004............................................... 30%
March 1, 2005............................................... 35%
March 1, 2006............................................... 40%
March 1, 2007............................................... 50%
17
The potential maximum amount payable to the earnout participants under the
earnout agreement is $50 million in cash or our common stock, at our option,
subject to a minimum of 20% payable in cash (75% of which is allocable to former
Hall-Houston redeemable preferred shareholders and 25% to the former Hall-
Houston 2002 preferred shareholders); however, if there are not sufficient net
proved reserves discovered through 2005, the earnout participants will receive
less than the potential maximum amount and there can be no assurance that the
earnout participants will become entitled to any payments under the earnout
agreement. Any common stock we issue under the earnout agreement will be
registered with the SEC upon issuance. Our obligation to make cash payments
under the earnout agreement is subject to any limitations on such payments
imposed under the terms of our senior credit facility.
REGISTRATION RIGHTS AGREEMENT
On December 16, 2001, we and Hall-Houston entered into a registration
rights agreement for the benefit of holders of registrable securities under such
agreement, which securities are all of our common stock issued or issuable in
the merger and related transactions, including common stock issuable upon
conversion of our Series D preferred stock and upon exercise of the $9 warrants
and the $11 warrants. We have agreed that, as soon as practicable, we will file
and use reasonable efforts to keep effective a shelf registration statement
under the Securities Act covering resales of the registrable securities. We may
delay, suspend or withdraw the registration of the registrable securities for up
to 120 days during any twelve month period if we determine in good faith that
the registration would require us to include disclosure that would reasonably be
expected to have a material impact on the negotiation of any acquisition,
disposition or other material transaction. We are also required to use
reasonable efforts to continue to file reports under the Exchange Act so that
holders of registrable securities may sell in private transactions under Rule
144 under the Securities Act. We have agreed to indemnify each holder who sells
under the shelf registration statement for any liabilities such holder may face
as a consequence of material misstatements or omissions contained in the shelf
registration statement, except where such misstatements or omissions are based
upon information provided by such holder. Our obligation to keep the shelf
registration statement effective terminates on January 15, 2004, or earlier if
we determine all of the registrable securities may be publicly sold by the
holders without the registration statement.
HALL-HOUSTON PRINCIPAL SHAREHOLDER AGREEMENT
On December 16, 2001, we entered into the principal shareholder agreement
with certain of the senior officers of Hall-Houston and entities controlled by
them and some of its directors and substantial security holders. The agreement
committed these persons and entities to accept the consideration being offered
by us for their Hall-Houston common stock, preferred stock, debt securities and
interests in oil and gas properties and otherwise to cooperate in the
consummation of the merger and related transactions. These persons held 95% of
the outstanding Hall-Houston common stock, 69% of the preferred stock and 38% of
the debt subject to the exchange offer. Hall-Houston shareholders approved the
merger, by written consent of the holders party to the principal shareholder
agreement, on December 14, 2001.
The principal shareholder agreement also obligates Gary L. Hall (together
with an entity controlled by him), Wayne P. Hall (together with an entity
controlled by him) and Mr. Sidner, severally and not jointly, to indemnify us
for damages arising out of breaches by Hall-Houston of representations,
warranties and covenants in the merger agreement and arising out of other
matters relating to the merger and other transactions. None of these persons is
obligated to pay any indemnity until our aggregate damages exceed $1 million and
the indemnity for each person or entity is capped at the imputed value of the
merger consideration being paid and issued to that person and entities
controlled by such person, with indemnity claims against the value of the
earnout being paid by withholding future earnout payments. Some indemnifiable
claims are not subject to the cap.
18
OTHER MATTERS RELATING TO THE MERGER
BACKGROUND OF THE MERGER AND RELATED TRANSACTIONS
In May 2001, in view of anticipated market conditions for the sale of
predominantly natural gas interests, Hall-Houston decided to solicit offers from
parties who might be interested in acquiring selected oil and gas interests
owned by it and some of its affiliates through an auction process and retained
RBC/Dain Rauscher Wessels to act as its investment banking advisor.
On June 5, 2001, RBC distributed an informational brochure to prospective
purchasers, including us. On or about that date, a representative of RBC
contacted Richard A. Bachmann, our chairman, president and chief executive
officer, regarding the proposed sale. Mr. Bachmann informed the representative
of RBC that we would only be interested in pursuing a transaction involving the
acquisition of Hall-Houston and the related interests, and not a purchase of
selected assets. Mr. Bachmann and the representative of RBC agreed to set up an
introductory meeting between Hall-Houston and us to consider an acquisition
transaction. On June 12, 2001, we executed a confidentiality agreement with
Hall-Houston and, on June 14, an RBC representative met with Mr. Bachmann in New
Orleans to deliver a confidential information memorandum relating to Hall-
Houston.
Our management and that of Hall-Houston met on June 19, June 25, and July
6, 2001 to describe the respective companies and discuss a possible acquisition
transaction. Among those in attendance for us were Mr. Bachmann, Suzanne V.
Baer, executive vice president and chief financial officer, and our former
general counsel. William O. Hiltz, one of our directors and the senior managing
director of Evercore Capital Partners L.P. and Evercore Partners L.P., was also
in attendance at the July 6 meeting. Hall-Houston executives in attendance
included Gary L. Hall, chairman and chief executive officer, Wayne P. Hall,
president, Bruce R. Sidner, vice president, exploration, John H. Peper, senior
vice president and general counsel, and Bennett A. Thomas, executive vice
president and chief financial officer. Representatives of RBC were also in
attendance. Hall-Houston executives indicated a willingness to continue
discussions regarding an acquisition transaction, but also stated that they
would proceed with the asset sale process.
From June 25, 2001 through the last week of July, Hall-Houston conducted
data room presentations and other due diligence exercises in connection with an
asset sale transaction. During July, our personnel and those of Hall-Houston,
respectively, conducted due diligence regarding the other in connection with an
acquisition transaction. Prior to the commencement of these efforts,
Hall-Houston signed a confidentiality agreement in favor of us and both parties
signed a mutual confidentiality agreement regarding an acquisition transaction.
On July 26, 2001, our board met. At that meeting, Mr. Hiltz presented a
financial analysis setting forth the pro forma effects of an acquisition
transaction with Hall-Houston. Mr. Bachmann indicated to the board that, subject
to their approval that day, we had retained Evercore Partners L.P. to act as a
financial advisor to us in connection with this transaction. He also indicated
that we intended to retain Merrill Lynch to render a fairness opinion on the
transaction if we came to an agreement with Hall-Houston. The board authorized
our management to discuss further an acquisition transaction with Hall-Houston
and to retain Evercore Partners L.P. and Merrill Lynch as financial advisors on
the transaction.
On August 1, 2001, by conference call, our management, including Mr.
Bachmann and Mr. Hiltz, presented a proposed transaction structure and
enterprise value to Hall-Houston management, including Gary L. Hall and Mr.
Peper. On August 2, 2001, by conference call, Hall-Houston management, including
Gary L. Hall, Wayne P. Hall, Mr. Peper, Mr. Sidner and Mr. Thomas, suggested a
higher enterprise value to our management, including Mr. Bachmann and Clinton W.
Coldren, executive vice president and chief operating officer, and Ms. Baer. The
parties discussed the differing enterprise values by telephone at various times
through August 9, 2001, at which time Mr. Bachmann informed Gary L. Hall and Mr.
Peper that the differences in value were too significant and the parties agreed
to terminate discussions. The discrepancy between valuations was caused
primarily by the differing estimates of Hall-Houston's potential oil and gas
reserves as well as differing estimates of future natural gas prices.
19
On August 13, 2001, Wayne P. Hall contacted Ms. Baer and proposed the use
of some kind of contingent payment arrangement based on Hall-Houston's future
additions to proved reserves to help resolve the difference of opinion over
valuation. The parties continued to discuss the possible structures for this
contingent payment and other aspects of the transaction throughout August.
During this period, natural gas futures prices for the near term month remained
extremely volatile, declining from $3.47/MMbtu on August 15 to $2.38/ MMbtu on
August 31.
In mid-August 2001, Hall-Houston stopped the asset sale process and started
investigating other financing and recapitalization alternatives, including the
sale of one or more individual properties, while continuing discussions with us.
On September 7 and 10, 2001, our management and that of Hall-Houston met to
further discuss the transaction structure and valuation, as well as governance,
social, legal, tax, accounting and other structural issues. Those in attendance
for us included Mr. Bachmann, Ms. Baer and our former general counsel. Those in
attendance for Hall-Houston included Gary L. Hall, Wayne P. Hall, Mr. Peper, Mr.
Sidner and Mr. Thomas. Representatives of RBC attended both meetings, and Mr.
Hiltz, other representatives from Evercore Partners L.P., representatives of
Merrill Lynch and the parties' respective outside legal counsel attended the
meeting on September 10, 2001. At these meetings, a term sheet describing the
general structure of the transaction was agreed upon, although many issues,
including purchase price, the amount of cash to be paid and the allocation of
value to the equity and debtholders of Hall-Houston, were not resolved.
On September 17 and 19, 2001, our board of directors met telephonically,
and Mr. Bachmann updated the board on the status of the negotiations with
Hall-Houston. During late September 2001, negotiations continued and our
management started discussing an increase in the commitments under our credit
agreement with our bank group. One of our consultants commenced discussions with
Hall-Houston executives regarding our post-acquisition organizational structure,
including the senior management structure. Volatile natural gas prices continued
to impact the pace and nature of the discussions. By September 26, 2001, the
futures price for natural gas for the near term month had declined to
$1.83/MMbtu.
In the third week of September 2001, a representative of RBC contacted Ms.
Baer and proposed that an investor purchase preferred stock in us to provide
additional cash that we could use as consideration. We had one discussion
regarding such an investment with this investor. Later in September, executives
of Hall-Houston met with this same investor, at which time it proposed making an
investment directly in Hall-Houston. These discussions continued through the end
of October, when the parties mutually agreed not to pursue such an investment.
Volatility continued in the natural gas markets during October. By October
31, the natural gas futures price for the near term month had risen to
$3.29/MMbtu. On November 13 and 16, 2001, Ms. Baer met with Hall-Houston
management, including Gary L. Hall, Mr. Sidner and Mr. Peper, to discuss the
issues still remaining from the September meetings. Further details of the
transaction were discussed on November 20, 2001 between Ms. Baer and Mr. Sidner,
Mr. Peper and Mr. Thomas. During the meetings, the parties agreed that the
consideration for the transaction would consist of cash, common stock, preferred
stock, senior subordinated notes and an earnout based upon the value of future
proved reserve additions on Hall-Houston unproved properties, although the
amounts to be given to the various Hall-Houston common, preferred and
debtholders and the holders of working and overriding royalty interests were not
agreed. The parties instructed their respective legal counsel to begin drafting
transaction documents.
On November 29, 2001, our board of directors met. Our management described
the proposed structure in detail and representatives of Merrill Lynch made a
presentation to the board. The board authorized management to continue
negotiations. Management of both companies continued negotiations
telephonically.
On December 11, 2001, our board of directors met. Representatives of
Merrill Lynch stated that they had analyzed us and Hall-Houston as a combined
company, had reviewed the terms of the proposed transactions, concluded that
they were fair to us and our stockholders, and were prepared to give a written
opinion to that effect. The board approved the terms of the transactions and
authorized our management to execute the transaction documents, subject to the
condition that our banks shall have agreed to a $100 million borrowing
20
base supporting the combined companies' credit facility. To reduce the risk of
natural gas price volatility, the board also considered and approved entering
into the "swaption" described under "Terms of the Merger and Related
Transactions -- Merger Agreement -- Termination Fee."
On December 14, 2001, Hall-Houston's board of directors met and approved
the transactions and authorized Hall-Houston executives to enter into the
transaction documents.
On December 16, 2001, the merger agreement and related documents were
executed and the executive officers and directors of Hall-Houston executed
agreements to vote in favor of the merger and related transactions and exchange
their Hall-Houston debt for the consideration being offered.
Following the signing of the merger agreement, we commenced an offer to the
Hall-Houston debtholders as described under "Terms of the Merger and Related
Transactions -- Debt Exchange Agreement." We also negotiated employment
agreements with Gary L. Hall, Mr. Peper and Mr. Sidner to become executive
officers of our company. In addition, at our request, Hall-Houston agreed with
the holders of the working interests to exchange their working interests, as
described under "Terms of the Merger Agreement and Related
Transactions -- Affiliate Interest Purchase and Sale Agreements-Working Interest
Purchase and Sale Agreement" for shares of Hall-Houston 2002 preferred stock,
which, in turn, would be exchanged for the consideration offered by us.
On January 15, 2002, the merger and related transactions were closed and we
amended our credit facility to provide for a $100 million borrowing base. On
January 17, 2002 Gary L. Hall, Mr. Peper and Mr. Sidner were elected to serve as
our vice chairman; executive vice president, law and business development and
corporate secretary; and executive vice president of exploration, respectively.
REASONS FOR THE MERGER AND RELATED TRANSACTIONS
At a meeting held on December 11, 2001, our board unanimously approved the
merger and related transactions and recommended that our stockholders vote to
approve these transactions.
Our board viewed all of the factors below under "-- Material Factors in
Favor of the Merger and Related Transactions" as favorable to its approval and
recommendation of the transactions. Although our board recognized the matters
considered under "-- Material Risks Related to the Merger and Related
Transactions" in its evaluation of the transactions, it concluded that the
potential benefits outweighed the risks.
MATERIAL FACTORS IN FAVOR OF THE MERGER AND RELATED TRANSACTIONS
Set forth below are the material factors weighing in favor of the merger
and related transactions that our board considered in reaching its decision to
approve them and to recommend that you vote in favor of them:
- Hall-Houston's inventory of exploratory prospects provide a significant
enhancement to our exploration portfolio;
- its exploration expertise complements our exploitation and development
skills;
- the experience of Hall-Houston's management team, particularly Gary L.
Hall, Mr. Sidner and Mr. Peper, and the similarities in culture of our
two organizations;
- the concentration of approximately 97% of Hall-Houston's proved reserves
in natural gas, which diversifies our portfolio predominantly consisting
of crude oil reserves;
- the location of all Hall-Houston's properties and prospects in the Gulf
of Mexico Shelf, where all of our properties and prospects are located,
which reduces our concentration without leaving our core focus area;
21
- Hall-Houston's flexibility in structuring the merger and related
transactions, allowing for a minimum of cash consideration; and
- the financial presentations of Merrill Lynch to our board of directors
and its opinion as to the fairness, from a financial point of view, of
the merger and related transactions to us and our stockholders, described
below under "-- Opinion of Merrill Lynch."
MATERIAL RISKS RELATED TO THE MERGER AND RELATED TRANSACTIONS
Set forth below are the material risks considered by our board in reaching
its decision to approve the merger and related transactions and to recommend
that you vote in favor of them:
- risks in integration of the two companies and management teams;
- financing of the Hall-Houston working capital deficit in addition to the
cash portion of the merger consideration would utilize a substantial
portion of our unused borrowing capacity therefore increasing our
leverage and financial risk;
- interests of the beneficiaries of the earnout agreement, including
present members of our management, might conflict with ours with respect
to future capital allocation, however, this is mitigated by the minimum
return threshold contemplated by the earnout agreement;
- uncertainty that at least 80% of Hall-Houston debtholders and 90% of its
preferred shareholders would voluntarily elect to receive the noncash
consideration offered by us instead of redemption for cash, as required
by the terms of the merger agreement; and
- that the value of Hall-Houston's reserves would fluctuate with natural
gas prices, which we mitigated by purchasing the "swaption" described
under "Terms of the Merger and Related Transactions -- Merger
Agreement -- Termination Fee," in order to hedge price fluctuations on
our natural gas between signing of the merger agreement and closing.
Because of the variety of factors considered in connection with its
evaluation of the merger and related transactions, our board did not find it
practicable to, and it did not, quantify or otherwise assign relative weights to
the specific factors it considered in reaching its determination. Individual
members of our board may have assigned different weights to different factors or
may have considered additional factors not listed above.
While our board did not specifically adopt the conclusions set forth on the
opinion of Merrill Lynch based on its financial analysis of the merger and
related transactions, our board did take into account, and placed reliance on,
the analyses performed, and the opinion rendered, by Merrill Lynch.
Our board weighed both the material factors in favor of and risks relating
to the merger and related transactions and determined that the material factors
in favor outweighed the risks. Consequently, it was our board's judgment that
the merger and related transactions are in the best interests of our
stockholders.
OUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THE MERGER
AND RELATED TRANSACTIONS.
OPINION OF MERRILL LYNCH
We retained Merrill Lynch to act as one of our financial advisors in
connection with the merger of our wholly-owned subsidiary with Hall-Houston and
related transactions. On December 11, 2001, Merrill Lynch rendered its oral
opinion to our board of directors, later confirmed in writing in the Merrill
Lynch fairness opinion, that, as of that date, based upon and subject to the
factors and assumptions set forth in the Merrill Lynch fairness opinion, the
consideration in the merger and related transactions was fair from a financial
point of view to our stockholders.
THE FULL TEXT OF THE MERRILL LYNCH FAIRNESS OPINION, WHICH SETS FORTH THE
ASSUMPTIONS MADE, MATTERS CONSIDERED, AND QUALIFICATIONS AND LIMITATIONS ON THE
REVIEW UNDERTAKEN BY MERRILL LYNCH, IS ATTACHED AS
22
ANNEX A TO THIS PROXY STATEMENT AND IS INCORPORATED IN THIS DOCUMENT BY
REFERENCE. THE SUMMARY OF THE MERRILL LYNCH FAIRNESS OPINION SET FORTH IN THIS
PROXY STATEMENT IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF
THE OPINION. OUR STOCKHOLDERS ARE URGED TO READ THE OPINION IN ITS ENTIRETY. THE
MERRILL LYNCH FAIRNESS OPINION WAS PROVIDED TO OUR BOARD OF DIRECTORS FOR ITS
INFORMATION AND IS DIRECTED ONLY TO THE FAIRNESS TO US FROM A FINANCIAL POINT OF
VIEW OF THE CONSIDERATION IN THE MERGER AND RELATED TRANSACTIONS AND DOES NOT
ADDRESS THE MERITS OF THE UNDERLYING DECISION TO ENGAGE IN THE MERGER AND
RELATED TRANSACTIONS AND DOES NOT CONSTITUTE A RECOMMENDATION TO OUR
STOCKHOLDERS AS TO HOW THE STOCKHOLDERS SHOULD VOTE ON THE APPROVAL OF THE
ISSUANCE OF SHARES IN THE MERGER OR ANY MATTER RELATED TO THE MERGER. MERRILL
LYNCH DID NOT EXPRESS ANY OPINION AS TO THE PRICES AT WHICH OUR COMMON STOCK
WILL TRADE FOLLOWING THE CONSUMMATION OF THE MERGER AND THE RELATED
TRANSACTIONS.
Merrill Lynch has consented to the use of Annex A, containing the Merrill
Lynch fairness opinion, in this proxy statement, and to the references to
Merrill Lynch under the headings "Summary" and "Other Matters Relating to the
Merger" in this proxy statement. In giving its consent, Merrill Lynch does not
admit that it comes within the category of persons whose consent is required
under Section 7 of the Securities Act or the rules and regulations of the
Securities and Exchange Commission promulgated thereunder.
The summary set forth below does not purport to be a complete description
of the analyses underlying the Merrill Lynch fairness opinion or the
presentation made by Merrill Lynch to our board of directors. The preparation of
a fairness opinion is a complex and analytical process involving various
determinations as to the most appropriate and relevant methods of financial
analysis and the application of those methods to the particular circumstances
and, therefore, the opinion is not readily susceptible to partial analysis or
summary description. In arriving at its opinion, Merrill Lynch did not attribute
any particular weight to any analysis or factor considered by it, but rather
made qualitative judgments as to the significance and relevance of each analysis
and factor. Accordingly, Merrill Lynch believes that its analyses must be
considered as a whole and that selecting portions of its analyses, without
considering all of its analyses, would create an incomplete view of the process
underlying the Merrill Lynch fairness opinion.
In performing its analyses, numerous assumptions were made with respect to
industry performance, general business, economic, market and financial
conditions and other matters, many of which are beyond the control of Merrill
Lynch, Hall-Houston or us. Any estimates contained in the analyses performed by
Merrill Lynch are not necessarily indicative of actual values or future results,
which may be significantly more or less favorable than suggested by the
analyses. Additionally, estimates of the value of businesses or capital
securities do not purport to be appraisals or to reflect the prices at which the
businesses or capital securities might actually be sold. Accordingly, the
analyses and estimates are inherently subject to substantial uncertainty. In
addition, the delivery of the Merrill Lynch fairness opinion was among several
factors taken into consideration by our board of directors in making its
determination to approve the merger and related transactions. Consequently, the
Merrill Lynch analyses described below should not be viewed as determinative of
the decision of our board of directors or our management with respect to the
fairness of the consideration in the merger and related transactions or the
value of Hall-Houston.
In arriving at its opinion, Merrill Lynch, among other things:
(1) Reviewed Hall-Houston's audited consolidated financial statements
for the fiscal years ended December 31, 2000 and 1999 and Hall-Houston's
unaudited consolidated financial statements for the ten months ended
October 31, 2001 provided to us by Hall-Houston;
(2) Reviewed certain publicly available business and financial
information relating to us that Merrill Lynch deemed to be relevant;
(3) Reviewed certain information, including financial forecasts,
relating to the business, earnings, cash flow, assets, liabilities and
prospects of Hall-Houston and us furnished to Merrill Lynch by Hall-
Houston and us;
(4) Reviewed the report prepared by Ryder Scott Company, L.P. and
furnished by us in connection with certain proved reserve data of
Hall-Houston as well as information relating to potential future drilling
sites and the probable, possible and potential exploration reserves
therefrom;
23
(5) Conducted discussions with members of senior management and
representatives of Hall-Houston and us concerning the matters described in
clauses 1, 2, 3 and 4 above, as well as the businesses and prospects of
both Hall-Houston and us before and after giving effect to the merger and
related transactions;
(6) Reviewed our results of operations and those of Hall-Houston and
compared them with those of certain companies which Merrill Lynch deemed to
be relevant;
(7) Compared the proposed financial terms of the merger and related
transactions with the financial terms of certain other transactions which
Merrill Lynch deemed to be relevant;
(8) Participated in certain discussions and negotiations among our
representatives, those of Hall-Houston and their and our financial and
legal advisors;
(9) Considered the pro forma effect of the merger and related
transactions on our capitalization ratios and earnings, cash flow and book
value per share;
(10) Reviewed a draft of the merger agreement dated December 16, 2001;
and
(11) Reviewed such other financial studies and analyses and took into
account such other matters as Merrill Lynch deemed necessary, including its
assessment of general economic, market and monetary conditions.
