Tuesday, May 09, 2006 11:53:45 AM
HEC Earnings NEWS NOW!!!!
10-Q: HARKEN ENERGY CORP
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Edgar Online
11:36 a.m. 05/09/2006
(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
The following discussion is intended to assist you in understanding our business and the results of our operations. It should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this report as well as our Annual Report on Form 10-K for the year ended December 31, 2005. Certain statements made in our discussion may be forward looking. Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations. These risks, uncertainties, and other factors include, among others, the risks described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission, as well as other risks described in this Quarterly Report. Unless the context requires otherwise, when we refer to "we," "us" and "our," we are describing Harken Energy Corporation and its consolidated companies on a consolidated basis.
OVERVIEW