In preparing its opinion, Merrill Lynch assumed and relied on the accuracy
and completeness of all information supplied or otherwise made available to
Merrill Lynch by Hall-Houston and us, discussed with or reviewed by or for
Merrill Lynch, or publicly available. Merrill Lynch did not assume any
responsibility for independently verifying this information or undertake an
independent evaluation or appraisal of any of our assets or liabilities or those
of Hall-Houston nor was Merrill Lynch furnished with any such evaluation or
appraisal. In addition, Merrill Lynch did not assume any obligation to conduct
any physical inspection of our properties or facilities or those of
Hall-Houston. With respect to the production and financial forecast information
furnished to or discussed with Merrill Lynch by Hall-Houston or us, Merrill
Lynch assumed that they were reasonably prepared and reflected the best
currently available estimates and judgment of Hall-Houston's or our management
as to our expected future financial performance or that of Hall-Houston, as the
case may be, and their respective petroleum engineers as to their respective
reserves, their future hydrocarbon production volumes and associated costs.
Merrill Lynch made no independent investigation of any legal matters or
accounting advice given to such parties and their respective boards of
directors, including advice as to the accounting and tax consequences of the
merger and the related transactions. Merrill Lynch also assumed that the terms
and provisions contained in the form of the merger agreement and the ancillary
agreements it reviewed would not differ from the last drafts reviewed by it in
any matter material to its opinion.
Merrill Lynch's opinion is necessarily based upon market, economic and
other conditions as they existed and could be evaluated on, and on the
information made available to Merrill Lynch as of, the date of its opinion.
Merrill Lynch assumed that in the course of obtaining the necessary regulatory
or other consents or approvals (contractual or otherwise) for the merger and
related transactions, no restrictions, including any divestiture requirements or
amendments or modifications, would be imposed that will have a material adverse
effect on the contemplated benefits of the merger and related transactions.
The following is a brief summary of the material analyses performed by
Merrill Lynch in connection with its preparation of the Merrill Lynch fairness
opinion. Some of these summaries of financial analyses include information
presented in tabular format. In order to understand fully the financial analyses
used by Merrill Lynch, the tables must be read together with the text of each
summary. The tables alone do not constitute a complete description of the
financial analyses. Considering the data set forth in the tables without
considering the full narrative description of the financial analyses, including
the methodologies and assumptions underlying the analyses, could create a
misleading or incomplete view of the financial analyses performed by Merrill
Lynch.
24
FINANCIAL AND PRODUCTION FORECASTS
We provided Merrill Lynch with our own and Hall-Houston's forecasted
financial and reserve performance based upon a uniform commodity price scenario.
The price scenario was based on the strip prices of oil and natural gas as of
December 7, 2001. The oil price forecasts were based on the price per barrel, or
Bbl, for West Texas Intermediate crude, and the natural gas price forecasts were
based on NYMEX (Henry Hub, Louisiana delivery) natural gas prices per MMbtu.
Natural gas pricing assumed a standard heating value of one MMbtu per 1,000
cubic feet, or Mcf, of natural gas. We made adjustments to both the crude oil
and natural gas price forecasts to reflect location and quality differentials.
The following table lists the assumed unadjusted crude oil and natural gas
prices we provided to Merrill Lynch.
OIL NATURAL GAS
YEAR ($/BBL) ($/MMBTU)
---- ------- -----------
2002........................................................ $20.38 $2.84
2003........................................................ 21.02 3.19
2004........................................................ 21.04 3.28
2005........................................................ 20.99 3.37
2006........................................................ 20.94 3.46
2007........................................................ 20.94 3.52
Thereafter.................................................. 20.94 3.57
We supplied production forecasts and associated production costs, in
conjunction with Hall-Houston, for proved, probable, possible and exploratory
reserves. Operating expenses and maintenance capital expenditures necessary to
lift and produce the proved, probable and possible reserves estimated in the
reserve reports were based on our estimates. All reserves pre-sold under
volumetric production payments were removed from reserve and production
forecasts.
COMPARABLE COMPANY TRADING ANALYSIS
Merrill Lynch reviewed and compared certain financial and operational
information and ratios of Hall-Houston to corresponding financial and
operational information and ratios for certain publicly traded corporations in
the oil and gas exploration and production industry. The selected companies were
chosen because they are publicly traded companies with financial and operating
characteristics that Merrill Lynch deemed to be similar to those of
Hall-Houston, including, among other things, reserve levels and offshore Gulf of
Mexico focus.
Merrill Lynch calculated various financial ratios for the selected
companies and compared them to those calculated for Hall-Houston. The ratios for
the selected companies were based on publicly available information, including
estimates provided by Merrill Lynch research and other equity research. Merrill
Lynch calculated the following financial ratios as multiples of enterprise value
(defined as market value of common equity plus book value of debt and any
preferred equity or minority interests less unrestricted cash): (i) estimated
2001 EBITDE (defined as earnings before interest, taxes, depreciation,
amortization and exploration expense), (ii) estimated 2002 EBITDE, (iii)
estimated current proved reserves, and (iv) estimated current daily production.
Based upon the comparable company trading analysis performed by Merrill
Lynch, a composite net enterprise value range for Hall-Houston of $89.5 to
$104.4 million was determined.
None of the selected companies are identical to Hall-Houston. Accordingly,
an analysis of these results is not purely mathematical. Rather, it involves
complex considerations and judgments concerning differences in financial and
operating characteristics of the selected companies and other factors that could
affect the public trading value of the comparable companies or company to which
it is being compared.
25
COMPARABLE TRANSACTION ANALYSIS
Merrill Lynch reviewed publicly available information relating to
comparable merger and acquisition transactions in respect to companies with
primarily exploration and production operations. Merrill Lynch particularly
focused on those transactions involving companies with operations based in the
Gulf of Mexico. With respect to Hall-Houston, Merrill Lynch examined multiples
of the consideration paid for the equity and indebtedness assumed in each
transaction to, among other measures, the acquired companies' last twelve months
EBITDE, estimated current level of proved reserves and estimated daily
production.
The comparable transactions in the exploration and production industry that
Merrill Lynch reviewed included mergers and acquisitions involving U.S.
independent exploration and production companies with transaction values in
excess of $100 million from January 2000 through October 2001.
Based upon the comparable transaction analysis performed by Merrill Lynch,
a composite net enterprise value range for Hall-Houston of $89.8 to $102.5
million was determined. The face value of the consideration to be delivered to
Hall-Houston was approximately $93.6 million at the time of the analysis.
None of the selected transactions are identical to our merger with
Hall-Houston. Accordingly, an analysis of the results of the foregoing is not
purely mathematical. Rather, it involves complex considerations and judgments
concerning the differences in our merger with Hall-Houston and the other
selected transactions.
NET ASSET VALUE ANALYSIS
Merrill Lynch also performed a net asset value calculation. Using a
discounted cash flow analysis, Merrill Lynch calculated the present value of the
pre-tax future cash flows that Hall-Houston could be expected to generate from
its existing base of proved reserves and risk-adjusted probable, possible and
exploratory reserves after December 31, 2001 based on our projection. These
pre-tax cash flows were discounted at 10% and at 12%. Merrill Lynch estimated
Hall-Houston's net asset value by adding (i) the risk-adjusted discounted pre-
tax cash flows generated by these reserves as estimated by our management to
(ii) an amount determined by our management for undeveloped acreage.
Additionally, a separate discounted cash flow analysis was performed using an
independent reserve and production report from Ryder Scott Company, L.P. on only
the proved, probable and possible reserves in order to validate the original
analysis.
Each of the separate reserve classes were risked according to guidance from
our management. From these classes, net cash flow was forecast by us through
December 2013 and discounted back to January 2002. This net cash flow includes
the effects of any pre-sold volumes of reserves pursuant to any volumetric
production payments, as well as all taxes, capital expenditures and abandonment
costs associated with the produced reserves.
Based upon the net asset value analysis performed by Merrill Lynch, a
composite net enterprise value range for Hall-Houston of $91.5 to $123.8 million
was determined. The face value of the consideration to be delivered to
Hall-Houston was approximately $93.6 million at the time of the analysis.
MERGER CONSEQUENCES
In addition to analyzing the value of the consideration delivered to
Hall-Houston, as well as the value of Hall-Houston itself, Merrill Lynch
reviewed the financial consequences of the merger and related transactions to
our earnings per share and cash flow per share. The analysis focused on the
absolute increase or decrease of our projected earnings per share and cash flow
per share for the years 2002 and 2003. The stand-alone forecasts for both
companies, as well as any merger related adjustments were provided by our
management. The merger consequences analysis performed by Merrill Lynch
indicated that the merger and related transactions would be accretive to us on
an earning per share and a cash flow per share basis for the years 2002 and
2003.
26
VALUATION OF CONSIDERATION
In connection with the merger and related transactions, Merrill Lynch
performed an analysis of the consideration to be delivered to the holders of
Hall-Houston's securities and affiliated interests of Hall-Houston. The values
obtained by Merrill Lynch's analysis of the consideration are only indicative of
the theoretical value of such consideration should that consideration have been
issued into a liquid market at the time of the analysis. Due to several
considerations, including our equity market capitalization, the size of each of
the components of the consideration and the lack of a credit rating for us by a
nationally recognized credit rating agency, Merrill Lynch did not believe that a
liquid market for any of the securities issued as part of the consideration
existed at the time of the analysis. As is the case with the valuation of
Hall-Houston, Merrill Lynch's view of the value of the proposed consideration is
based upon market, economic and other conditions as they existed and could be
evaluated on, and on the information made available to Merrill Lynch as of the
date of its opinion.
We provided Merrill Lynch with the proposed terms of the consideration to
be delivered to Hall-Houston security holders and holders of affiliate
interests. Based upon those proposed terms, Merrill Lynch's analysis of the
consideration indicated that the value of the consideration was not materially
different from the face value of the securities to be delivered at the time of
the analysis.
MERRILL LYNCH FINANCIAL ADVISOR FEE
Pursuant to an engagement letter dated November 1, 2001, we retained
Merrill Lynch to act as our financial advisor in connection with the merger and
related transactions. Pursuant to the engagement letter, we have agreed to pay
Merrill Lynch a fee of $1,000,000, for services rendered in connection with the
merger and related transactions. We also have agreed to reimburse Merrill Lynch
for the expenses reasonably incurred by it in entering into and performing
services by it in connection with its engagement (including reasonable counsel
fees) and to indemnify Merrill Lynch and its affiliates and their respective
officers, directors, employees, agents and controlling persons against certain
expenses, losses, claims, damages or liabilities in connection with its services
performed in connection with its engagement, including liabilities under federal
securities laws.
We retained Merrill Lynch based upon Merrill Lynch's experience and
expertise. Merrill Lynch is an internationally recognized investment banking and
advisory firm. Merrill Lynch, as part of its investment banking business, is
continuously engaged in the valuation of businesses and securities in connection
with mergers and acquisitions, negotiated underwritings, competitive biddings,
secondary distributions of listed and unlisted securities, private placements
and valuations for corporate and other purposes. Merrill Lynch has in the past
provided financial advisory and/or financing services to us, including lead
managing our initial public offering of common stock in November 2000, and may
continue to do so and has received, and may receive, fees for the rendering of
these services. In the ordinary course of its business, Merrill Lynch and its
affiliates may actively trade our equity securities for their own accounts and
for the accounts of customers and, accordingly, may at any time hold a long or
short position in these securities.
ENERGY PARTNERS PRINCIPAL SHAREHOLDER VOTING AGREEMENT
The principal shareholder voting agreement was entered on January 15, 2002
between Hall-Houston and Mr. Bachmann (holding 9.1% of our common stock),
Evercore Capital Partners L.P. and affiliated entities (holding 33.9%) and
Energy Income Fund, L.P. (holding 16.8%). In this agreement, these stockholders
agreed to vote in favor of the merger and all transactions contemplated by the
merger agreement at any meeting of our stockholders or by written consent. The
agreement contains customary representations and warranties from the
stockholders regarding ownership of our common stock and capacity to enter into
the agreement. The agreement terminates upon approval of the transactions
contemplated by the merger, and would have terminated if the merger agreement
had been terminated.
27
INTERESTS OF DIRECTORS AND OFFICERS OF ENERGY PARTNERS AND HALL-HOUSTON IN THE
MERGER AND RELATED TRANSACTIONS
INTERESTS OF DIRECTORS AND OFFICERS OF ENERGY PARTNERS IN THE MERGER
Evercore Partners L.P., an affiliate of two of our directors and of
Evercore Capital Partners L.P., which, together with its affiliates, owns 33.9%
of our outstanding common stock and has the right under our stockholders
agreement to appoint four of our nine directors, acted as one of our financial
advisors in connection with the merger and related transactions. We have agreed
to pay Evercore Partners L.P. $400,000 for their advisory services after the
closing of the merger and related transactions.
Under our directors and officers liability insurance policy, we will
indemnify our directors and officers for claims arising out of alleged breaches
of fiduciary duty that may have arisen out of their negotiation and approval of
the merger and related transactions. Under the Hall-Houston principal
shareholder agreement described under "Terms of the Merger and Related
Transactions -- Other Agreements Relating to the Merger -- Hall-Houston
Principal Shareholder Agreement," our directors and officers enjoy the same
indemnity we do with regard to Hall-Houston's breaches of representations and
warranties in the merger agreement and related documents.
INTERESTS OF DIRECTORS AND OFFICERS OF HALL-HOUSTON IN THE MERGER
Many of Hall-Houston's directors, officers and affiliates received
consideration in the merger and related transactions in exchange for their
common stock, preferred stock, debt and/or overriding royalty interests. The
table below sets forth the amount and type of consideration received by these
individuals on January 15, 2002 and thereafter as a result of distributions from
the 1996 override trust, 2000 override trust and employee royalty trust and
amounts which remain beneficially owned in such trusts.
LIQUIDATION
SHARES OF PREFERENCE OF
COMMON $11 $9 SERIES D FACE AMOUNT OF EARNOUT
STAKEHOLDER CASH STOCK WARRANTS WARRANTS PREFERRED STOCK 11% NOTES PERCENTAGE
----------- ------------- ---------- ----------- --------- --------------- -------------- ----------
Gary L. Hall(1)............ $ 396,179.79 43,635.60 1,039,304.5 346,435.4 $ 1,742,347.44 $ 1,742,347.44 28.9949%
Chairman and Chief
Executive
Officer
Wayne P. Hall(2)........... $ 82,070.19 10,727.30 258,839.7 86,279.9 $ 153,000.00 $ 153,000.00 7.4073%
President
John H. Peper(3)........... $ 34,101.55 5,034.29 87,534.8 29,178.3 $ 102,000.00 $ 102,000.00 2.7662%
Senior Vice President and
General Counsel
Bennett A. Thomas(4)....... $ 24,453.71 901.14 76,145.0 25,381.3 -- -- 1.1073%
Executive Vice President
and
Chief Financial Officer
Bruce R. Sidner(5)......... $ 77,774.67 7,268.91 233,940.4 77,979.8 $ 196,729.12 $ 196,729.12 5.3769%
Vice President,
Exploration
Paul B. Candies(6)......... $1,581,468.50 158,360.57 445,312.3 148,437.4 $12,301,857.57 $12,301,857.57 29.6873%
Director
W.P. Dillard(7)............ $ 83,040.14 6,367.77 23,620.0 7,873.3 $ 680,393.42 $ 680,393.42 1.5747%
Director
---------------
(1) Includes consideration received by Gary L. Hall jointly with Ollabelle D.
Hall, spouse, by Ollabelle D. Hall, by Preston R. Hall, son, and by various
entities which Gary L. Hall, together with his family in certain instances,
control and includes consideration received by the 2000 and 1996 override
trusts, some of which has been distributed, for the benefit of such persons.
Excludes consideration held for all other persons by the 2000 and 1996
override trusts, of which Gary L. Hall is trustee with shared voting power
of the common stock held by the trusts. Excludes consideration received by
Patrick R. Hall, son, and Wayne
28
P. Hall, Gary L. Hall's brother. Includes consideration received and to be
received from the employee royalty trust in the merger and related
transactions including cash and common stock attributable to the employee
royalty trust as a beneficiary of the 1996 override trust.
(2) Includes consideration received by Valerie A. Hall, spouse, and by Sarah E.
Hall, daughter, along with consideration received for the benefit of Wayne
P. Hall by the Hall-Houston Oil Company 401K Profit Sharing Plan and Trust
and includes consideration received by the 2000 and 1996 override trusts,
some of which has been distributed, for the benefit of such persons.
Excludes consideration held for all other persons by the 2000 and 1996
override trusts, of which Wayne P. Hall is trustee with shared voting power
of the common stock held by the trusts. Excludes consideration received by
Barrett D. Hall, son, and Gary L. Hall, Wayne P. Hall's brother. Includes
consideration received and to be received from the employee royalty trust in
the merger and related transactions including cash and common stock
attributable to the employee royalty trust as a beneficiary of the 1996
override trust.
(3) Includes consideration received for the benefit of Mr. Peper by the
Hall-Houston Oil Company 401K Profit Sharing Plan and Trust. Includes
consideration received by the 2000 and 1996 override trusts, some of which
has been distributed, for the benefit of Mr. Peper. Includes consideration
received and to be received from the employee royalty trust in the merger
and related transactions including cash and common stock attributable to the
employee royalty trust as a beneficiary of the 1996 override trust.
(4) Consists of consideration received for the benefit of Mr. Thomas by the
Hall-Houston Oil Company 401K Profit Sharing Plan and Trust. Includes
consideration received and to be received from the employee royalty trust in
the merger and related transactions including cash and common stock
attributable to the employee royalty trust as a beneficiary of the 1996
override trust.
(5) Includes consideration received by trusts associated with Mr. Sidner's minor
children along with consideration received for the benefit of Mr. Sidner by
the Hall-Houston Oil Company 401K Profit Sharing Plan and Trust. Includes
consideration received, some of which has been distributed, by the 2000 and
1996 override trusts for the benefit of Mr. Sidner and trusts associated
with his minor children. Includes consideration received and to be received
from the employee royalty trust in the merger and related transactions
including cash and common stock attributable to the employee royalty trust
as a beneficiary of the 1996 override trust.
(6) Consists of consideration received by Candies Family Investments, LLC and by
Otto Candies, LLC, both of which Mr. Candies serves as the president.
Includes consideration received, some of which has been distributed, by the
2000 and 1996 override trusts for the benefit of Candies Family Investments,
LLC and Otto Candies, LLC. Excludes consideration received by the 1996
override trust for the benefit of Kevin S. Candies Children's Trust II, Otto
B. Candies Children's Trust and Paul B. Candies Children's Trust.
(7) Includes consideration received, some of which has been distributed, by the
2000 and 1996 override trusts for the benefit of Mr. Dillard.
Upon completion of the merger and related transactions, three officers and
directors of pre-merger Hall-Houston were employed by us, and their present
titles are as follows: Gary L. Hall (vice chairman), Mr. Sidner (executive vice
president of exploration) and Mr. Peper (executive vice president, general
counsel and corporate secretary). Each entered into an employment agreement with
us which expires on January 15, 2005. Under the agreements, Gary L. Hall, Mr.
Sidner and Mr. Peper will receive annual salaries of at least $300,000, $225,000
and $174,000, respectively, and received options to purchase 200,000, 100,000
and 75,000 shares of common stock, respectively, at an exercise price equal to
$7.98 per share, the market price of our common stock on the option grant date.
These options will vest over three years and any unvested options will be
forfeited in the case of termination for cause or voluntary termination by the
executive officer. Each of these persons must exercise each option within 10
years from the date of the agreement or the option will lapse. These executives
may not be involuntarily terminated without cause, except in connection with a
change of control, in which case our compensation obligations under the
agreements would cease after a 90-day notice period. Upon our change of control,
these executive officers' options and other incentive awards as to which there
are no conditions for vesting other than continued employment will become fully
vested and become fully exercisable. In addition, each of these persons is
prohibited from soliciting or otherwise attempting to
29
induce our other employees to discontinue their relationship with us and from
interfering with our third-party contractual relationships for a period ending
two years following his employment with us.
In connection with the merger, we amended our stockholders agreement to
provide that Gary L. Hall, Wayne P. Hall, Mr. Candies, Mr. Dillard, Mr. Sidner
and Mr. Peper shall collectively have the right to nominate one of our nine
directors so long as these persons and their affiliates collectively hold 10% of
our voting securities outstanding or issuable upon the exercise of warrants or
options or upon conversion of convertible stock. That board designee is
currently Gary L. Hall.
TERMS OF THE ENERGY PARTNERS SECURITIES ISSUED
IN THE MERGER AND RELATED TRANSACTIONS
TERMS OF THE COMMON STOCK
Holders of common stock are entitled to one vote per share with respect to
each matter presented to our stockholders on which the holders of common stock
are entitled to vote. Except as may be provided in connection with any preferred
stock in a certificate of designation filed pursuant to the Delaware General
Corporation Law or as may otherwise be required by law or our certificate of
incorporation, the common stock is our only capital stock entitled to vote in
the election of directors and on all other matters presented to our
stockholders; provided that, except as required by law or our certificate of
incorporation, holders of common stock are not entitled to vote on any amendment
to our certificate of incorporation that solely relates to the terms of any
outstanding series of preferred stock or the number of shares of such series and
does not affect the number of authorized shares of preferred stock or the terms
of the common stock if the holders of preferred stock are entitled to vote
thereon. The common stock does not have cumulative voting rights.
Subject to the prior rights of holders of preferred stock, if any, holders
of common stock are entitled to receive dividends as may be lawfully declared
from time to time by our board of directors. Upon our liquidation, dissolution
or winding up, whether voluntary or involuntary, holders of common stock will be
entitled to receive such assets as are available for distribution to our
stockholders after there shall have been paid or set apart for payment the full
amounts necessary to satisfy any preferential or participating rights to which
the holders of each outstanding series of preferred stock are entitled by the
express terms of the series.
TERMS OF THE WARRANTS
UNDERLYING SECURITIES
There are 1,000,000 shares of common stock underlying the $9 warrants and
3,000,000 shares of common stock underlying the $11 warrants.
EXERCISE PERIOD AND PRICE
The $9 warrants and the $11 warrants are exercisable beginning on the later
of (i) the date that the issuance of the common stock underlying the warrant is
approved by our stockholders and (ii) January 15, 2003. The warrants expire on
January 15, 2007. The $9 warrants are exercisable for $9.00 per share and the
$11 warrants are exercisable for $11.00 per share.
ADJUSTMENTS TO CONVERSION PRICE
The conversion price may be adjusted under the following circumstances:
- if we subdivide our outstanding shares of common stock into a larger
number of shares of common stock;
- if we combine our outstanding shares of common stock into a smaller
number of shares of common stock;
30
- if we declare a dividend or make a distribution on the common stock
payable in shares of our capital stock (other than common stock) or
capital stock of any subsidiary or any other assets (other than cash);
and
- if we merge or consolidate into another corporation, or sell, transfer or
otherwise dispose of all or substantially all of our property, assets or
business to another corporation.
TERMS OF THE PREFERRED STOCK
Set forth below is a summary of the terms of our Series D preferred stock.
RANKING
The Series D preferred stock shall in all respects rank senior in right and
priority to our common stock and equal in right and priority to other preferred
stock with respect to the right to receive dividends or other distributions on
our liquidation, dissolution or winding-up.
LIQUIDATION PREFERENCE
In the event of our complete liquidation, dissolution or winding-up,
whether voluntary or involuntary, the holders of shares of Series D preferred
stock shall each be entitled to receive out of our assets legally available for
distribution to our stockholders, before any distribution shall be made to the
holders of our common stock, an amount equal to the liquidation preference value
plus accrued and unpaid dividends to the date of payment. If, upon any
liquidation, dissolution or winding up, our assets, or the proceeds thereof,
shall be insufficient to pay in full the preferential amounts as to which the
Series D preferred stock and any other series of preferred stock would be
entitled, then such assets or the proceeds thereof shall be distributed among
holders of Series D preferred stock and the holders of any other preferred stock
ratably in accordance with the respective amounts that would be payable on such
shares if all amounts payable thereon were paid in full.
DIVIDENDS
Dividends will be paid semiannually in arrears on June 30 and December 31
of each year. The dividend rate will be 7% until December 31, 2004, then 8%
until December 31, 2005, then 9% until December 31, 2006 and 10% thereafter.
Dividends are payable in cash only until December 31, 2005. After such date
until December 31, 2008, dividends may be paid either in cash or additional
shares of Series D preferred stock, at our option, after which dividends must be
paid in cash.
CONVERSION RIGHTS
Provided that full cumulative dividends on the Series D preferred stock
have been or contemporaneously are declared and paid to the date of conversion,
Series D preferred stock shall be convertible, at the option of the record
holder thereof at any time prior to the close of business on the date prior to
the optional redemption date for such share, into the number of shares of fully
paid and nonassessable shares of common stock determined by dividing the
liquidation preference amount by the conversion price in effect at the time of
conversion.
The certificate of designations provides that the conversion price is $8.54
per share, but may be adjusted under the following circumstances:
- if we subdivide our outstanding shares of common stock into a larger
number of shares of common stock, then the conversion price shall be
proportionately decreased;
- if we combine our outstanding shares of common stock into a smaller
number of shares of common stock, then the conversion price shall be
proportionately increased;
- if we declare a dividend or make a distribution on the common stock
payable in shares of our capital stock (other than common stock) or
capital stock of any subsidiary or any other assets (other than cash),
then we will make appropriate adjustments; and
31
- if we merge or consolidate into another corporation, or sell, transfer or
otherwise dispose of all or substantially all of our property, assets or
business to another corporation, then each holder shall have the right to
convert their shares into the kind and amount of shares of stock and
other securities and property receivable upon or deemed to be held
following such transaction by a holder of common stock.
OPTIONAL REDEMPTION
We may, at our option on or after January 15, 2005, redeem shares of Series
D preferred stock, in whole but not in part, at any time, at a redemption price
per share equal to the liquidation preference amount plus accrued and unpaid
dividends to the date of redemption.
VOTING
General Voting Rights. Holders of Series D preferred stock shall not be
entitled to any voting rights except as may be required by Delaware law, other
than voting rights in certain circumstances where we have failed to pay
dividends.
Vote of Series Required. So long as any shares of Series D preferred stock
are outstanding, the affirmative vote of the holders of a majority of the shares
of Series D preferred stock outstanding at the time shall be necessary to
permit, effect or validate:
- the authorization, creation or issuance, or any increase in the
authorized or issued amount, of any class or series of stock senior to
the Series D preferred stock; and
- the amendment, alteration or repeal of any of the provisions of the
restated certificate of incorporation which would adversely affect the
voting powers, designations, preferences, redemption rights, and relative
participating, optional or other rights and the qualifications,
limitations or restrictions of the Series D preferred stock.
EXCHANGE
We may, at our option, on any scheduled dividend payment date, exchange the
Series D preferred stock, in whole but not in part, together with any accrued
and unpaid dividends, for a principal amount of debt securities maturing on
January 15, 2009 with similar terms to the Series D preferred stock equal to the
liquidation preference amount of the Series D preferred stock; provided that on
the date of such exchange there is no contractual impediment to such exchange.
TERMS OF THE 11% SENIOR SUBORDINATED NOTES DUE 2009
Set forth below is a summary of the terms of our 11% notes.
MATURITY AND INTEREST
The 11% notes mature on January 15, 2009 at face value plus any accrued and
unpaid interest and bear interest at an annual rate of 11%, payable semiannually
on January 15 and July 15 of each year.
RANKING
The 11% notes rank equally with all of our other debt, except they are
expressly subordinated to our senior credit facility and are subordinated to our
secured debt to the extent of the security therefor. We are prohibited from
incurring any debt which is expressly senior to the 11% notes but junior to our
senior credit facility.
PREPAYMENTS
The 11% notes are prepayable at any time, at our option. Additionally, if
we complete a public or Rule 144A offering of debt securities, to the extent
permitted by our senior credit facility, we must use all net proceeds to prepay
the 11% notes. All prepayments are at face value plus any accrued interest.
32
EVENTS OF DEFAULT
The following are events of default with respect to the 11% notes:
- nonpayment of principal when due;
- nonpayment of interest when due that is not cured after 15 days;
- any other breach of any covenant or condition of the notes that has not
been cured within 30 days of notice by holders of at least 25% of the 11%
notes then outstanding;
- the entering of an involuntary bankruptcy decree which has not been
stayed within 60 days; and
- the commencement of a voluntary bankruptcy.
Upon the occurrence of any event of default, holders of 25% of the 11%
notes may accelerate and declare all amounts outstanding under the 11% notes due
and payable.
33
HALL-HOUSTON'S MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion is intended to assist in an understanding of
Hall-Houston's historical consolidated financial position and results of
operations for each year in the three-year period ended December 31, 2001.
Hall-Houston's historical consolidated financial statements and notes thereto
included elsewhere in this proxy statement contain detailed information that
should be referred to in conjunction with the following discussion. The
following discussion includes forward-looking statements that reflect
Hall-Houston's plans, estimates and beliefs. Hall-Houston's actual results could
differ materially from those discussed in these forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed below and elsewhere in this proxy statement.
OVERVIEW
Hall-Houston was a privately owned Houston-based oil and natural gas
exploration and production company that was incorporated in 1983 and began
actively drilling in the shallow to moderate depth waters of the Gulf of Mexico
in 1985. Since that time, Hall-Houston's primary focus has been the acquisition,
exploration, exploitation and development of oil and natural gas prospects and
fields off the coasts of Louisiana and Texas which Hall-Houston believes is a
well established oil and natural gas producing basin with a substantial history
of exploration and development activity. As of December 31, 2001, Hall-Houston
had estimated proved reserves of approximately 54.9 Bcf of natural gas and 297
Mbbls of oil, or an aggregate of approximately 56.7 Bcfe, with a present value
of estimated pre-tax future cash flows of $79.3 million (based upon year-end
2001 prices and a discount rate of 10%).
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001
Revenues. Revenues decreased $11.5 million to $36.0 million in 2001.
- Oil and Natural Gas Revenues. Hall-Houston's oil and natural gas
revenues increased $8.6 million to $27.9 million in 2001. Natural gas
revenues increased $9.3 million to $27.0 million in 2001. Higher natural
gas production volumes associated with East Cameron Blocks 161 and 263
and High Island Block A-327 accounted for $9.1 million of the increase
coupled with a $0.2 million increase associated with increased average
natural gas prices. Oil revenues decreased $0.7 million to $0.9 million
in 2001. Lower oil production volumes associated with High Island Block
A-442 (which was sold during 2000) accounted for $0.6 million of the
decrease coupled with a $0.1 million decrease associated with decreased
average oil prices. The vast majority of oil production in 2001 was
derived from associated condensate from natural gas production.
- Gain on Sale of Oil and Natural Gas Properties. Gain on sale of oil and
natural gas properties decreased $21.3 million to $6.5 million in 2001.
One property, East Cameron Block 76, was sold in 2001 resulting in a gain
of $6.3 million compared with the sale of four properties in 2000.
Adjustments to prior year sales resulted in a gain of $0.2 million.
- Other Income. Other income increased $1.2 million to $1.7 million in
2001. Other income of $1.6 million was recognized in 2001 associated with
the cash settlement of natural gas put option contracts. There were no
such transactions in 2000. Sales of purchased gas decreased $0.4 million
to less than $0.1 million in 2001.
Lease Operating Expense. Lease operating expense increased $2.7 million to
$8.8 million in 2001. Increased operating costs resulted from increased natural
gas production along with costs attributable to an unsuccessful workover on the
South Timbalier Block 185 C-1 well.
34
Exploration Expenditures and Dry Hole Costs. Exploration expenditures and
dry hole costs increased $11.2 million to $14.3 million in 2001. Dry hole costs
of $12.1 million were recognized in 2001, which included $6.7 million associated
with High Island Block A-288 and $5.7 million associated with Vermilion Block
348. Seismic, geological and geophysical expenditures of $2.2 million were
expensed in 2001.
Impairment of Oil and Natural Gas Properties. Impairment increased $6.4
million to $7.3 million in 2001. Impairments recognized in 2001 included $0.2
million associated with an unproved leasehold interest in East Cameron Block 246
and $7.1 million associated with East Cameron Block 196 and West Cameron Blocks
149 and 427 as the carrying value of these properties exceeded their estimated
discounted future net cash flows.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization (DD&A) increased $10.6 million to $18.1 million in 2001 primarily
due to increased natural gas production and an increase in the depreciable asset
base resulting from exploration and development activities. Included in DD&A is
a $1.5 million provision associated with estimated costs of dismantling and
abandoning offshore oil and natural gas properties in the future.
General and Administrative Expense. General and administrative expense
decreased $1.0 million to $3.2 million in 2001. Contributing to the decrease was
a reduction of $0.3 million in contributions associated with Hall-Houston's
401(k) plan, reductions in professional fees of $0.2 million and an increase of
$0.6 million in the amount of general and administrative expense reimbursed by
working interest owners of properties for which Hall-Houston serves as operator.
Offsetting such reductions was a $0.1 million increase in office expense.
Merger-Related Costs. Merger-related costs of $0.4 million were recognized
in 2001. There were no such costs in 2000.
Other Expense. Other expense decreased $0.2 million to $0.6 million in
2001. Hall-Houston established an allowance for doubtful accounts of $0.4
million in 2001, the majority of which was associated with the sale of natural
gas production to ENA Upstream Company LLC, a subsidiary of Enron Corporation.
ENA Upstream Company LLC filed for bankruptcy protection in January 2002.
Offsetting this increase was a reduction in natural gas purchases of $0.6
million.
Interest Expense. Interest expense increased $4.4 million to $9.4 million
in 2001. Additional borrowings of $51.0 million in 2001 associated with credit
facilities, established in 2001 and 2000, coupled with loans from Hall-Houston's
employee royalty trust resulted in a $7.1 million increase in interest expense.
The increase was offset by a $2.7 million reduction in interest expense
following the June 2000 repayment of credit facilities established in 1999 and
prior. Hall-Houston's average monthly long-term debt outstanding increased to
$66.8 million in 2001 from $35.8 million in 2000 with an average interest rate
of 12% in 2001.
Income Tax Benefit. Income tax benefit increased $8.8 million to $10.5
million in 2001. The increase is associated with the merger of Hall-Houston and
Energy Partners. The merger is subject to an election under IRC Section 338 of
the Internal Revenue Code which treats the sale of Hall-Houston as a sale of its
assets at which time Hall-Houston will recognize a gain and will use the
majority of its net operating losses. Therefore, Hall-Houston recorded a benefit
for a portion of its deferred tax assets.
Net Income. As a result of the conditions noted above, Hall-Houston
recognized a net loss of $15.2 million in 2001 compared to net income of $22.0
million in 2000.
YEAR ENDED DECEMBER 31, 2000
Revenues. Revenues increased $19.6 million to $47.5 million in 2000.
- Oil and Natural Gas Revenues. Hall-Houston's oil and natural gas
revenues increased $9.6 million to $19.3 million in 2000. Natural gas
revenues increased $9.4 million to $17.7 million in 2000. Sharply
increased average natural gas prices accounted for $6.7 million of the
increase coupled with a $2.7 million increase associated with increased
natural gas production volumes from East Cameron Blocks 88, 89 and 160
and South Timbalier Block 185 offset by decreased natural gas production
35
volumes from Vermilion Blocks 320 and 325. Oil revenues increased $0.2
million to $1.6 million in 2000. Increased average oil prices accounted
for $0.6 million of the increase offset by a $0.4 million decrease
resulting from decreased oil production. The vast majority of oil
production in 2000 was derived from associated condensate from natural
gas production.
- Gain on Sale of Oil and Natural Gas Properties. Gain on sale of oil and
natural gas properties increased $10.3 million to $27.7 million in 2000.
A property sale, which included South Pelto Block 17, East Cameron Blocks
88 and 89 and High Island Block A-442, resulted in an aggregate gain of
$27.7 million.
- Other Income. Other income decreased $0.2 million to $0.5 million in
2000. Sales of purchased gas decreased $0.3 million to $0.4 million in
2000. Miscellaneous income increased to $0.1 million in 2000.
Lease Operating Expense. Lease operating expense decreased $1.1 million to
$6.0 million in 2000. The decrease resulted from an increased percentage of
production coming from certain properties that have lower operating costs.
Exploration Expenditures and Dry Hole Costs. Exploration expenditures and
dry hole costs decreased $8.9 million to $3.1 million in 2000. Dry hole costs of
$0.3 million were recognized in 2000. Seismic, geological and geophysical
expenditures of $2.8 million were expensed in 2000.
Impairment of Oil and Natural Gas Properties. Impairment of oil and
natural gas properties decreased $5.3 million to $1.0 million in 2000.
Impairments recognized in 2000 included the leasehold interests in various
onshore properties which were impaired $0.7 million and West Cameron Block 149
which was impaired $0.3 million as the carrying value of the property exceeded
its estimated discounted future net cash flows.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization increased $1.2 million to $7.5 million in 2000 primarily due to
increased natural gas production volumes. This expense includes a provision of
$0.6 million associated with estimated costs of dismantling and abandoning
offshore oil and natural gas properties in the future.
General and Administrative Expense. General and administrative expenses
decreased $0.2 million to $4.2 million in 2000 primarily due to a $0.2 million
decrease in personnel costs.
Other Expense. Other expense decreased $3.5 million to $0.8 million in
2000. During 1999, Hall-Houston reached an out of court settlement with various
parties to a lawsuit and a $3.5 million charge against income was recognized.
There was no such transaction in 2000. Natural gas purchases decreased $0.2
million to $0.7 million in 2000. This decrease was offset by a $0.2 million
increase in miscellaneous expense associated with a nonrecurring credit of $0.2
million recognized in 1999. There was no such item in 2000.
Interest Expense. Interest expense increased $0.9 million to $5.0 million
in 2000. Additional borrowings of $36.0 million during 2000 associated with
Hall-Houston's 2000 Exploration and Development Facility and South Timbalier
Block 185 Facility accounted for $2.1 million of the increase in interest
expense offset by a decrease of $1.0 million following the repayment of
Hall-Houston's 1996 Exploration and Development Facility in June 2000.
Hall-Houston's average monthly long-term debt outstanding increased to $35.8
million in 2000 from $28.1 million in 1999 with an average interest rate of 12%
in 2000.
Net Income. As a result of the conditions noted above, Hall-Houston
recognized net income of $22.0 million in 2000 compared to a net loss of $16.2
million in 1999.
LIQUIDITY AND CAPITAL RESOURCES
Hall-Houston's growth has been financed in part by incurring a significant
amount of debt and entering into prepaid natural gas delivery obligations. These
liabilities and other obligations resulted in a highly leveraged balance sheet.
Hall-Houston's growth has, at times, also resulted in working capital deficits
and short-term liquidity problems. In certain instances, Hall-Houston has from
time to time though a variety of means monetized the reserves it has proved.
Such monetization provided Hall-Houston with working capital
36
and alleviated short-term liquidity problems. Hall-Houston's focus on the
acquisition and drilling of prospects places a significant demand on its
managerial, operational and financial resources.
Hall-Houston had a working capital deficit of $28.6 million as of December
31, 2001 compared to a deficit of $1.8 million as of December 31, 2000. During
2001, Hall-Houston borrowed an additional $51.0 million to fund acquisition,
exploration and development activities and to fund general working capital
requirements. Borrowings in 2001 included $15.0 million under its 2000
Exploration and Development Facility, $15.0 million under its East Cameron Block
161 Facility, $11.0 million under its East Cameron Block 263 Facility and $10.0
million under its West Cameron Block 431 Facility.
Hall-Houston had been in arrears in the payment of cash dividends on its
redeemable preferred stock since July 30, 2001 and as of December 31, 2001
accrued dividends in arrears were $1.7 million. In addition, Hall-Houston was
statutorily unable to redeem one-third of its outstanding redeemable preferred
stock on August 15, 2001 as provided by its terms. These securities were
converted in the merger into the consideration offered by Energy Partners.
Net cash of $64.8 million used in investing activities for the twelve
months ended December 31, 2001 included exploration and development expenditures
of $74.0 million, oil and natural gas property acquisitions of $1.6 million
offset by proceeds from the sale of oil and natural gas properties of $10.8
million. Exploration expenditures incurred are excluded from operating cash
flows and included in investing activities. Cash and cash equivalents at
December 31, 2001 were $1.2 million.
Hall-Houston has experienced substantial working capital requirements,
primarily due to Hall-Houston's active capital expenditure program.
LONG-TERM DEBT AND LEASE OBLIGATIONS
The following table summarizes Hall-Houston's obligations under operating
leases as of December 31, 2001. Hall-Houston's long-term debt obligations, $80.2
million as of December 31, 2001, have been excluded from the table as the
long-term debt was either converted into Energy Partners securities under the
debt exchange agreement or was redeemed by Energy Partners on January 15, 2002.
PAYMENTS DUE BY PERIOD
--------------------------------------------------
TOTAL 1 YEAR 2-3 YEAR 4-5 YEAR THEREAFTER
------ ------ -------- -------- ----------
(IN THOUSANDS)
Operating Leases......................... $5,261 $611 $1,418 $1,465 $1,767
DERIVATIVE INSTRUMENTS
During 2001, Hall-Houston entered into a number of commodity options to
reduce exposure to fluctuations in the price of natural gas. The transactions
consisted of financially settled natural gas put options. The natural gas put
options were financially settled based on the average of the reported settlement
price for the last three scheduled trading days of the NYMEX Henry Hub Natural
Gas Futures Contracts for the applicable settlement period. The counterparty was
required to make a payment to Hall-Houston if the settlement price for any
settlement period was below the target price specified in the put option
contract. Premiums associated with entering into such transactions were $1.4
million and Hall-Houston recognized gains of $3.0 million as a result of the
settlement price being below the target price specified in the applicable
contract. The gains and expenses related to these transactions were recognized
and recorded in other income.
CRITICAL ACCOUNTING POLICIES
In preparing Hall-Houston's financial statements in accordance with
accounting principles generally accepted in the United States, management must
make a number of estimates and assumptions related to the reporting of assets,
liabilities, revenues and expenses and the disclosure of contingent assets and
liabilities. Application of certain of Hall-Houston's accounting policies
requires a significant number of estimates. These accounting policies are
described below.
37
- Depreciation, depletion and amortization. Hall-Houston utilizes the
successful efforts method to account for exploration and development
expenditures. Successful exploratory drilling costs and all development
capital expenditures are capitalized and systematically charged to
expense using the units of production method based on proved developed
oil and natural gas reserves as estimated by internal engineers and an
independent petroleum engineer. Hall-Houston also uses proved developed
reserves to recognize expense for future estimated dismantlement and
abandonment costs. Although the engineers are knowledgeable of and follow
the guidelines for reserves as established by the U.S. Securities and
Exchange Commission, the estimation of reserves requires the engineers to
make a significant number of assumptions based on professional judgment.
Estimated reserves are, therefore, often subject to future revision,
certain of which could be substantial, based on the availability of
additional information, including: reservoir performance, new geological
and geophysical data, additional drilling, technological advancements,
price changes and other economic factors. Changes in oil and natural gas
prices can lead to a decision to start-up or shut-in production, which
can lead to revisions to reserve quantities. Reserve revisions inherently
lead to adjustments of depreciation rates utilized by Hall-Houston.
Hall-Houston cannot predict the types of reserve revisions that will be
required in future periods.
- Impairment of properties. Hall-Houston continually monitors its
long-lived assets recorded in property and equipment in its consolidated
balance sheet to make sure that they are fairly presented. Hall-Houston
must evaluate its properties for potential impairment when circumstances
indicate that the carrying value of an asset could exceed its fair value.
A significant amount of judgment is involved in performing these
evaluations since the results are based on estimated future events. Such
events include a projection of future oil and natural gas prices, an
estimate of the ultimate amount of recoverable oil and natural gas
reserves that will be produced from a field, the timing of this future
production, future costs to produce the oil and natural gas, and future
inflation levels. The need to test a property for impairment can be based
on several factors, including a significant reduction in prices for oil
and/or natural gas, unfavorable adjustments to reserves, or other changes
to contracts, environmental regulations or tax laws. All of these factors
must be considered when testing a property's carrying value for
impairment. Hall-Houston cannot predict the need for, nor estimate the
amount of, impairment charges that may be recorded in the future.
- Income taxes. As part of the process of preparing the consolidated
financial statements, Hall-Houston is required to estimate the income
taxes in each of the jurisdictions in which it operates. This process
involves estimating the actual current tax exposure together with
assessing temporary differences resulting from differing treatment of
items, such as depreciation, amortization and certain accrued
liabilities, for tax and accounting purposes. These differences and the
net operating loss carryforwards result in deferred tax assets and
liabilities, which are included within Hall-Houston's consolidated
balance sheet. Hall-Houston must then assess the likelihood that the
deferred tax assets will be recovered from future taxable income and, to
the extent it believes that recovery is not likely, it must establish a
valuation allowance. To the extent Hall-Houston establishes a valuation
allowance or increases or decreases this allowance in a period,
Hall-Houston must include an expense or reduction of expense within the
tax provision in the consolidated statement of operations. Deferred
income tax assets and liabilities are recorded whenever underlying
transactions result in temporary differences between financial accounting
and what will be included in Hall-Houston's tax returns. Permanent
differences are taken into account in determining Hall-Houston's
effective tax rate. The intent of recording deferred taxes is to cause
financial income tax expense to be consistent with the underlying tax
rates. To the extent deferred tax estimation does not correctly predict
how transactions are later reflected in tax returns, adjustments will be
required.
38
NEW ACCOUNTING POLICIES
In 2001, the Financial Accounting Standards Board issued four new
pronouncements:
- Statement 141, Business Combinations, requires the purchase method of
accounting for all business combinations and applies to all business
combinations initiated after June 30, 2001 and to all business
combinations accounted for by the purchase method that are completed
after June 30, 2001.
- Statement 142, Goodwill and Other Intangible Assets, requires that
goodwill as well as other intangible assets be tested annually for
impairment and is effective for fiscal years beginning after December 15,
2001.
- Statement 143, Accounting for Asset Retirement Obligations, requires
entities to record the fair values of a liability for an asset retirement
obligation in the period in which it is incurred and a corresponding
increase in the carrying amount of the related long-lived asset and is
effective for fiscal years beginning after June 15, 2002.
- Statement 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, provides that long-lived assets to be disposed of by sale be
measured at the lower of carrying amount or fair value less cost to sell,
whether reported in continuing operations or in discontinued operations,
and broadens the reporting of discontinued operations to include all
components of an entity with operations that can be distinguished from
the rest of the entity and that will be eliminated from the ongoing
operations of the entity in a disposal transaction. This statement is
effective for fiscal years beginning after December 15, 2001.
Statements 141 and 142 will not apply to Hall-Houston at this time. We are
currently assessing the impact of Statements 143 and 144 on our future financial
condition and results of operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Hall-Houston is exposed to changes in interest rates. Changes in interest
rates affect the interest earned on Hall-Houston's cash and cash equivalents.
Hall-Houston does not use interest rate derivative instruments to manage
exposure to interest rate changes. Hall-Houston's long-term credit facilities
had fixed interest rates of 12% at December 31, 2001.
COMMODITY PRICE RISK
Hall-Houston's revenues, profitability and future growth depend
substantially on prevailing prices for oil and natural gas. Prices also affect
the amount of cash flow available for capital expenditures and its ability to
borrow and raise additional capital. Lower prices may also reduce the amount of
oil and natural gas that Hall-Houston can produce economically.
Hall-Houston established a volumetric production payment in September 1994
and subsequently amended it several times. This production payment and
subsequent production payments provided Hall-Houston with net proceeds
aggregating $125.6 million. These proceeds were received in exchange for an
obligation to deliver 73.1 million MMbtu of natural gas from Hall-Houston's
interest in the properties committed to the production payments. The aggregate
volumes of natural gas to be delivered under the one remaining production
payment totaled 2.5 million MMbtu as of December 31, 2001 which is scheduled to
be delivered in 2002. Natural gas production volumes from the properties
committed to the production payment in excess of the volumes used to satisfy the
delivery obligations are being sold under a contract that allows Hall-Houston to
select from among several different market sensitive pricing mechanisms.
Hall-Houston markets substantially all of the oil and natural gas
production volumes from the properties it operates, other than from properties
that are committed to the production payment, for both its account and the
account of other working interest owners in these properties. Hall-Houston's
oil, condensate and natural gas production is sold to a variety of purchasers,
typically under short-term (less than 12 months) contracts or
39
30-day spot gas purchase contracts. Hall-Houston is currently party to one
long-term purchase contract covering production volumes from its East Cameron
Block 160. Hall-Houston is not dependent upon, or confined to, any one purchaser
or small group of purchasers. Currently, most of Hall-Houston's natural gas
production volumes are sold to KCS Energy Services, Inc. and Duke Energy
Corporation. Hall-Houston's purchasers of oil and condensate include Plains
Marketing, L.P. and Texon Energy Corporation. Hall-Houston believes that the
prices for oil, condensate, liquids and natural gas it receives are comparable
to market prices in the areas where Hall-Houston has production. Hall-Houston
also has a natural gas processing agreement with Dynegy Midstream Services
associated with production at its East Cameron Block 160.
40
THE COMPANIES
DESCRIPTION OF BUSINESS OF HALL-HOUSTON
Prior to the merger, Hall-Houston was a privately owned Houston-based oil
and natural gas exploration and production company that was incorporated in 1983
and began actively drilling in the shallow to moderate depth waters of the Gulf
of Mexico in 1985. Since that time, Hall-Houston's primary focus has been the
acquisition, exploration and development of oil and natural gas prospects off
the coasts of Louisiana and Texas which Hall-Houston believes is a well
established oil and natural gas producing basin with a substantial history of
exploration and development activity. As of December 31, 2001, Hall-Houston had
estimated proved reserves of approximately 54.9 Bcf of natural gas and 297 Mbbls
of oil, or an aggregate of approximately 56.7 Bcfe, with a present value of
estimated pre-tax future cash flows of $79.3 million (based upon year-end 2001
prices and a discount rate of 10%).
Hall-Houston's exploration strategy is to acquire oil and natural gas
prospects in the Gulf of Mexico on which it believes reserves can be found that
can be developed and placed on production relatively quickly and inexpensively.
Hall-Houston typically avoids higher risk exploration prospects, focusing
instead on prospects which it believes have moderate exploration risk and which
tend also to have moderate reserve potential. Hall-Houston evaluates and
generates drilling prospects using a regional and integrated approach with a
seismic database as a platform.
DESCRIPTION OF BUSINESS OF ENERGY PARTNERS
We are an independent oil and natural gas exploration and production
company concentrated in the shallow to moderate depth waters of the central
region of the Gulf of Mexico Shelf. We have focused on the Central Gulf of
Mexico Shelf area because that area provides us with favorable geologic and
economic conditions, including multiple reservoir formations, regional economies
of scale, extensive infrastructure and comprehensive geologic databases. We
believe that the large, established fields in this region offer a balanced and
ample inventory of existing and prospective exploitation and development
opportunities, as well as the long-term potential for reserve additions and
production increases from deeper geologic formations. Most of our properties are
located in the Terrebonne Trough area of this region. As of December 31, 2001,
we had estimated proved reserves of approximately 61.8 Bcf of natural gas and
25,462 Mbbls of oil, or an aggregate of approximately 35.8 million Boe, with a
present value of estimated pre-tax future net cash flows of $129.1 million
(based upon year-end 2001 prices and a discount rate of 10%).
We were incorporated in January 1998 by Richard A. Bachmann, our founder,
chairman, president and chief executive officer. Mr. Bachmann, the former
president and chief operating officer of The Louisiana Land and Exploration
Company, assembled a team of geoscientists and management professionals with
considerable region-specific geological, geophysical, technical and operational
experience to form the foundation of our company. The industry relationships of
Mr. Bachmann and the rest of our team provides us with access to the operators
of the Gulf of Mexico Shelf fields that we target for redevelopment.
We have grown through a combination of multi-year, multi-well drill-to-earn
programs and strategic acquisitions. Under our drill-to-earn programs, we use
our personnel and capital to identify and pursue additional drilling
opportunities on properties previously developed by our drill-to-earn partners
and recover our investment through sharing revenue from the new production we
establish. After successful drilling of wells, we earn an interest in the
reserves we find and develop. We generally operate the properties during the
drilling phase of these programs and seek to reduce costs and improve reservoir
recovery efficiencies through our geophysical, technical and operational
expertise.
41
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS OF ENERGY PARTNERS
On January 15, 2002, we acquired Hall-Houston and affiliated interests.
Consideration consisting of $5.1 million of cash, 574,931 shares of our common
stock $0.01 par value per share, $38.4 million, face amount, of our Series D
preferred stock, $1.00 par value, $38.4 million in our 11% notes due 2009, 1
million warrants to purchase our common stock at $9.00 per share and 3 million
warrants to purchase our common stock at $11.00 per share. In addition we
assumed Hall-Houston's working capital deficit. All of the purchase price was
allocated to the net assets acquired.
The following unaudited pro forma condensed consolidated financial
information has been prepared by management utilizing our historical financial
statements and those of Hall-Houston for the year ended December 31, 2001.
Adjustments have been made to reflect the financial impact of purchase
accounting and other items had the acquisition taken place on January 1, 2001
with respect to operating data and December 31, 2001 with respect to the balance
sheet data. The pro forma adjustments are described in the accompanying notes
and are based upon preliminary estimates and certain assumptions that management
of the companies believes reasonable under the circumstances.
The unaudited pro forma condensed consolidated financial information is
presented for comparative purposes only and does not purport to be indicative of
the results which would actually have been obtained had the acquisition been
effected on the pro forma date, nor is it indicative of the results which may be
obtained in the future. The unaudited pro forma condensed consolidated financial
information in the opinion of management reflects all adjustments necessary to
present fairly the data for such periods.
42
ENERGY PARTNERS, LTD
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2001
(IN THOUSANDS)
(UNAUDITED)
HISTORICAL HISTORICAL
EPL HALL-HOUSTON ADJUSTMENTS PRO FORMA
---------- ------------ ----------- ---------
Current assets:
Cash and cash equivalents.................... $ -- $ 1,178 $ 1,178
Trade and other accounts receivable.......... 13,753 6,283 20,036
Fair value of commodity derivative
instruments............................... 2,047 -- 2,047
Prepaid expenses and other................... 1,459 3,568 5,027
-------- -------- --------
Total current assets...................... 17,259 11,029 28,288
Property and equipment -- net.................. 223,862 84,968 (a) 38,191 347,021
Other assets................................... 363 928 1,291
Deferred financing costs....................... 1,293 1,168 (a) (1,168) 1,293
-------- -------- --------
$242,777 $ 98,093 $377,893
======== ======== ========
Current liabilities:
Accounts payable and accrued expenses........ $ 21,389 $ 32,250 (a) (4,132) $ 49,507
Current maturities of long-term debt and
notes payable............................. 85 7,365 7,450
-------- -------- --------
Total current liabilities................. 21,474 39,615 56,957
Long-term debt................................. 25,408 86,739 (a) (86,739) 75,217
(a) 11,438
(a) 38,371
Deferred revenue............................... -- 4,055 4,055
Deferred income taxes.......................... 16,782 (12,447) (a) 12,447 16,782
Other.......................................... 14,246 6,784 (a) (2,001) 19,029
Redeemable preferred stock..................... -- 18,004 (a) (18,004) --
Stockholders' equity:
Preferred stock.............................. -- -- (a) 34,746 34,746
Common stock................................. 269 32 (a) (32) 275
(a) 6
Additional paid-in-capital................... 180,995 82 (a) (82) 187,229
(a) 6,234
Accumulated other comprehensive income....... 981 -- 981
Accumulated deficit.......................... (17,378) (44,771) (a) 44,771 (17,378)
-------- -------- --------
Total stockholders' equity................ 164,867 (44,657) 205,853
-------- -------- --------
$242,777 $ 98,093 $377,893
======== ======== ========
43
ENERGY PARTNERS, LTD
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
HISTORICAL HISTORICAL
EPL HALL-HOUSTON ADJUSTMENTS PRO FORMA
---------- ------------ ------------ ---------
Revenue:
Oil and gas.................................. $143,870 $ 27,904 $171,774
Other........................................ 2,057 1,650 3,707
-------- -------- --------
145,927 29,554 175,481
-------- -------- --------
Costs and expenses:
Lease operating.............................. 36,269 8,760 (b) (1,948) 43,081
Taxes, other than on earnings................ 7,190 -- 7,190
Exploration expenditures and dry holes....... 15,141 14,283 29,424
Impairment of oil and gas properties......... -- 7,312 7,312
Depreciation, depletion and amortization..... 46,870 18,064 (c) 3,026 67,960
General and administrative
Stock-based compensation................ 1,651 -- 1,651
Other general and administrative........ 18,182 4,274 (b) 1,948 24,404
-------- -------- --------
Total costs and expenses............. 125,303 52,693 181,022
-------- -------- --------
Income (loss) from operations.................. 20,624 (23,139) (5,541)
-------- -------- --------
Other income (expense):
Interest income........................... 329 329 658
Interest expense.......................... (1,916) (9,406) (d) 4,797 (6,525)
Gain on sale of oil and gas assets........ 39 6,457 6,496
-------- -------- --------
(1,548) (2,620) 629
-------- -------- --------
Income (loss) before income taxes.... 19,076 (25,759) (4,912)
Income taxes................................... (7,102) 10,535 (e) (1,665) 1,768
-------- -------- --------
Net income (loss).................... $ 11,974 $(15,224) $ (3,144)
======== ======== ========
Basic earnings (loss) per share................ $ 0.45 (f) $ (0.24)
======== ========
Basic weighted average shares outstanding...... 26,865 27,440
======== ========
Diluted earnings (loss) per share.............. $ 0.44 (f) $ (0.24)
======== ========
Diluted weighted average shares outstanding.... 26,920 27,440
======== ========
44
ENERGY PARTNERS, LTD.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(1) ENTRIES
(a) EPL acquired Hall-Houston and affiliated interests for aggregate
consideration consisting of $5.1 million of cash, 574,931 shares of EPL's
common stock valued at $5.81 per share, $38.4 million, face amount, of
Series D Exchangeable Convertible Preferred Stock (Preferred Stock) which
has a conversion price of $8.54 per share, $38.4 million in 11% Senior
Subordinated Notes (Senior Subordinated Notes) and warrants with a Black
Scholes value of $2.9 million which will convert into 1 million shares of
EPL common stock at a strike price of $9.00 and 3 million shares of EPL
common stock at a strike price of $11.00. EPL also paid interest accruing
through the closing date and assumed Hall-Houston's working capital deficit
as of January 15, 2002. This entry adjusts the historical book values of
Hall-Houston's assets and liabilities to their estimated fair values as of
December 31, 2001. The calculation of the total purchase price and the
preliminary allocation to assets and liabilities are shown below (in
thousands, except share data):
Calculation and preliminary allocation of purchase price:
Shares of EPL common stock issued........................... 574,931
Average EPL stock price..................................... $ 5.81
--------
Fair value of common stock issued........................... $ 3,340
Fair value of EPL warrants issued........................... 2,900
Cash paid................................................... 1,725
--------
Fair value of common stock, warrants and cash............... $ 7,965
Fair value of EPL Preferred Stock issued to Hall-Houston
debtholders............................................... 34,746
Fair value of EPL Senior Subordinated Notes issued to
Hall-Houston debtholders.................................. 38,371
Cash paid to Hall-Houston debtholders not accepting debt
exchange consideration.................................... 3,414
Cash paid to Hall-Houston debtholders for accrued interest
and nominal overriding royalty interests.................. 3,429
Plus estimated merger costs to be incurred.................. 2,870
--------
Total purchase price................................... $ 90,795
Plus fair value of liabilities assumed by EPL:
Current liabilities(1)...................................... $ 35,483
Deferred income taxes....................................... --
Other non current liabilities, excluding abandonment
liability of $2.0 million................................. 8,838
--------
Total purchase price plus liabilities assumed.......... $135,116
--------
Fair value of assets acquired by EPL:
Current assets.............................................. $ 11,029
Proved oil and gas properties............................... 117,927
Unproved oil and gas properties............................. 4,893
Other property and equipment................................ 339
Other assets................................................ 928
--------
Fair value of assets acquired.......................... $135,116
--------
---------------
(1) excludes $1.7 million of accrued Hall-Houston dividends as the rights
to such were relinquished in connection with the merger and $2.4
million of accrued interest paid at closing.
45
ENERGY PARTNERS, LTD.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION -- (CONTINUED)
The entire purchase price has been allocated to the net assets acquired.
Deferred financing costs of $1.2 million for Hall-Houston debt which was
redeemed or converted has been given no value in the purchase accounting
and abandonment liabilities of $2.0 million accrued on Hall-Houston
producing leases have been adjusted out of other liabilities in the
purchase accounting as the abandonment will be accrued by EPL over the
producing lives of the leases acquired.
Due to the taxable nature of the transaction, EPL will make an election
under Section 338 of the Internal Revenue Service Code. This election will
restate the tax basis of Hall-Houston's assets to fair market value
resulting in no difference between the book and tax basis of the assets and
liabilities acquired. All Hall-Houston deferred tax assets have been
eliminated in the purchase accounting entries.
The purchase price allocation is preliminary and is subject to change due
to several factors, including changes in the fair values of Hall-Houston's
assets and liabilities as of the closing date of the merger and the actual
merger costs incurred.
Payment of up to an additional $50 million for the acquisition is
contingent upon the attainment of certain objectives. Annually beginning
March 1, 2003 through 2007, additional consideration, if any, will be paid
in stock or cash at our option (with a minimum of 20% in cash), based upon
a percentage of the amount by which the before tax net present value
related, in general, to exploratory prospect acreage acquired exceeds a net
present value discounted at 30%. Due to the uncertainty inherent in
estimating the value of the contingent consideration, total final
consideration will not be determined until March 1, 2007. Any amounts paid
will be capitalized as additional purchase price when paid and have not
been included in the pro forma calculations.
(b) To reclassify Hall-Houston insurance expense from lease operating to
general and administrative to be consistent with the classification in
EPL's historical statement of operations.
(c) This adjustment reflects the change in depreciation, depletion and
amortization amounts recorded on a historical basis to amounts that would
have been included in the financial statements effective January 1, 2001.
(d) To record the net change in interest expense from:
- $38.4 million of Senior Subordinated Notes at the current interest rate
of 11%
- Interest expense on $11.4 million of additional borrowings under EPL's
bank credit facility at EPL's then outstanding borrowing rate of 3.4%
- The reduction in interest expense due to the redemption or conversion of
all Hall-Houston long-term debt.
Senior Subordinated Notes issued in exchange for
Hall-Houston debt......................................... $ 4,221
Increased borrowing under EPL bank facility using current
rate...................................................... 388
Redemption of Hall-Houston debt............................. (9,406)
-------
Adjustment needed........................................... $(4,797)
-------
(e) To record the provision for federal and state income taxes at a corporate
statutory rate of 36%.
46
ENERGY PARTNERS, LTD.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION -- (CONTINUED)
(f) To reflect pro forma net earnings (loss) per basic share. Pro forma diluted
earnings per share has not been presented below as any common stock
equivalents would be antidilutive. Loss available to common stockholders is
derived as follows (in thousands, except per share amounts):
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Net loss..................................... $(3,144)
Preferred stock dividends.................... (3,475)
-------
Basic loss per share:
Loss available to common stockholders........ $(6,619) 27,440 $(0.24)
------- ------
(2) SUPPLEMENTAL PRO FORMA INFORMATION ON OIL AND GAS OPERATIONS (UNAUDITED)
The following pro forma supplemental information regarding oil and gas
operations is presented pursuant to the disclosure requirements of
Statement of Financial Accounting Standards No. 69, "Disclosures About Oil
and Gas Producing Activities."
The following table reflects the costs incurred in oil and gas property
acquisitions, exploration and development activities of EPL and
Hall-Houston and the combined company on a pro forma basis, for the year
ended December 31, 2001 (in thousands):
COMBINED
EPL HALL-HOUSTON COMPANY
-------- ------------ --------
Oil and gas property acquisitions.............. $ 2,516 $ 3,146 $ 5,662
Exploration.................................... 45,592 53,606 99,198
Development.................................... 55,882 23,289 79,171
-------- ------- --------
Total costs incurred...................... $103,990 $80,041 $184,031
======== ======= ========
The following tables set forth the changes in the net quantities of oil and
gas reserves of EPL, Hall-Houston and the combined company on a pro forma
basis, for the year ended December 31, 2001:
HALL-HOUSTON COMBINED
EPL OIL-MBBLS COMPANY
------ ------------ --------
Proved developed and undeveloped reserves:
December 31, 2000............................... 27,521 394 27,915
Purchases of reserves in place............... 117 -- 117
Sale of reserves............................. -- (302) (302)
Extensions, discoveries and other
additions.................................. 2,797 311 3,108
Revisions.................................... (1,192) (73) (1,265)
Production................................... (3,781) (33) (3,814)
------ ---- ------
December 31, 2001............................... 25,462 297 25,759
====== ==== ======
Proved developed reserves as of:
December 31, 2000............................... 25,024 352 25,376
December 31, 2001............................... 22,176 297 22,473
47
ENERGY PARTNERS, LTD.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION -- (CONTINUED)
HALL-HOUSTON COMBINED
EPL GAS-MMCF COMPANY
------- ------------ --------
Proved developed and undeveloped reserves:
December 31, 2000.............................. 49,150 40,998 90,148
Purchases of reserves in place.............. 301 -- 301
Sale of reserves............................ -- (5,273) (5,273)
Extensions, discoveries and other
additions................................. 28,383 18,554 46,937
Revisions................................... (3,422) 6,765 3,343
Production.................................. (12,615) (6,170) (18,785)
------- ------ -------
December 31, 2001.............................. 61,797 54,874 116,671
======= ====== =======
Proved developed reserves as of:
December 31, 2000.............................. 39,522 23,268 62,790
December 31, 2001.............................. 38,099 38,082 76,181
Subsequent to December 31, 2001, Hall-Houston acquired additional working
interests in several of its properties from affiliates. In addition, EPL
acquired overriding royalty interests directly from affiliates of
Hall-Houston. These transactions combined increased proved reserves by
approximately 5.8 Bcfe or 5%, as compared to the proved reserve quantities
of the combined company as of December 31, 2001 that are disclosed in the
previous tables and underlie the standardized measure data which follows.
The following table sets forth the standardized measure of discounted
future net cash flows relating to proved oil and gas reserves for EPL,
Hall-Houston and the combined company on a pro forma basis, as of December
31, 2001 (in thousands):
COMBINED
EPL HALL-HOUSTON ADJUSTMENT(1) COMPANY
--------- ------------ ------------- ---------
Future cash inflows............. $ 630,941 $148,609 $ 779,550
Future production costs....... (293,945) (21,312) (315,257)
Future development and
abandonment costs.......... (168,989) (27,852) (196,841)
Future income tax expense..... (4,688) -- (35,800) (40,488)
--------- -------- ---------
Future net cash flows after
income taxes.................. 163,319 99,445 226,964
10% annual discount for
estimated timing of cash
flows......................... (39,942) (20,161) 8,340 (51,763)
--------- -------- ---------
Standardized measure of
discounted future net cash
flows......................... $ 123,377 $ 79,284 $ 175,201
========= ======== =========
---------------
(1) Hall-Houston's historical financial information includes net operating
loss carryforwards sufficient to offset future taxable income. This
entry adjusts the combined company future income taxes and related
discount to reflect the pro forma future tax expense as the net
operating losses will not be brought forward to the combined company.
The computation of the standardized measure of discounted future net cash
flows relating to proved oil and gas reserves at December 31, 2001 was
based on period end spot prices adjusted for lease quality, transportation
fees and price differentials. The December 31, 2001 computation for EPL was
based on period end prices of approximately $2.71 per Mcf for natural gas
and $18.21 per barrel for crude oil while
48
ENERGY PARTNERS, LTD.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION -- (CONTINUED)
Hall-Houston's computation was based on period end prices of approximately
$2.65 per Mcf and $20.14 per barrel for crude oil.
The following table includes the components of the changes in the
standardized measure of discounted future net cash flows of EPL,
Hall-Houston and the combined company on a pro forma basis, for the year
ended December 31, 2001 (in thousands):
COMBINED
EPL HALL-HOUSTON ADJUSTMENT(1) COMPANY
--------- ------------ ------------- ---------
Beginning of the period......... $ 348,102 $ 187,500 $ 535,602
Sales and transfers of oil and
gas produced net of production
costs......................... (100,411) (14,386) (114,797)
Net changes in prices and
production costs.............. (349,126) (202,112) (551,238)
Extensions, discoveries and
improved recoveries, net of
future production costs....... 49,217 32,469 81,686
Revisions of quantity
estimates..................... (12,619) 11,904 (715)
Previously estimated development
costs incurred during the
period........................ 10,861 23,289 34,150
Purchases and sales of reserves
in place...................... 637 (16,006) (15,369)
Changes in estimated future
development costs............. (20,014) (1,321) (21,335)
Changes in production rates
(timing) and other............ 11,638 (41,265) (29,627)
Accretion of discount........... 48,995 26,065 75,060
Net change in income taxes...... 136,097 73,147 (27,460) 181,784
--------- --------- ---------
Net decrease.................... (224,725) (108,216) (360,401)
--------- --------- ---------
End of period................... $ 123,377 $ 79,284 $ 175,201
========= ========= =========
---------------
(1) Hall-Houston's historical financial information includes net operating
loss carryforwards sufficient to offset future taxable income. This
entry adjusts the combined company discounted future income taxes to
reflect the change in the pro forma future tax expense as the net
operating losses will not be brought forward to the combined company.
49
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of December 31, 2001 and
2000...................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999.......................... F-4
Consolidated Statements of Stockholders' Deficit for the
years ended December 31, 2001, 2000 and 1999.............. F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Hall-Houston Oil Company:
We have audited the accompanying consolidated balance sheets of
Hall-Houston Oil Company and subsidiaries as of December 31, 2001 and 2000, and
the related consolidated statements of operations, stockholders' deficit, and
cash flows for each of the years in the three-year period ended December 31,
2001. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Hall-Houston
Oil Company and subsidiaries as of December 31, 2001 and 2000, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
As described in note 2 to the consolidated financial statements, the
Company changed its method of accounting for derivative instruments in 2001.
KPMG LLP
Houston, Texas
March 19, 2002
F-2
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
(DOLLAR AMOUNTS IN THOUSANDS)
2001 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 606 $ 4,608
Cash collateral account, restricted....................... 572 2,545
Accounts receivable:
Trade, net of allowance of $1,192 and $592 at December
31, 2001 and 2000, respectively........................ 5,403 9,936
Insurance recovery...................................... -- 1,152
Employees and affiliates................................ 7 20
Other................................................... 42 69
Taxes receivable.......................................... 831 --
Inventories............................................... 1,200 1,015
Prepaid expense........................................... 2,310 992
Other current assets...................................... 58 49
-------- --------
Total current assets............................... 11,029 20,386
-------- --------
Oil and natural gas properties, at cost, using the
successful-efforts method of accounting................... 149,391 86,375
Less accumulated depreciation, depletion, impairment, and
amortization.............................................. (64,762) (41,242)
-------- --------
Net oil and natural gas properties................. 84,629 45,133
Other property and equipment, net of accumulated
depreciation.............................................. 339 403
Deferred income taxes, net.................................. 12,447 2,791
Deferred financing costs, net of accumulated amortization of
$552 in 2001 and $111 in 2000............................. 1,168 889
Other assets................................................ 928 722
-------- --------
$110,540 $ 70,324
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Notes payable............................................. $ 7,365 $ --
Accounts payable and accrued liabilities.................. 32,174 22,137
Gas imbalances payable.................................... 76 76
-------- --------
Total current liabilities.......................... 39,615 22,213
-------- --------
Long-term debt.............................................. 80,156 36,000
Employee royalty trust obligation........................... 6,583 5,654
Accrued dismantlement and abandonment costs................. 6,398 3,078
Other long-term liabilities................................. 386 367
Deferred revenue............................................ 4,055 12,303
-------- --------
Total liabilities.................................. 137,193 79,615
-------- --------
Mandatory redeemable preferred stock, $0.01 par value.
Authorized 5,000,000 shares; $100 liquidation preference
per share; issued and outstanding 180,038 shares.......... 18,004 18,004
Stockholders' deficit:
Common stock, $0.01 par value. Authorized 19,000,000
Series A and 6,000,000
Series B Nonvoting shares; issued and outstanding
3,175,489 Series A shares.............................. 32 32
Additional paid-in capital.................................. 82 82
Accumulated deficit......................................... (44,771) (27,409)
-------- --------
Total stockholders' deficit........................ (44,657) (27,295)
Contingencies (note 16)
-------- --------
$110,540 $ 70,324
======== ========
See accompanying notes to consolidated financial statements.
F-3
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2001 2000 1999
-------- ------- --------
Revenue:
Oil and natural gas revenues.............................. $ 27,904 $19,254 $ 9,679
Gain on sale of oil and natural gas properties............ 6,457 27,734 17,482
Other..................................................... 1,650 489 716
-------- ------- --------
36,011 47,477 27,877
-------- ------- --------
Costs and expenses:
Lease operating........................................... 8,760 6,023 7,160
Exploration expenditures and dry hole costs............... 14,283 3,070 11,999
Impairment of oil and natural gas properties.............. 7,312 957 6,224
Depreciation, depletion and amortization.................. 18,064 7,452 6,283
General and administrative................................ 3,247 4,202 4,423
Merger-related costs...................................... 427 -- --
Other..................................................... 600 825 4,326
-------- ------- --------
52,693 22,529 40,415
-------- ------- --------
Income (loss) from operations..................... (16,682) 24,948 (12,538)
Other income (expense):
Interest income........................................... 329 308 294
Interest expense.......................................... (9,406) (5,001) (4,054)
-------- ------- --------
(9,077) (4,693) (3,760)
-------- ------- --------
Income (loss) before income taxes................. (25,759) 20,255 (16,298)
Income tax benefit.......................................... 10,535 1,742 122
-------- ------- --------
Net income (loss)................................. (15,224) 21,997 (16,176)
Preferred stock dividends................................... (2,138) (1,913) (2,250)
-------- ------- --------
Net income (loss) attributed to common
stockholders.................................... $(17,362) $20,084 $(18,426)
======== ======= ========
Net income (loss) per share attributed to common
stockholders:
Basic..................................................... $ (5.47) $ 6.32 $ (5.80)
======== ======= ========
Diluted................................................... $ (5.47) $ 3.65 $ (5.80)
======== ======= ========
Weighted average number of common shares outstanding used in
computing net income (loss) per share:
Basic..................................................... 3,175 3,175 3,175
======== ======= ========
Diluted................................................... 3,175 6,033 3,175
======== ======= ========
See accompanying notes to consolidated financial statements.
F-4
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(DOLLAR AMOUNTS IN THOUSANDS)
ADDITIONAL TOTAL
COMMON PAID-IN ACCUMULATED STOCKHOLDERS'
STOCK CAPITAL DEFICIT DEFICIT
------ ---------- ----------- -------------
Balances as of December 31, 1998................. $32 $82 $(29,067) $(28,953)
Accrued dividends in arrears on mandatory
redeemable preferred stock..................... -- -- (2,250) (2,250)
Net loss......................................... -- -- (16,176) (16,176)
--- --- -------- --------
Balances as of December 31,1999.................. 32 82 (47,493) (47,379)
Dividends on mandatory redeemable preferred
stock.......................................... -- -- (1,913) (1,913)
Net income....................................... -- -- 21,997 21,997
--- --- -------- --------
Balances as of December 31, 2000................. 32 82 (27,409) (27,295)
Accrued dividends in arrears on mandatory
redeemable preferred stock..................... -- -- (1,688) (1,688)
Dividends on mandatory redeemable preferred
stock.......................................... -- -- (450) (450)
Net loss......................................... -- -- (15,224) (15,224)
--- --- -------- --------
Balances as of December 31, 2001................. $32 $82 $(44,771) $(44,657)
=== === ======== ========
See accompanying notes to consolidated financial statements.
F-5
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(DOLLAR AMOUNTS IN THOUSANDS)
2001 2000 1999
-------- -------- --------
Cash flows from operating activities:
Net income (loss)......................................... $(15,224) $ 21,997 $(16,176)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Gain on sale of oil and gas assets...................... (6,457) (27,734) (17,482)
Depreciation, depletion, and amortization............... 18,064 7,452 6,283
Amortization of deferred revenue........................ (8,248) (7,441) (7,985)
Dry hole and impairment costs........................... 19,443 1,262 14,888
Deferred income taxes................................... (9,656) (2,791) --
Change in assets and liabilities affecting operating
activities:
Decrease (increase) in accounts receivable............ 5,725 (7,420) (3,298)
Decrease (increase) in taxes receivable............... (831) -- 926
Decrease (increase) in materials and supplies
inventory.......................................... (185) 369 (875)
Decrease (increase) in other assets................... (1,092) 15 341
Increase in accounts payable and accrued
liabilities........................................ 9,127 1,962 7,560
Increase in deferred revenue.......................... -- 5,710 17,765
Increase (decrease) in other liabilities.............. 929 (473) 2,707
Other................................................. (94) (90) (225)
-------- -------- --------
Total adjustments.................................. 26,725 (29,179) 20,605
-------- -------- --------
Net cash provided by (used in) operating
activities....................................... 11,501 (7,182) 4,429
-------- -------- --------
Cash flows from investing activities:
Property acquisitions..................................... (1,650) (3,064) (180)
Exploration and development expenditures.................. (73,957) (30,675) (47,319)
Other property and equipment additions.................... (57) (80) (198)
Proceeds from sales of oil and gas assets................. 10,817 56,468 20,774
-------- -------- --------
Net cash provided by (used in) investing
activities....................................... (64,847) 22,649 (26,923)
-------- -------- --------
Cash flows from financing activities:
Borrowings under short-term debt.......................... 7,661 -- --
Borrowings under long-term debt........................... 48,388 32,525 32,399
Principal payments under long-term debt and notes
payable................................................. (7,860) (48,497) (137)
Cash dividends on mandatory redeemable preferred stock.... (900) (3,713) (450)
Deposits to cash collateral account....................... (12,388) (12,525) (33,470)
Fundings from cash collateral account..................... 45,630 29,682 55,038
Refunding obligations to cash collateral account.......... (31,187) (15,469) (25,296)
-------- -------- --------
Net cash provided by (used in) financing
activities....................................... 49,344 (17,997) 28,084
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents...................................... (4,002) (2,530) 5,590
Cash and cash equivalents, beginning of year................ 4,608 7,138 1,548
-------- -------- --------
Cash and cash equivalents, end of year...................... $ 606 $ 4,608 $ 7,138
======== ======== ========
Supplemental cash flow information:
Interest paid............................................. $ 7,247 $ 5,171 $ 2,138
======== ======== ========
Income taxes paid......................................... $ 1,000 $ -- $ --
======== ======== ========
Non cash transactions:
Vendor offset received relating to the Company's 2000
Exploration and Development Facility (see note 5)....... $ 2,612 $ 2,475 $ --
======== ======== ========
Vendor offset received relating to the Company's 1996
Exploration and Development Facility (see note 5)....... $ -- $ -- $ 6,511
======== ======== ========
Facility fees associated with long-term debt (see note
5)...................................................... $ 720 $ 1,000 $ --
======== ======== ========
Property acquisition -- assumption of abandonment
liability............................................... $ 1,325 $ -- $ --
======== ======== ========
Accrued preferred dividends in arrears.................... $ 1,688 $ -- $ 2,250
======== ======== ========
See accompanying notes to consolidated financial statements.
F-6
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
(1) ORGANIZATION
BACKGROUND AND BUSINESS
Hall-Houston Oil Company (the Company), a Texas corporation, was
incorporated in 1982 and commenced operations in November 1983. The Company is
an independent energy company engaged in oil and natural gas exploration,
development, and production operations primarily in the shallow to moderate
depth waters of the Gulf of Mexico off the coasts of Louisiana and Texas.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The consolidated financial statements of the Company include its wholly
owned subsidiaries, Hall-Houston Operating Company and Hall-Houston Malaysia
Ltd., which were formed during 1990 and the net assets of the Hall-Houston
Employee Royalty Trust (see note 11). All significant intercompany accounts and
transactions are eliminated in consolidation. Hall-Houston Malaysia Ltd. was
formed to engage in oil and natural gas exploration, development, and production
operations offshore of Malaysia and has been inactive since 1999.
CASH COLLATERAL ACCOUNT, RESTRICTED
The Company's restricted cash was invested in short-term, highly-liquid
investments. The carrying value approximated fair value because of the
short-term maturity of these investments. As of December 31, 2001 and 2000, the
amount disclosed as restricted cash is available to the Company in accordance
with the terms of the Company's 2000 Exploration and Development Facility (see
note 5).
INVENTORIES
Materials and supplies are carried at the lower of average cost or market
value. There was no reduction of average cost to market value during 2001 or
2000.
REVENUE RECOGNITION
The Company records revenue in accordance with the entitlement method of
accounting for production imbalances in which any amount of production volumes
received in excess of the Company's net revenue interest in the property is
recorded as a liability. If less than the Company's entitlement is received, the
underproduction is recorded as a receivable. Production imbalances are recorded
at the lower of the sales price in effect at the time of production or current
market value. Substantially all of such amounts are anticipated to be settled
with production in future periods. The Company's imbalance position was not
significant in terms of units or value at December 31, 2001 or 2000.
OTHER PROPERTY AND EQUIPMENT
Other property and equipment is carried at cost. Depreciation of other
property and equipment is provided for on a straight-line basis over the
estimated useful lives of the assets ranging from three to five years.
OIL AND NATURAL GAS PROPERTIES
The Company uses the successful efforts method of accounting for its oil
and natural gas producing activities. Costs to acquire mineral interests in oil
and natural gas properties, to drill and equip exploratory
F-7
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
wells that find proved reserves, and to drill and equip development wells are
capitalized. Costs to drill exploratory wells that do not find proved reserves
and geological and geophysical costs are expensed. Capitalized costs of
producing oil and natural gas properties are depleted on a units-of-production
basis over the estimated life of the related proved reserves. Oil is converted
to equivalent cubic feet of natural gas on an energy content basis of one barrel
to 6 thousand cubic feet (Mcf). Depreciation and depletion of capitalized costs
is provided on a property-by-property basis. Costs associated with unproved
properties and costs associated with properties that have yet to commence
production of approximately $19,857,000 and $18,325,000 as of December 31, 2001
and 2000, respectively, have been excluded from depreciation and depletion.
Unproved leasehold costs are assessed periodically on a
property-by-property basis and impairments in value are recognized to the
extent, if any, that the cost of the property has been impaired. Costs of oil
and natural gas properties surrendered are charged against the valuation
allowance. The Company recorded unproved leasehold impairment of approximately
$237,000, $718,000, and $1,761,000 in 2001, 2000, and 1999, respectively.
The estimated costs of dismantling and abandoning offshore oil and natural
gas properties are provided for currently using the units-of-production basis
over the estimated life of the related proved reserves. Such provision is
included in depreciation, depletion, and amortization in the accompanying
statements of operations. As of December 31, 2001, estimated costs of
dismantling and abandoning offshore oil and natural gas properties, net of
salvage value, were approximately $9,466,000. To date, approximately $6,398,000
has been accrued for and is included in the accompanying consolidated balance
sheets.
The Company reviews its long-lived assets to be held and used, including
proved oil and natural gas properties accounted for under the successful efforts
method of accounting, whenever events or circumstances indicate the carrying
value of those assets may not be recoverable. Generally accepted accounting
principles require that an impairment loss be recognized whenever the carrying
amount of an asset exceeds the estimated future net cash flows (undiscounted) of
the asset. The Company performs its impairment review of proved oil and natural
gas properties on a depletable unit basis. For any depletable unit determined to
be impaired, an impairment loss equal to the difference between the carrying
value and the fair value of the depletable unit is immediately recognized. Fair
value, on a depletable unit basis, is estimated to be the present value of
expected future cash flows computed by applying expected future oil and natural
gas prices, as determined by management, to estimated future production of oil
and natural gas reserves over the economic lives of the reserves. Impairment of
proved properties of approximately $7,075,000, $239,000, and $4,463,000 was
recognized in 2001, 2000, and 1999, respectively.
Upon the sale or retirement of a complete unit of proved property, the cost
and related accumulated depreciation, depletion, impairment, and amortization
are eliminated from the property accounts, and the resulting gain or loss is
recognized.
ENVIRONMENTAL
The Company is subject to extensive federal, state, and local environmental
laws and regulations. These laws, which are constantly changing, regulate the
discharge of materials into the environment and may require the Company to
remove or mitigate the environmental effect of the disposal or release of
petroleum or chemical substances at various sites. Environmental expenditures
are expensed or capitalized depending on their future economic benefit.
Expenditures that relate to an existing condition caused by past operations and
that have no future economic benefit are expensed. Liabilities for expenditures
of a noncapital nature are recorded when environmental assessment and/or
remediation is probable, and the costs can be reasonably estimated.
F-8
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
INCOME TAXES
The Company accounts for income taxes under the asset and liability method,
which requires that deferred tax assets and liabilities be recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using the
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in the tax rates is
recognized in income in the period that includes the enactment date. Total
deferred tax assets are reduced by a valuation allowance to an amount that in
management's judgment is more likely than not to be realized as a future tax
benefit. The provision for deferred tax expense or benefit is the change during
the period in the deferred tax assets, net of any valuation allowance, and
liabilities.
DEFERRED FINANCING COSTS
Facility fees incurred in conjunction with the establishment of various
debt facilities are deferred and are amortized as additional interest expense
over the maturity period of the related debt (see note 5).
EARNINGS PER SHARE
Basic earnings per share is computed by dividing income (loss) available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is computed in the same manner as
basic earnings per share except that the denominator is increased to include the
number of additional common shares that could have been outstanding assuming the
conversion of Redeemable Preferred Stock (see note 8) which have a dilutive
effect on earnings per share. For the years ended December 31, 2001 and 1999,
the Company excluded all potentially dilutive securities, as a net loss was
incurred during the periods.
CASH EQUIVALENTS AND STATEMENTS OF CASH FLOWS
For purposes of the statements of cash flows, highly liquid investments
with original maturities of three months or less are considered cash
equivalents. At December 31, 2001, 2000, and 1999, interest bearing cash
equivalents were approximately $1,000,000, $6,300,000, and $10,700,000,
respectively.
CONCENTRATION OF CREDIT RISK
A portion of the Company's oil and natural gas production revenues are
derived from uncollateralized sales to customers in the oil and natural gas
industry. The concentration of credit risk within a single industry affects the
Company's overall exposure to credit risk as the industry may be similarly
affected by changes in economic and other conditions. During November 2001, the
Company sold natural gas production to ENA Upstream Company LLC, an indirect
subsidiary of Enron Corp. ENA Upstream Company LLC filed for bankruptcy
protection under Chapter 11 of the Federal Bankruptcy Code in January 2002. The
Company recorded an allowance associated with such receivable of approximately
$414,000 as of December 31, 2001.
DERIVATIVE INSTRUMENTS
During 2001, the Company entered into a number of commodity option
contracts to reduce exposure to fluctuations in the price of natural gas. The
contracts consisted of cash settled natural gas put options. The natural gas put
options were settled based on the average of the reported settlement price for
the last three scheduled trading days of the NYMEX Henry Hub Natural Gas Futures
Contracts for the applicable settlement period. The counterparty was required to
make a payment to the Company if the settlement price
F-9
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
for any settlement period was below the target price specified in the put option
contract. Premiums associated with entering into such transactions were
approximately $1,452,000 and the Company recognized gains from increases in the
intrinsic value of the derivative instruments of approximately $3,007,000 as a
result of the settlement price being below the target price specified in the
applicable contract. The Company did not designate the commodity option
contracts as cash flow hedges under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities which the Company adopted January 1, 2001.
The Company had no derivative instruments in 2000 or 1999.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities,
as well as the reported amounts of revenues and expenses and reserve information
which affects the depreciation, depletion, and amortization calculation and the
measurement of impairment of the carrying amount of proved oil and gas
properties on total capitalized costs. Actual results could differ from those
estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period amounts for
comparability with current year presentation.
(3) SALES OF OIL AND NATURAL GAS PROPERTIES
During 2001, 2000, and 1999, the Company sold its interests in certain
domestic proved oil and natural gas properties in unrelated transactions with
third parties. The oil and natural gas property sales had a positive impact on
the Company's liquidity and capital resources and resulted in substantial gains
to the Company.
The following chronological table lists such sales for the years ended
December 31, 2001, 2000, and 1999, respectively, with the corresponding gain or
loss:
YEAR ENDED DECEMBER 31, 2001 CASH PROCEEDS GAIN/(LOSS)
---------------------------- ------------- -----------
October 2001................................................ $10,601,000 $6,277,000
Net adjustments to prior year's sales....................... 216,000 180,000
----------- ----------
$10,817,000 $6,457,000
=========== ==========
During 2001, the Company sold the interest it owned in East Cameron Block
76 associated with an oil and natural gas discovery that was the product of
exploratory drilling activities during the year ended December 31, 2001.
YEAR ENDED DECEMBER 31, 2000 CASH PROCEEDS GAIN/(LOSS)
---------------------------- ------------- -----------
April 2000................................................. $ 10,000 $ 10,000
June 2000.................................................. 56,458,000 27,663,000
Net adjustments to prior year's sales...................... -- 61,000
----------- -----------
$56,468,000 $27,734,000
=========== ===========
F-10
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
During 2000, the Company sold the interests it owned in South Pelto Block
17, East Cameron Blocks 88 and 89 and High Island Block A-442 associated with
oil and natural gas discoveries made by the Company through the closing date of
the sale.
YEAR ENDED DECEMBER 31, 1999 CASH PROCEEDS GAIN/(LOSS)
---------------------------- ------------- -----------
June 1999.................................................. $ 194,000 $ 194,000
November 1999.............................................. 19,151,000 17,651,000
Net adjustments to prior year's sales...................... 1,429,000 (363,000)
----------- -----------
$20,774,000 $17,482,000
=========== ===========
The Company sold two overriding royalty interests in June of 1999 and the
Company sold the interest it owned in West Cameron Block 587 in November of 1999
associated with an oil and natural gas discovery which was the product of
exploratory drilling activities during the year.
The Company has indemnified the purchasers of the oil and natural gas
properties against certain title defects, environmental and property tax claims,
and any other related liens accruing to the oil and natural gas properties sold
through the respective sales' closing dates. Management does not believe such
indemnification obligations will have a material adverse impact on the Company's
financial condition.
(4) NOTES PAYABLE
The following details the Company's short-term borrowings as of December
31, 2001:
2001
----------
Note payable bearing interest at 10%, due January 31, 2002,
secured by certain interests in oil and natural gas
properties (see note 12).................................. $4,000,000
Note payable due in monthly installments through October
2002, including interest at 5.77%, unsecured.............. 1,365,000
Note payable to a commercial bank, bearing interest at
2.89%, due May 21, 2002, guaranteed by related parties
(see note 12)............................................. 2,000,000
----------
$7,365,000
==========
The Company had no short-term borrowings outstanding at December 31, 2000.
(5) LONG-TERM DEBT
The following details the Company's long-term debt as of December 31, 2001
and 2000:
2001 2000
----------- -----------
2000 Exploration and Development Facility.................. $30,600,000 $15,600,000
South Timbalier Block 185 Facility......................... 14,619,000 20,400,000
East Cameron Block 161 Facility............................ 13,846,000 --
East Cameron Block 263 Facility............................ 10,891,000 --
West Cameron Block 431 Facility............................ 10,200,000 --
----------- -----------
$80,156,000 $36,000,000
=========== ===========
F-11
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
2000 EXPLORATION AND DEVELOPMENT FACILITY
During September 2000, the Company completed a financing referred to as the
"Hall-Houston 2000 Exploration and Development Facility" (2000 Facility) through
the private placement of $30,600,000 of 2000 12% Senior Exploration and
Development Facility Notes (2000 Notes). The 2000 Notes were issued by the
Company pursuant to a Note Purchase and Sale Agreement effective September 1,
2000 which also provided for the Note Purchasers to have rights to overriding
royalty interests in certain oil and natural gas properties. The 2000 Facility
is intended to provide financing for oil and natural gas exploration and
development costs incurred by the Company within the United States of America.
The 2000 Facility was established with a revolving credit facility feature
(2000 Revolver). The 2000 Revolver is scheduled to terminate on December 31,
2002, at which time the 2000 Revolver converts to a term loan (2000 Term Loan)
maturing on December 31, 2004. Through the term of the 2000 Revolver, amounts
advanced under the 2000 Notes and subsequently repaid are available to be
redrawn. The obligations under the 2000 Notes represent a general corporate
obligation of the Company, but no financial covenant compliance or reserve
coverage ratio obligations are imposed on the Company.
Outstanding advances under the 2000 Notes bear interest at 12% per annum
payable quarterly in arrears beginning September 30, 2000. A facility fee of 2%
of the amount committed by each purchaser was added to each purchaser's
outstanding principal amount of the loan and the facility fee bears interest at
12% per annum payable quarterly in arrears. A commitment fee of 1/2 of 1% per
annum on the undrawn commitment amount is also payable quarterly in arrears. As
of December 31, 2001, amounts outstanding under the 2000 Facility totaled
$30,600,000 inclusive of the $600,000 facility fee.
During the term of the 2000 Revolver, amounts advanced under the 2000 Notes
are deposited in a cash collateral account, with such funds being available only
for the payment of domestic oil and natural gas exploration and development
costs incurred by the Company and for the payment of principal and accrued
interest outstanding thereunder. Upon conversion of the 2000 Revolver to the
2000 Term Loan, funds in the collateral account will be available to the Company
only for the payment of principal and accrued interest outstanding under the
2000 Notes.
Also during the term of the 2000 Revolver, the Company is required to
deposit into the cash collateral account 50% of the net cash flow from
production operations conducted on the Company's domestic oil and natural gas
properties, subject to certain exclusions, and 50% of the net cash proceeds
received by the Company from the sale of an interest in any such property or the
sale of a production payment created out of any such interest, subject to
certain exclusions, until the amount then deposited in the cash collateral
account equals the outstanding balance of principal and accrued interest. Upon
conversion of the 2000 Revolver to the 2000 Term Loan, the required amount to be
deposited into the cash collateral account increases from 50% to 75%. During the
2000 Term Loan period, funds on deposit in the cash collateral account will be
distributed not less frequently than quarterly to the holders of the 2000 Notes
in payment of outstanding principal and accrued interest. The 2000 Term Loan
period will continue until the earlier of the 2000 Notes having been paid in
full or December 31, 2004, at which time outstanding advances, facility fees,
accrued interest, and commitment fees under the 2000 Notes will be repaid and
the 2000 Facility will terminate.
The payment and other obligations under the 2000 Notes are collateralized
by the funds held in the cash collateral account. Upon request of those holders
of 2000 Notes representing in excess of 50% of the 2000 Facility amount, the
Company will collateralize the payment and other obligations under the 2000
Facility with mortgages covering its domestic oil and natural gas properties
representing not less than 85% of the value associated with the Company's
interest in all of its domestic oil and natural gas properties, subject to
certain exclusions. The value of the Company's domestic oil and natural gas
properties is calculated from the estimated pre-tax future cash flow from all
categories of proved, probable, and possible reserves, discounted at
F-12
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
a 10% per annum discount rate, attributable to the net revenue interest of the
Company in those oil and natural gas properties. To the extent required, the
calculation will be made by the Company as of the end of each calendar quarter
and will be based on the most recent independent engineering report and
internally generated engineering reports, supplements, and updates. The Company
has the right to terminate the 2000 Facility and repay outstanding advances,
facility fees, accrued interest, and commitment fees at any time prior to its
scheduled termination date. In connection with any such termination, the balance
of any funds on deposit in the cash collateral account for the 2000 Facility
will be released to the Company and all mortgages and other security interests
will be released.
Generally, holders of the 2000 Notes also acquired rights to receive
overriding royalty interests in the oil and natural gas properties on which
funds from the cash collateral account for the 2000 Facility are spent. The
right to an overriding royalty interest on any particular property is fully
earned when the overriding royalty interest is created and the overriding
royalty interest survives the repayment of the 2000 Notes. Overriding royalty
interests are earned on a property acquisition with existing production at the
time of acquisition, if the acquisition is paid for with funds from the cash
collateral account for the 2000 Facility. Overriding royalty interests are
earned in respect to other oil and natural gas properties when funds associated
with the 2000 Facility are drawn from the cash collateral account for the
payment of oil and natural gas exploration or development activities on such
properties. The amount of the overriding royalty interest on each property is 2%
proportionately reduced to the Company's interest in that property, subject to
further reduction in certain instances.
SOUTH TIMBALIER BLOCK 185 FACILITY
During June 2000, the Company completed a financing referred to as the
"Hall-Houston South Timbalier Block 185 Facility" (ST 185 Facility) through the
private placement of $20,400,000 of South Timbalier Block 185 12% Senior Secured
Facility Notes (ST 185 Notes). The ST 185 Notes were issued by the Company
pursuant to a Note Purchase and Sale Agreement (ST 185 Agreement) effective June
1, 2000. Amounts outstanding under the ST 185 Facility are secured by mortgages
covering all of the Company's mortgageable leasehold and other interests and
rights in that portion of South Timbalier Block 185 containing oil and natural
gas reserves associated with the discovery well drilled thereon by the Company
in 1999 (ST 185 Dedicated Reserves). The ST 185 Agreement also provides for such
purchasers to be paid an amount equal to the production proceeds that would be
attributable to a 2% overriding royalty interest in the ST 185 Dedicated
Reserves proportionately reduced to the Company's interest in the property (ST
185 Nominal Overriding Royalty Interest). The proceeds from the ST 185 Facility
provided general working capital to the Company.
Within 30 days of the ST 185 Notes being repaid and the ST 185 Facility
being terminated, the holders of the ST 185 Notes will be paid an amount equal
to the value of the ST 185 Nominal Overriding Royalty Interest at such time. If
the repayment of the loan is in connection with the sale of the Company's
interest in South Timbalier Block 185, the value of such ST 185 Nominal
Overriding Royalty Interest will be that portion of the purchase price allocated
thereto by the purchaser of such interest. If the repayment of the loan is other
than in connection with the sale of such interest, the value of such ST 185
Nominal Overriding Royalty Interest will be determined based upon the future
cash flow attributable to the ST 185 Dedicated Reserves discounted at 25% per
annum, as determined in good faith by the Company based upon the most recent
estimates of proved and probable reserves and production rates using production
prices determined as of the close of business on the third business day prior to
the date of repayment based on the forward 12 month New York Mercantile Exchange
strip prices of oil or natural gas, as the case may be, escalated at 3% per
annum thereafter, less estimated transportation and other allowable costs.
F-13
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
The ST 185 Notes mature on December 31, 2003, include a facility fee equal
to 2% of the amount committed by each purchaser and bear interest at 12% per
annum. Interest at 12% and the ST 185 Nominal Overriding Royalty Interest
payment accruing through September 30, 2000 were paid November 14, 2000.
Thereafter quarterly payments in an amount equal to 75% of the Company's net
revenue received during the relevant calendar quarter from the sale of ST 185
Dedicated Reserves plus the amount due in respect of the ST 185 Nominal
Overriding Royalty Interest are payable 45 days after the end of each calendar
quarter. Payments associated with such 75% of net revenue calculation are
applied first to interest and then to the principal balance. As of December 31,
2001 amounts outstanding under the ST 185 Facility totaled approximately
$14,619,000 inclusive of the $400,000 facility fee.
EAST CAMERON BLOCK 161 FACILITY
During January 2001, the Company completed a financing referred to as the
"Hall-Houston East Cameron Block 161 Facility" (EC 161 Facility) through the
private placement of $15,300,000 of East Cameron Block 161 12% Senior Secured
Facility Notes (EC 161 Notes). The EC 161 Notes were issued by the Company
pursuant to a Note Purchase and Sale Agreement (EC 161 Agreement) effective
January 15, 2001. Amounts outstanding under the EC 161 Facility are secured by
mortgages covering all of the Company's mortgageable leasehold and other
interests and rights in that portion of East Cameron Block 161 containing oil
and natural gas reserves associated with the discovery wells drilled thereon by
the Company (EC 161 Dedicated Reserves). The EC 161 Agreement also provides for
such purchasers to be paid an amount equal to the production proceeds that would
be attributable to a 2% overriding royalty interest in the EC 161 Dedicated
Reserves proportionately reduced to the Company's interest in the property (EC
161 Nominal Overriding Royalty Interest). The proceeds from the EC 161 Facility
provided general working capital to the Company.
Within 30 days of the EC 161 Notes being repaid and the EC 161 Facility
being terminated, the holders of the EC 161 Notes will be paid an amount equal
to the value of the EC 161 Nominal Overriding Royalty Interest at such time. If
the repayment of the loan is in connection with the sale of the Company's
interest in East Cameron Block 161, the value of such EC 161 Nominal Overriding
Royalty Interest will be that portion of the purchase price allocated thereto by
the purchaser of such interest. If the repayment of the loan is other than in
connection with the sale of such interest, the value of such EC 161 Nominal
Overriding Royalty Interest will be determined based upon the future cash flow
attributable to EC 161 Dedicated Reserves discounted at 25% per annum, as
determined in good faith by the Company based upon the most recent estimates of
proved and probable reserves and production rates and operating and capital
costs and using production prices based on the first day of the calendar quarter
in which such full and final payment occurs based on all the forward monthly
prices on the New York Mercantile Exchange for oil or natural gas, as the case
may be, escalated at 3% per annum thereafter, less estimated transportation and
other allowable costs.
The EC 161 Notes mature on December 31, 2003, include a facility fee equal
to 2% of the amount committed by each purchaser and bear interest at 12% per
annum. Interest at 12% and the EC 161 Nominal Overriding Royalty Interest
payment accruing through March 31, 2001 was paid May 15, 2001. Thereafter
quarterly payments in an amount equal to 75% of the Company's net revenue
received during the relevant calendar quarter from the sale of EC 161 Dedicated
Reserves plus the amount due in respect of the EC 161 Nominal Overriding Royalty
Interest are payable 45 days after the end of each calendar quarter. Payments
associated with such 75% of net revenue calculation are applied first to
interest and then to the principal balance. As of December 31, 2001, amounts
outstanding under the EC 161 Facility totaled approximately $13,846,000
inclusive of the $300,000 facility fee.
F-14
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
EAST CAMERON BLOCK 263 FACILITY
During April 2001, the Company completed a financing referred to as the
"Hall-Houston East Cameron Block 263 Facility" (EC 263 Facility) through the
private placement of $11,220,000 of East Cameron Block 263 12% Senior Secured
Facility Notes (EC 263 Notes). The EC 263 Notes were issued by the Company
pursuant to a Note Purchase and Sale Agreement (EC 263 Agreement) effective
March 1, 2001. Amounts outstanding under the EC 263 Facility are secured by
mortgages covering all of the Company's mortgageable leasehold and other
interests and rights in that portion of East Cameron Block 263 containing oil
and natural gas reserves associated with the discovery wells drilled thereon by
the Company (EC 263 Dedicated Reserves). The EC 263 Agreement also provides for
such purchasers to be paid an amount equal to the production proceeds that would
be attributable to a 2% overriding royalty interest in the EC 263 Dedicated
Reserves proportionately reduced to the Company's interest in the property (EC
263 Nominal Overriding Royalty Interest). The proceeds from the EC 263 Facility
provided general working capital to the Company.
Within 30 days of the EC 263 Notes being repaid and the EC 263 Facility
being terminated, the holders of the EC 263 Notes will be paid an amount equal
to the value of the EC 263 Nominal Overriding Royalty Interest at such time. If
the repayment of the loan is in connection with the sale of the Company's
interest in East Cameron Block 263, the value of such EC 263 Nominal Overriding
Royalty Interest will be that portion of the purchase price allocated thereto by
the purchaser of such interest. If the repayment of the loan is other than in
connection with the sale of such interest, the value of such EC 263 Nominal
Overriding Royalty Interest will be determined based upon the future cash flow
attributable to the EC 263 Dedicated Reserves discounted at 25% per annum, as
determined in good faith by the Company based upon the most recent estimates of
proved and probable reserves and production rates and operating and capital
costs and using production prices based on the first day of the calendar quarter
in which such full and final payment occurs based on all the forward monthly
prices on the New York Mercantile Exchange for oil or natural gas, as the case
may be, escalated at 3% per annum thereafter, less estimated transportation and
other allowable costs.
The EC 263 Notes mature on March 31, 2004, include a facility fee equal to
2% of the amount committed by each purchaser and bear interest at 12% per annum.
Interest at 12% and the EC 263 Nominal Overriding Royalty Interest payment
accruing through April 30, 2001 was paid June 15, 2001. Thereafter quarterly
payments in an amount equal to 75% of the Company's net revenue received during
the relevant calendar quarter from the sale of EC 263 Dedicated Reserves plus
the amount due in respect of the EC 263 Nominal Overriding Royalty Interest are
payable 45 days after the end of each calendar quarter. Payments associated with
such 75% of net revenue calculation are applied first to interest and then to
the principal balance (the payment for the calendar quarter ending June 30, 2001
related to net revenues received in May and June of 2001). As of December 31,
2001, amounts outstanding under the EC 263 Facility totaled approximately
$10,891,000 inclusive of the $220,000 facility fee.
WEST CAMERON BLOCK 431 FACILITY
During September 2001, the Company completed a financing referred to as the
"Hall-Houston West Cameron Block 431 Facility" (WC 431 Facility) through the
private placement of $10,200,000 of West Cameron Block 431 12% Senior Secured
Facility Notes (WC 431 Notes). The WC 431 Notes were issued by the Company
pursuant to a Note Purchase and Sale Agreement (WC 431 Agreement) effective July
16, 2001. Amounts outstanding under the WC 431 Facility are secured by mortgages
covering all of the Company's mortgageable leasehold and other interests and
rights in that portion of West Cameron Block 431 containing oil and natural gas
reserves associated with the discovery well drilled thereon by the Company (WC
431 Dedicated Reserves). The WC 431 Agreement also provides for such purchasers
to be paid an amount equal to the production proceeds that would be attributable
to a 2% overriding royalty interest in the WC 431 Dedicated Reserves
proportionately reduced to the Company's interest in the property (WC 431
F-15
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
Nominal Overriding Royalty Interest). The proceeds from the WC 431 Facility
provided general working capital to the Company.
Within 30 days of the WC 431 Notes being repaid and the WC 431 Facility
being terminated, the holders of the WC 431 Notes will be paid an amount equal
to the value of the WC 431 Nominal Overriding Royalty Interest at such time. If
the repayment of the loan is in connection with the sale of the Company's
interest in West Cameron Block 431, the value of such WC 431 Nominal Overriding
Royalty Interest will be that portion of the purchase price allocated thereto by
the purchaser of such interest. If the repayment of the loan is other than in
connection with the sale of such interest, the value of such WC 431 Nominal
Overriding Royalty Interest will be determined based upon the future cash flow
attributable to the WC 431 Dedicated Reserves discounted at 25% per annum, as
determined in good faith by the Company based upon the most recent estimates of
proved and probable reserves and production rates and capital costs and using
production prices on the first day of the calendar quarter in which the full and
final payment occurs based on all of the forward monthly prices on the New York
Mercantile Exchange for oil or natural gas, as the case may be, escalated at 3%
per annum thereafter, less estimated transportation and other allowable costs.
The WC 431 Notes mature on March 31, 2004, include a facility fee equal to
2% of the amount committed by each purchaser and bear interest at 12% per annum
payable in quarterly installments due and payable 45 days after the end of each
calendar quarter. The first three such quarterly installments shall be in the
aggregate amount of accrued and unpaid interest on the loan balance through the
end of the relevant calendar quarter. Thereafter quarterly payments in an amount
equal to 75% of the Company's net revenue received during the relevant calendar
quarter from the sale of WC 431 Dedicated Reserves plus the amount due in
respect of the WC 431 Nominal Overriding Royalty Interest are payable 45 days
after the end of each calendar quarter. Payments associated with such 75% of net
revenue calculation are applied first to interest and then to the principal. As
of December 31, 2001, amounts outstanding under the WC 431 Facility totaled
$10,200,000 inclusive of the $200,000 facility fee.
1996 EXPLORATION AND DEVELOPMENT FACILITY
On November 25, 1996, the Company completed a financing referred to as the
"Hall-Houston 1996 Exploration and Development Facility" (1996 Facility) through
the private placement of $35,000,000 of 1996 12% Senior Secured Exploration and
Development Facility Notes (1996 Notes), $1,500,000 of which was subscribed for
by the Hall-Houston Employee Royalty Trust (see note 11). The 1996 Notes were
issued by the Company pursuant to a Note Purchase and Sale Agreement (1996
Agreement) dated November 1, 1996 which also provided for such purchasers to
have rights to overriding royalty interests in certain oil and natural gas
properties. The 1996 Facility provided financing for oil and natural gas
exploration and development costs incurred by the Company within the domestic
United States of America.
The 1996 Facility was established with a revolving credit facility feature
(1996 Revolver). Under the terms of the 1996 Agreement, in December 1998, the
Company received approval to extend the 1996 Revolver for a one-year period
resulting in a scheduled commitment termination date of December 31, 1999 at
which time the 1996 Revolver converted to a term loan (1996 Term Loan) maturing
on December 31, 2001. Through the term of the 1996 Revolver, amounts advanced
under the 1996 Notes and subsequently repaid were available to be redrawn. The
obligations under the 1996 Notes represent a general corporate obligation of the
Company, but no financial covenant compliance or reserve coverage ratio
obligations are imposed on the Company. On June 8, 2000, the Company paid in
full amounts outstanding under the 1996 Notes and the 1996 Facility terminated.
In connection with such termination, the balance of any funds on deposit in the
cash collateral account for the 1996 Facility were released to the Company and
all mortgages and other security interests were released.
F-16
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
Outstanding advances under the 1996 Notes bore interest at 12% per annum
payable quarterly in arrears beginning January 30, 1997. A commitment fee of
1/2 of 1% per annum on the undrawn commitment amount was also payable quarterly
in arrears. During the term of the 1996 Revolver, amounts advanced under the
1996 Notes were deposited in a cash collateral account with such funds being
available only for the payment of domestic oil and natural gas exploration and
development costs incurred by the Company and for the payment of principal and
accrued interest outstanding thereunder.
Holders of the 1996 Notes also acquired rights to receive overriding
royalty interests in the oil and natural gas properties on which funds from the
cash collateral account for the 1996 Facility were spent. The right to an
overriding royalty interest on any particular property was fully earned when the
overriding royalty interest was created and the overriding royalty interest
survives the repayment of the 1996 Notes. The amount of the overriding royalty
interest on each property was 4%, proportionately reduced to the Company's
interest in that property.
1999 ACQUISITION AND DEVELOPMENT FACILITY
On September 15, 1999, the Company completed a financing referred to as the
"Hall-Houston 1999 Acquisition and Development Facility" (1999 Facility) through
the private placement of $15,000,000 of 1999 12% Senior Secured East Cameron
Blocks 88 and 89 Acquisition and Development Facility Notes (1999 Notes). The
1999 Notes were issued by the Company pursuant to a Note Purchase and Sale
Agreement (1999 Agreement) dated September 1, 1999. Quarterly payments in an
amount equal to 75% of the Company's net revenue from East Cameron Blocks 88 and
89 were payable 45 days after the end of each calendar quarter and payments were
applied first to interest and then to the principal balance.
The 1999 Agreement also provided for such purchasers to have rights to a 3%
overriding royalty interest in East Cameron Blocks 88 and 89. Amounts advanced
under the 1999 Notes were deposited in a cash collateral account with such funds
being available only for the acquisition of an additional interest in the East
Cameron Blocks 88 and 89 and for further development of the East Cameron 88 and
89 Blocks. On June 8, 2000, the Company paid in full amounts outstanding under
the 1999 Notes and the 1999 Facility terminated.
(6) PRODUCTION PAYMENTS
During 2001, 2000, and 1999, the Company was subject to volumetric
production payment obligations created in favor of KCS Energy Services, Inc.
(KCS Services) and KCS Energy Marketing, Inc. These obligations were created and
subsequently supplemented between September 1994 and August 2000 in exchange for
advance payments to the Company aggregating approximately $125,628,000. Of this
amount, approximately $12,219,000 was received in 1994, approximately
$20,181,000 was received in 1995, approximately $6,562,000 was received in 1996,
approximately $17,370,000 was received in 1997, approximately $45,821,000 was
received in 1998, approximately $17,765,000 was received in 1999 and the balance
of $5,710,000 was received in 2000. These proceeds were received in exchange for
the obligation to deliver a specified volume of natural gas production that, in
the aggregate for the production payments, totaled 73,136,351 million British
thermal units (MMbtu).
Under the terms of these production payments, the aggregate delivery
obligation from the committed oil and natural gas properties commenced in
December 1994, continues through December 2002 and varies from month to month
during that period, with recourse for the delivery obligation associated with
each production payment being limited solely to the Company's interests in the
oil and natural gas properties committed to that production payment (a number of
oil and natural gas properties have depleted subsequent to being committed to
the production payments). In August 1998, the Company sold a number of oil and
natural gas properties committed to the production payment obligation. The buyer
of the oil and natural gas properties assumed
F-17
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
delivery obligations of 29,606,288 MMbtu, and the Company was released from
these future delivery obligations. Natural gas volumes are to be delivered from
the Company's interest in the oil and natural gas properties committed to the
production payment (at December 31, 2001, these included interests in East
Cameron Block 160, High Island Block A-327, South Pelto Block 18, Vermilion
Block 320 and West Cameron Block 149). The Company is scheduled to deliver
2,474,741 MMbtu during 2002 in fulfillment of the Company's remaining future
delivery obligations under the volumetric production payments. Deferred revenue
of approximately $4,055,000 and $12,303,000 at December 31, 2001 and 2000,
respectively relates to the production payments and such amounts are amortized
to natural gas revenues as production volumes are delivered to KCS Services.
During January 2000, KCS Services filed for bankruptcy protection under
Chapter 11 of the Federal Bankruptcy Code. During February 2001, KCS Services
emerged from bankruptcy. Management of the Company does not believe that this
will have any adverse impact on the Company's operations.
(7) FAIR VALUE OF FINANCIAL INSTRUMENTS
For purposes of estimating the fair value of financial instruments, the
Company has determined that the carrying amounts recorded on the balance sheet
approximate the fair value for cash and cash equivalents, accounts receivable
and current liabilities. In making this determination, the Company considered
the short-term maturity of those assets and liabilities. The following table
details the carrying value and approximate fair value of the Company's long-term
debt at December 31, 2001 and 2000.
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------------ ------------------------------
CARRYING APPROXIMATE FAIR CARRYING APPROXIMATE FAIR
VALUE VALUE VALUE VALUE
----------- ---------------- ----------- ----------------
Long-term debt (see note
5)........................ $80,156,000 $80,156,000 $36,000,000 $40,203,000
The fair value of the fixed-rate long-term debt as of December 31, 2001 was
estimated by assessing the consideration received by holders of such long-term
debt in the Energy Partners, Ltd. merger and acquisition of the Company (see
note 17) and the consideration received by holders of such long-term debt who
did not elect to participate in the merger and acquisition. The fair value of
the fixed-rate long-term debt as of December 31, 2000 was estimated by
discounting the principal and interest payments at rates available for debt of
similar terms and maturity.
(8) MANDATORILY REDEEMABLE PREFERRED STOCK
The Company is authorized to issue up to 5,000,000 shares of Redeemable
Preferred Stock with a $0.01 par value per share and a $100 liquidation value
per share. Issued and outstanding shares were 180,038 at December 31, 2001 and
2000, respectively. The Redeemable Preferred Stock has the following features:
(i) a dividend rate of $10 per share per annum, payable quarterly; (ii)
dividends could, at the Company's option, be paid through September 1998 in
shares of Redeemable Preferred Stock at a price of $100 per share; and (iii)
dividends in arrears accrue at a rate of $12.50 per share per annum until such
dividends in arrears are paid. The Company has been in arrears in payment of
cash dividends on its Redeemable Preferred Stock since July 30, 2001 and as of
December 31, 2001 accrued dividends in arrears total approximately $1,688,000
which are included in the accompanying 2001 consolidated balance sheet in
accounts payable and accrued liabilities.
The holders of the Redeemable Preferred Stock are entitled to elect three
directors to the board of directors. The board of directors is restricted to
nine members with the balance of up to six members to be elected by the holders
of Series A Common Stock. Each share of Redeemable Preferred Stock is currently
convertible into 15.87 shares of the Company's Series A Common Stock.
F-18
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
The Company currently can, at its option, redeem on a non pro-rata basis
the Redeemable Preferred Stock at a redemption price of $100 per share plus
accrued and unpaid dividends. Optional redemption offers to any management
shareholder (defined as Gary L. Hall, Wayne P. Hall or Bruce R. Sidner) may only
be made on a pro-rata basis to all holders. At December 31, 2001 and 2000, the
Redeemable Preferred Stock was subject to mandatory redemption in three equal
installments on August 15, 2001, 2002, and 2003 with a redemption price of $100
per share plus accrued and unpaid dividends. The Company was statutorily unable
to redeem one-third of the outstanding Redeemable Preferred Stock on August 15,
2001 as provided by its terms.
(9) STOCK WARRANTS
Warrants to purchase 1,577,521 shares of Series B Nonvoting Common Stock
expired unexercised on August 15, 2001. Such warrants had been outstanding with
a predecessor of Chase Bank and had been issued in connection with a prior
lending transaction. The warrants had an initial exercise price of $5.00 per
share, subject to adjustment, and were exercisable during the ten-year period
following their issuance.
(10) EARNINGS PER SHARE
Presented below is a reconciliation of income and shares for purposes of
computing basic and diluted earnings per share.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2001 2000 1999
------------------------ ----------------------- ------------------------
LOSS SHARES INCOME SHARES LOSS SHARES
------------ --------- ----------- --------- ------------ ---------
Income (loss) per common
share -- basic......... $(17,362,000) 3,175,489 $20,084,000 3,175,489 $(18,426,000) 3,175,489
Convertible preferred
stock.................. -- -- 1,913,000 2,857,203 -- --
Income (loss) per common
share -- diluted....... $(17,362,000) 3,175,489 $21,997,000 6,032,692 $(18,426,000) 3,175,489
For all periods presented, the stock warrants were considered to be
anti-dilutive in computing diluted earnings per share.
(11) HALL-HOUSTON EMPLOYEE ROYALTY TRUST
In 1988, the Company established a grantor trust (Employee Royalty Trust)
for the purpose of providing deferred compensation for management and employees
and subsequently transferred to the Employee Royalty Trust certain overriding
royalty interests in unproved oil and natural gas leases. The Employee Royalty
Trust is consolidated with the Company for financial statement and income tax
purposes.
During 2000, the Employee Royalty Trust sold its overriding royalty
interests in certain oil and natural gas properties to an unaffiliated purchaser
for approximately $136,000 and increased its deferred compensation obligation by
the same amount. The gains on the sale of Employee Royalty Trust overriding
royalty interests and the related employee compensation in an equal amount are
eliminated for financial reporting purposes. In addition, during 2001 and 2000
the Employee Royalty Trust received distributions of approximately $48,000 and
$50,000, respectively, from a trust associated with the Company's 1996 Facility
(see note 5) and increased its deferred compensation obligation by the same
amount. The distributions and the related employee compensation in an equal
amount are eliminated for financial reporting purposes. During 2000, the
Employee Royalty Trust distributed approximately $1,036,000 as compensation to
management and employees in the form of cash bonuses.
F-19
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
During 1996, the Employee Royalty Trust participated in the Company's 1996
Facility (see note 5) by committing to advance funds, with such borrowings to be
evidenced by a $1,500,000 1996 Note issued by the Company. The Company repaid
all amounts outstanding to the Employee Royalty Trust under such borrowing and
interest of approximately $79,000 during 2000. In addition, during 2001 and 2000
the Employee Royalty Trust made short-term loans to the Company for $5,800,000,
which bear interest at prime plus 3% per annum. On January 15, 2002, the
Employee Royalty Trust sold the promissory notes totaling $5,800,000, including
the right to payment of all indebtedness (both principal and interest), and
overriding royalty interests it held to Energy Partners, Ltd. (see note 17). The
Company paid interest of approximately $159,000 associated with such borrowings
during 2000. The note receivable of the Employee Royalty Trust and the note
payable of the Company to the Employee Royalty Trust have been eliminated for
financial reporting purposes. As of December 31, 2001 and 2000, the Employee
Royalty Trust held cash of approximately $267,000 and $56,000, respectively. In
addition, as of December 31, 2000, the Employee Royalty Trust had investments of
approximately $19,000 available for distribution.
(12) RELATED PARTY TRANSACTIONS
During 2001, an entity affiliated with a director of the Company made a
short-term loan to the Company of $5,000,000 (see note 4) of which $4,000,000
had been advanced and was outstanding as of December 31, 2001. The Note is due
on January 31, 2002, bears interest at 10% per annum and is secured by the
Company's interest in certain oil and natural gas properties.
During 2001, Wayne P. Hall and Bruce R. Sidner (each an officer, director,
and shareholder in the Company) and an entity affiliated with Gary L. Hall (an
officer, director, and controlling shareholder in the Company) guaranteed a loan
made to the Company by a commercial bank (see note 4), which guarantee was
collateralized by assets pledged by two such persons. Such parties received no
consideration for guaranteeing the Company's loan.
During 2001, an entity affiliated with a director of the Company
participated in the Company's WC 431 Facility (see note 5) by advancing
$4,000,000 with such borrowings being evidenced by a $4,080,000 WC 431 Note
inclusive of the $80,000 facility fee. As of December 31, 2001, amounts
outstanding thereunder totaled $4,080,000 inclusive of the facility fee. Terms
of such WC 431 Note were identical to those of other participants in the
Company's WC 431 Facility.
During 2001, an entity affiliated with a director of the Company
participated in the Company's EC 263 Facility (see note 5) by advancing
$1,920,000 with such borrowings being evidenced by a $1,958,400 EC 263 Note
inclusive of the $38,400 facility fee. As of December 31, 2001, amounts
outstanding thereunder totaled approximately $1,901,000 inclusive of the
facility fee. Terms of such EC 263 Note were identical to those of other
participants in the Company's EC 263 Facility.
During 2001, various officers and directors and entities affiliated with
them participated in the Company's EC 161 Facility (see note 5) by advancing
$8,000,000 with such borrowings being evidenced by $8,160,000 of EC 161 Notes
inclusive of the $160,000 facility fee. As of December 31, 2001, amounts
outstanding thereunder totaled approximately $7,384,000 inclusive of the
facility fee. Terms of such EC 161 Notes were identical to those of other
participants in the Company's EC 161 Facility.
During 2000, various officers and directors and entities affiliated with
them participated in the Company's 2000 Facility (see note 5) by committing to
advance $10,500,000 with such borrowings being evidenced by $10,710,000 of 2000
Notes inclusive of the $210,000 facility fee. As of December 31, 2001, amounts
outstanding thereunder totaled $10,710,000 inclusive of the facility fee. Terms
of such 2000 Notes were identical to those of other participants in the
Company's 2000 Facility.
F-20
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
During 2000, various officers and directors and entities affiliated with
them participated in the Company's ST 185 Facility (see note 5) by advancing
$9,100,000 with such borrowings being evidenced by $9,282,000 of ST 185 Notes
inclusive of the $182,000 facility fee. As of December 31, 2001 amounts
outstanding thereunder totaled approximately $6,651,000 inclusive of the
facility fee. Terms of such ST 185 Notes were identical to those of other
participants in the Company's ST 185 Facility.
During 1999, a director, entities affiliated with an officer and an entity
affiliated with a director participated in the Company's 1999 Facility (see note
5) by advancing $6,350,000 with such borrowings being evidenced by $6,350,000 of
1999 Notes (which amount was repaid in full in 2000, with no amounts remaining
outstanding as of December 31, 2000). The terms of such 1999 Notes were
identical to those of other participants in the Company's 1999 Facility.
During 1999, an entity consisting primarily of various officers, directors,
and affiliated entities purchased for approximately $2,306,000 overriding
royalty interests in a number of oil and natural gas properties from the
Employee Royalty Trust (see note 11). The entity also purchased for
approximately $194,000 overriding royalty interests in two oil and natural gas
properties from the Company.
During 1996, various officers, directors, and affiliated entities (other
than the Employee Royalty Trust, which is discussed in note 11) participated in
the Company's 1996 Facility (see note 5) by committing to advance $16,800,000
(which was subsequently increased to approximately $16,852,000 in 1998), with
such borrowings being evidenced by $16,852,000 of 1996 Notes (under which
$16,849,000 had been advanced and was subsequently repaid in full in 2000, with
no amounts remaining outstanding as of December 31, 2000). The terms of such
1996 Notes were identical to those of other participants in the Company's 1996
Facility.
Gary L. Hall (an officer, director, and controlling shareholder in the
Company), certain of his relatives and affiliated entities, Bruce R. Sidner,
Wayne P. Hall, and John H. Peper (each an officer, director, and shareholder in
the Company) and entities affiliated with W.P. Dillard (a director and
shareholder of the Company) have participated as working interest owners in
various oil and natural gas properties in which the Company also owned and, in
certain instances presently owns, an interest. Amounts due from such persons
were approximately $381,000 and $358,000 as of December 31, 2001 and 2000,
respectively.
The Company has entered into master service agreements, master time charter
agreements and production management agreements with certain holders of the
Company's securities. In particular, the Company has such an agreement with a
entity affiliated with a member of the Company's board of directors. Under these
agreements, the relevant holders provide goods and services on a nonexclusive
basis as requested by the Company in its drilling and production operations. In
certain cases, amounts paid by the Company under these agreements are material
to the Company or relevant supplier. Amounts outstanding under such agreements
were approximately $3,108,000 and $471,000 as of December 31, 2001 and 2000,
respectively.
(13) INCOME TAXES
Components of income tax benefit for the years ended December 31, 2001,
2000, and 1999 are as follows:
2001 2000 1999
------------ ----------- ---------
Current expense (benefit)..................... $ (879,000) $ 1,049,000 $(122,000)
Deferred expense (benefit).................... (9,656,000) (2,791,000) --
------------ ----------- ---------
Total............................... $(10,535,000) $(1,742,000) $(122,000)
============ =========== =========
F-21
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
Reconciliations of the United States federal statutory rate to the
Company's effective rate of income (loss) are as follows:
PERCENTAGE OF PRETAX EARNINGS
------------------------------
2001 2000 1999
-------- -------- --------
Federal statutory rate..................................... (35.00)% 35.00% (35.00)%
Change in valuation allowance for deferred tax assets...... (3.52) (43.55) 34.25
Other...................................................... (2.38) (0.05) --
------ ------ ------
Effective tax rate......................................... (40.90)% (8.60)% (0.75)%
====== ====== ======
At December 31, 2001 the Company had entered into a merger agreement (see
note 17). The Company and the purchaser will make an election under IRC Section
338 to treat the sale of the Company as a sale of the Company's assets at which
time the Company will recognize a gain and will use a majority of its net
operating losses. Therefore, the Company recorded a benefit for a portion of its
deferred tax assets as of December 31, 2001. The Company has determined that it
is more likely than not that a portion of the deferred tax assets will not be
realized and has recorded a valuation allowance for those amounts. During 2001
and 2000, the valuation allowance decreased by approximately $907,000 and
$8,820,000, respectively.
The components of net deferred tax assets at December 31, 2001 and 2000 are
as follows:
2001 2000
----------- -----------
Net operating loss carryforwards........................... $ 7,964,000 $ --
Oil and natural gas property differences................... 4,744,000 3,428,000
Compensation accrual....................................... 2,304,000 1,979,000
Alternative minimum tax credits............................ 1,935,000 2,791,000
----------- -----------
16,947,000 8,198,000
Valuation allowance on deferred tax assets................. (4,500,000) (5,407,000)
----------- -----------
Net deferred tax assets.................................... $12,447,000 $ 2,791,000
=========== ===========
Temporary differences between the financial and tax basis of the Company's
deferred tax assets and liabilities are principally related to differences in
the financial statement amounts and tax basis amounts for oil and natural gas
properties due to differences in determining depletion, depreciation, and
amortization, intangible drilling costs, abandonments, and lease impairments.
The tax effect of alternative minimum tax credit carryforwards available to the
Company for tax purposes have been measured as deferred tax assets.
At December 31, 2001, the Company has approximately $22,755,000 in net
operating loss carryforwards, which expire beginning in the year 2012.
F-22
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
(14) LEASES
The Company leases office space under a noncancelable operating lease which
expires on April 30, 2002. The Company amended such lease agreement in 2002.
Future minimum annual lease payments are as follows under such amended
agreement:
RENTAL
PAYMENTS
----------
2002........................................................ $ 611,000
2003........................................................ 703,000
2004........................................................ 715,000
2005........................................................ 727,000
2006........................................................ 738,000
Thereafter.................................................. 1,767,000
----------
$5,261,000
==========
The Company incurred rent expense of approximately $423,000, $391,000, and
$396,000 during the years ended December 31, 2001, 2000, and 1999, respectively.
(15) EMPLOYEE BENEFIT PLAN
The Company has a 401(k) plan for the benefit of its employees. The
Company's contribution to the 401(k) plan is discretionary. The Company did not
elect to make a contribution for 2001 and the Company contribution committed for
2000 amounted to approximately $352,000. During 2001, the Company contributed
approximately $352,000 in cash in satisfaction of the Company's 2000 401(k)
contribution commitment.
(16) CONTINGENCIES
The Company has been named as a defendant in various lawsuits incidental to
the nature of its operations. There are also certain commitments and
uncertainties related to its normal operations or incidental to the property
sales previously made by the Company. Management believes that there are no
commitments, uncertainties or contingent liabilities that will have a material
adverse effect on the consolidated financial position or results of operations
of the Company, although it is possible that new information or future
developments could require the Company to reassess its potential exposure
related to these matters.
(17) AGREEMENT AND PLAN OF MERGER
On January 15, 2002, the Company was acquired by Energy Partners, Ltd.
(EPL) and became a wholly owned subsidiary of EPL.
Holders of the Company's long-term debt tendered approximately $76,742,000
of such debt in exchange for a combination of approximately $38,371,000 in
newly-issued EPL 11% Senior Subordinated Notes and approximately 383,707 shares
of newly-issued EPL Exchangeable Convertible Preferred Stock which has a
liquidation preference of $100 per share. The balance of the Company's
non-tendered debt of approximately $3,414,000 was retired for cash. Holders of
the Company's debt also received cash in payment of accrued interest of
approximately $2,841,000. Holders of classes of debt with nominal overriding
royalty interests (see note 5) also received approximately $984,000 in
accordance with the terms of the applicable credit facility.
Common shareholders exchanged their stock for $150,000 in cash and warrants
to purchase 1,000,000 shares of EPL common stock.
F-23
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
Redeemable Preferred shareholders exchanged their stock for $225,000 in
cash and warrants to purchase 1,500,000 shares EPL common stock. Redeemable
Preferred shareholders also received the right to 75% of contingent
consideration, the value of which will not exceed $50,000,000, related, in
general, to the before tax present value of future proved reserve additions from
exploratory prospect acreage held by the Company on January 15, 2002. The
Redeemable Preferred shareholders relinquished their rights to dividends in
arrears and redemption obligations beyond the cash and securities received as
merger consideration.
Contemporaneously with the acquisition, the Company issued 125,000 shares
of 2002 Preferred Stock in exchange for the working interests held by certain
entities affiliated with Gary L. Hall (an officer, director, and controlling
shareholder in the Company), and Bruce R. Sidner, Wayne P. Hall and John H.
Peper (each an officer, director, and shareholder in the Company). The 2002
Preferred shareholders then exchanged their stock for warrants to purchase
500,000 shares of EPL common stock. The 2002 Preferred Stock shareholders also
received the right to 25% of contingent consideration, the value of which will
not exceed $50,000,000, related, in general, to the before tax present value of
future proved reserve additions from exploratory prospect acreage held by the
Company on January 15, 2002.
The Employee Royalty Trust exchanged promissory notes totaling $5,800,000,
including the right to payment of all indebtedness (both principal and
interest), and overriding royalty interests held by it for $250,000 in cash and
warrants to purchase 1,000,000 shares of EPL common stock.
The trusts associated with the Company's 2000 Facility and 1996 Facility
received approximately $1,100,000 in cash and 574,931 shares of EPL common stock
in exchange for the overriding royalty interests held by such trusts.
(18) SUPPLEMENTAL OIL AND NATURAL GAS DISCLOSURES (UNAUDITED)
Users of this information should be aware that the process of estimating
quantities of proved and proved developed natural gas and crude oil reserves is
very complex, requiring significant subjective decisions in the evaluation of
all available geological, engineering, and economic data for each reservoir. The
data for a given reservoir may also change substantially over time as a result
of numerous factors including, but not limited to, additional development
activity, evolving production history, and continual reassessment of the
viability of production under varying economic conditions. Consequently,
material revisions to existing reserve estimates occur from time to time.
Although every reasonable effort is made to ensure that reserve estimates
reported represent the most accurate assessments possible, the significance of
the subjective decisions required and variances in available data for various
reservoirs make these estimates generally less precise than other estimates
presented in connection with financial statement disclosures.
Proved reserves are estimated quantities of natural gas, crude oil and
condensate that geological, and engineering data demonstrate, with reasonable
certainty, to be recoverable in future years from known reservoirs under
existing economic and operating conditions.
Proved developed reserves are proved reserves that can be expected to be
recovered through existing wells with existing equipment and operating methods.
F-24
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
The following table sets forth the Company's net proved reserves, including
the changes therein, and proved developed reserves:
CRUDE
NATURAL GAS OIL/CONDENSATE
(MMCF) (BARRELS)
----------- --------------
Proved developed and undeveloped reserves:
December 31, 1998........................................ 11,523 120,185
Purchases of reserves in place........................ 16,169 329,186
Sale of reserves...................................... (29,918) --
Extension, discoveries, and other additions........... 61,791 703,297
Production............................................ (1,415) (58,509)
------- ---------
December 31, 1999........................................ 58,150 1,094,159
Purchases of reserves in place........................ -- --
Sale of reserves...................................... (39,925) (438,067)
Extension, discoveries, and other additions........... 26,598 (175,639)
Production............................................ (3,825) (85,984)
------- ---------
December 31, 2000........................................ 40,998 394,469
Purchases of reserves in place........................ -- --
Sale of reserves...................................... (5,273) (302,236)
Extension, discoveries, and other additions........... 25,319 238,028
Production............................................ (6,170) (33,476)
------- ---------
December 31, 2001........................................ 54,874 296,785
======= =========
Proved developed reserves:
December 31, 1999........................................ 40,846 644,950
December 31, 2000........................................ 23,268 351,590
December 31, 2001........................................ 38,082 296,785
Capitalized costs for oil and natural gas producing activities consist of
the following:
YEAR ENDED DECEMBER 31,
----------------------------------------
2001 2000 1999
------------ ----------- -----------
Proved properties............................ $143,744,000 $81,086,000 $77,115,000
Unproved properties.......................... 5,647,000 5,289,000 6,390,000
Accumulated depreciation, depletion,
impairment, and amortization............... (64,762,000) (41,242,000) (39,282,000)
------------ ----------- -----------
Net capitalized costs.............. $ 84,629,000 $45,133,000 $44,223,000
============ =========== ===========
F-25
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
Costs incurred for oil and natural gas property acquisition, exploration,
and development activities for the years ended December 31, 2001, 2000, and 1999
are as follows:
2001 2000 1999
----------- ----------- -----------
Acquisition................................... $ 3,146,000 $ 1,826,000 $ 9,174,000
Exploration................................... 53,606,000 17,189,000 29,143,000
Development................................... 23,289,000 17,209,000 15,693,000
----------- ----------- -----------
Total costs incurred................ $80,041,000 $36,224,000 $54,010,000
=========== =========== ===========
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO RESERVES
The following information has been developed utilizing procedures
prescribed by Statement of Financial Accounting Standards No. 69 (SFAS No. 69),
Disclosures about Oil and Natural Gas Producing Activities. It may be useful for
certain comparative purposes, but should not be solely relied upon in evaluating
the Company or its performance. Further, information contained in the following
table should not be considered as representative of realistic assessments of
future cash flows, nor should the Standardized Measure of Discounted Future Net
Cash Flows be viewed as representative of the current value of the Company's oil
and natural gas properties.
The Company believes that the following factors should be taken into
account in reviewing the following information: (1) future costs and selling
prices will probably differ from those required to be used in these
calculations; (2) due to future market conditions and governmental regulations,
actual rates of production achieved in future years may vary significantly from
the rate of production assumed in the calculations; (3) selection of a 10%
discount rate is arbitrary and may not be reasonable as a measure of the
relative risk inherent in realizing future net oil and natural gas revenues; and
(4) future net revenues may be subject to different rates of income taxation.
Under the standardized measure, future cash inflows were estimated by
applying period-end oil and natural gas prices adjusted for fixed and
determinable escalations to the estimated future production of period-end proved
reserves. Future cash inflows were reduced by estimated future development,
abandonment and production costs based on period-end costs in order to arrive at
net cash flow before tax. Future income tax expense has been computed by
applying period-end statutory tax rates to aggregate future net cash flows,
reduced by the tax basis of the properties involved and tax carryforwards. Use
of a 10% discount rate is required by SFAS 69.
Management does not rely solely upon the following information in making
investment and operating decisions. Such decisions are based upon a wide range
of factors, including estimates of probable as well as proved reserves and
varying price and cost assumptions considered more representative of a range of
possible economic conditions that may be anticipated.
F-26
HALL-HOUSTON OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001, 2000 AND 1999
The standardized measure of discounted future net cash flows relating to
proved oil and natural gas reserves is as follows:
2001 2000 1999
------------- ------------- -----------
Future cash inflows....................... $ 148,609,000 $ 401,737,000 $156,169,000
Future production costs................... (21,312,000) (18,394,000) (25,739,000)
Future development and abandonment
costs................................... (27,852,000) (28,399,000) (30,981,000)
Future income tax expense................. -- (106,151,000) (9,920,000)
------------- ------------- -----------
Future net cash flows after income
taxes................................... 99,445,000 248,793,000 89,529,000
10% annual discount for estimated timing
of cash flows........................... (20,161,000) (61,293,000) (18,056,000)
------------- ------------- -----------
Standardized measure of discounted future
net cash flows.......................... $ 79,284,000 $ 187,500,000 $71,473,000
============= ============= ===========
A summary of the changes in the standardized measure of discounted future
net cash flows applicable to proved oil and natural gas reserves for the years
ended December 31, 2001, 2000, and 1999 are as follows:
2001 2000 1999
------------- ------------- ------------
Beginning of the period.................. $ 187,500,000 $ 71,473,000 $ 4,830,000
Sales, net of production costs........... (14,386,000) (8,333,000) 2,563,000
Purchases of reserves in place........... -- -- 18,633,000
Net changes in prices and production
costs.................................. (202,112,000) 330,809,000 (15,660,000)
Extensions, discoveries, and improved
recovery, net of future production
costs.................................. 32,469,000 159,641,000 93,243,000
Change in estimated future development
costs.................................. (1,321,000) (11,076,000) 121,000
Development costs incurred............... 23,289,000 17,209,000 15,693,000
Revision in quantity estimates........... 11,904,000 4,459,000 (4,689,000)
Accretion of discount.................... 26,065,000 7,167,000 483,000
Net change in income taxes............... 73,147,000 (72,950,000) (197,000)
Sales of reserves in place............... (16,006,000) (62,521,000) (51,482,000)
Changes in production rates and other.... (41,265,000) (248,378,000) 7,935,000
------------- ------------- ------------
End of period............................ $ 79,284,000 $ 187,500,000 $ 71,473,000
============= ============= ============
The computation of the standardized measure of discounted future net cash
flows relating to proved oil and natural gas reserves at December 31, 2001 was
based on period-end prices which approximated $2.65 per Mcf for natural gas and
$20.14 per barrel for crude oil.
F-27
ANNEX A
[MERRILL LYNCH BULL LOGO]
December 16, 2001
Board of Directors
Energy Partners, Ltd.
201 E. St. Charles Avenue
Suite 3600
New Orleans, LA 70170
Attention: Richard A. Bachmann
Members of the Board of Directors:
Energy Partners, Ltd. (the "Company"), Newco, a wholly owned subsidiary of
the Company (the "Purchaser") and Hall-Houston Oil Company (the "Subject
Company") propose to enter into an agreement and plan of merger substantially in
the form of the draft dated December 16, 2001 (the "Agreement") pursuant to
which the Purchaser will be merged with and into the Subject Company in a
transaction (the "Acquisition Transaction") in which (a) each outstanding share
of the Subject Company's Series A Common Stock, par value $0.01 per share, and
Series B Nonvoting Common Stock, par value $0.01 per share (the "Common
Shares"), will be entitled to receive (1) $0.047237 in cash, (2) 0.2361842
warrants to purchase shares of the common stock, par value $0.01 per share, of
the Company (the "Company Shares") at an exercise price of $11.00 per share (the
"$11 Warrants"), and (3) 0.078728 warrants to purchase Company Shares at an
exercise price of $9.00 per share (the "$9 Warrants") and (b) each outstanding
share of the Subject Company's Redeemable Preferred Stock, par value $0.01 per
share (the "Preferred Shares"), will be entitled to receive (1) $1.249736 in
cash, (2) its pro rata share of 75% of the earnout (as described in the
Agreement), (3) 6.248681 $11 Warrants, and (4) 2.082894 $9 Warrants. Pursuant to
certain other documents to be entered into among the parties (together with the
Agreement, the "Transaction Documents"), the Company will also acquire (a) from
certain third party affiliates of the Subject Company all of their working and
net revenue interests and other rights relating to exploitation, production and
operation of oil and gas leases, contracts and wells owned, leased or operated
by the Subject Company and its subsidiaries for aggregate consideration of (1)
125,000 $9 Warrants, (2) 375,000 $11 Warrants, and (3) 25% of the earnout, and
(b) from other third party affiliates of the Subject Company all of their
overriding royalty interests and other rights relating to exploitation,
production and operation of oil and gas leases, contracts and wells owned,
leased or operated by the Subject Company and its subsidiaries for aggregate
consideration of (1) $1,100,002.41 in cash and (2) 574,931 Company Shares. In
addition, the Company will acquire certain promissory notes and overriding
royalty interests from a Subject Company employee royalty trust in exchange for
aggregate consideration of (1) $250,000 in cash, (2) 250,000 $9 Warrants, (3)
750,000 $11 Warrants. Finally, holders of the outstanding debt of the Subject
Company will consent to receive (1) five (5) shares of the Company's Series D
Exchangeable Convertible Preferred Stock ("Convertible Preferred Stock") and (2)
$500 aggregate principal amount of the Company's 11% Senior Subordinated Notes
due 2008 ("Senior Subordinated Notes") per $1,000 principal amount of Subject
Company debt, plus cash in full payment for nominal overriding royalty interests
associated with certain of such Subject Company debt and cash equal to accrued
and unpaid interest on such debt. It is a condition to the completion of the
Acquisition Transaction that the holders of at least 80% of the Subject
Company's outstanding debt be tendered for exchange by January 14, 2002. The
merger and other consideration referred to in the preceding three sentences is
referred to herein as the "Consideration". The terms and conditions of the
Acquisition Transaction are more fully set forth in the Transaction Documents.
You have asked us whether, in our opinion, the Consideration to be paid by
the Company pursuant to the Acquisition Transaction is fair to the Company from
a financial point of view.
[MERRILL LYNCH BULL LOGO]
In arriving at the opinion set forth below, we have, among other things:
(1) Reviewed the Subject Company's audited financial information for
the two fiscal years ended December 31, 2000 and the Subject Company's
unaudited financial information for the ten months ended October 31, 2001
provided to us by the Subject Company;
(2) Reviewed certain publicly available business and financial
information relating to the Company that we deemed to be relevant;
(3) Reviewed certain information, including financial forecasts,
relating to the business, earnings, cash flow, assets, liabilities and
prospects of the Subject Company and the Company furnished to us by the
Subject Company and the Company;
(4) Reviewed the report prepared by Ryder Scott Company, L.P. and
furnished to us by the Company in connection with certain proved reserve
data of the Subject Company as well as information relating to potential
future drilling sites and the probable, possible and potential exploration
reserves therefrom;
(5) Conducted discussions with members of senior management and
representatives of the Subject Company and the Company concerning the
matters described in clauses 1, 2, 3 and 4 above, as well as the businesses
and prospects of both the Subject Company and the Company before and after
giving effect to the Acquisition Transaction;
(6) Reviewed the results of operations of the Company and the Subject
Company and compared them with those of certain companies which we deemed
to be relevant;
(7) Compared the proposed financial terms of the Acquisition
Transaction with the financial terms of certain other transactions which we
deemed to be relevant;
(8) Participated in certain discussions and negotiations among
representatives of the Company and the subject Company and their financial
and legal advisors;
(9) Considered the pro forma effect of the Acquisition Transaction()
on the Company's capitalization ratios and earnings, cash flow and book
value per share;
(10) Reviewed the Transaction Documents;
(11) Reviewed such other financial studies and analyses and took into
account such other matters as we deemed necessary, including our assessment
of general economic, market and monetary conditions.
In preparing our opinion, we have assumed and relied on the accuracy and
completeness of all information that was supplied or otherwise made available to
us by the Subject Company or the Company, or discussed with or reviewed by or
for us, or that is publicly available, and we have not assumed any
responsibility for independently verifying such information or undertaken an
independent evaluation or appraisal of any of the assets or liabilities of the
Subject Company or the Company or been furnished with any such evaluation or
appraisal. In addition, we have not assumed any obligation to conduct any
physical inspection of the properties or facilities of the Subject Company or
the Company. With respect to the financial forecast information furnished to or
discussed with us by the Subject Company or the Company, we have assumed that
such information has been reasonably prepared and reflects the best currently
available estimates and judgment of the Subject Company's or the Company's
management as to the expected future financial performance of the Subject
Company or the Company, as the case may be. In addition, we have assumed that
the reserve reports and other reserve information of the Subject Company which
we reviewed have been reasonably prepared and reflect the best currently
available estimates of management of the Subject Company and the Company as to
the Subject Company's reserves, future production and associated costs. We have
made no independent investigation of any legal matters or accounting advice
given to the Subject
A-2
[MERRILL LYNCH BULL LOGO]
Company or the Company and their respective boards of directors, including,
without limitation, advice as to the accounting and tax consequences of the
Acquisition Transaction.
In rendering this opinion, we have also assumed, with your permission: (1)
that the terms and provisions contained in the final form of the Agreement and
the other Transaction Documents will not differ from those contained in the
drafts of those documents we have heretofore reviewed with respect to any matter
material to our opinion expressed herein; (2) that the conditions to the
consummation of the Acquisition Transaction will be satisfied without material
expense; and (3) the veracity of the representations and warranties of the
parties contained in the Agreement and the other Transaction Documents.
Our opinion is necessarily based upon market, economic and other conditions
as they exist and can be evaluated on, and on the information made available to
us as of, the date hereof. We have assumed that in the course of obtaining the
necessary regulatory or other consents or approvals (contractual or otherwise)
for the Acquisition Transaction, no restrictions, including any divestiture
requirements or amendments or modifications, will be imposed that will have a
material adverse effect on the contemplated benefits of the Acquisition
Transaction.
This opinion is for the use and benefit of the Board of Directors of the
Company and shall not be used for any other purpose. It does not address the
merits of the underlying decision by the Company to engage in the Acquisition
Transaction. This opinion is not intended to be relied upon or confer any rights
or remedies upon any employee, creditor, shareholder or other equity holder of
the Company, or any other party. This opinion may not be reproduced,
disseminated, quoted, summarized or referred to at any time or in any manner,
nor shall any public references to Merrill Lynch, Pierce, Fenner & Smith
Incorporated or any of its affiliates be made by the Company or any of its
affiliates without our prior written consent.
We are not expressing any opinion herein as to the prices at which the
Company Shares or any other securities of the Company will trade following the
announcement or consummation of the Acquisition Transaction.
We are acting as financial advisor to the Company in connection with the
Acquisition Transaction and will receive a fee from the Company for our
services, all of which is contingent upon the consummation of the Acquisition
Transaction. In addition, the Company has agreed to indemnify us for certain
liabilities arising out of our engagement. We have, in the past, provided
financial advisory and financing services to the Company and may continue to do
so and have received, and may receive, fees for the rendering of such services.
In addition, in the ordinary course of our business, we may actively trade the
securities of the Company for our own account and for the accounts of customers
and, accordingly, may at any time hold a long or short position in such
securities.
On the basis of, and subject to the foregoing, we are of the opinion that,
as of the date hereof, the Consideration to be paid by the Company pursuant to
the Acquisition Transaction is fair from a financial point of view to the
Company.
Very truly yours,
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
A-3
FORM OF PROXY
ENERGY PARTNERS, LTD.
PROXY FOR
SPECIAL MEETING OF STOCKHOLDERS
JUNE 25, 2002
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS. The undersigned
stockholder of Energy Partners, Ltd., a Delaware corporation ("EPL" or "the
Company"), hereby appoints Richard A. Bachmann and Gary L. Hall, or either of
them, as proxies, each with power to act without the other and with full power
of substitution, on behalf of the undersigned to vote the number of shares of
Common Stock of EPL that the undersigned would be entitled to vote if personally
present at the Special Meeting of Stockholders of Energy Partners, Ltd. to be
held on Tuesday, June 25, 2002 at 9:00 A.M., Central Daylight Saving Time, at
the Company's Principal Executive Offices at 201 St. Charles Avenue, Suite 3400,
New Orleans, Louisiana 70170 and at any adjournment or postponement thereof, on
the following matters:
(Continued and to be signed on the other side)
This proxy, when properly executed, will be voted in the manner directed herein
by the undersigned stockholder. IF NO DIRECTION IS MADE, THIS PROXY WILL BE
VOTED "FOR" PROPOSALS 1 AND 2. Receipt of the proxy statement, dated May 23,
2002, is hereby acknowledged.
You are encouraged to specify your choices by marking the appropriate boxes, SEE
REVERSE SIDE, but you need not mark any boxes if you wish to vote in accordance
with the board of directors' recommendation. The proxies cannot vote your shares
unless you sign and return this card.
(1) Proposal to approve the merger of a subsidiary of the Company with
Hall-Houston Oil Company, the exchange or repayment of Hall-Houston's
outstanding long-term debt and the purchase of overriding royalty interests
owned by Hall-Houston affiliates in specified oil and gas properties.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
(2) To consider and take action upon any other matter which may properly come
before the meeting and any adjournment or postponement thereof.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
Please sign your name exactly as it appears hereon. Joint owners must each sign.
When signing as attorney, executor, administrator, trustee or guardian, please
give your full title as it appears thereon.
--------------------------------------------------------------------------------
Signature of Stockholder(s)
--------------------------------------------------------------------------------
Signature of Stockholder(s)
Date ________, 2002
PLEASE MARK, SIGN, DATE AND RETURN USING THE ENCLOSED ENVELOPE.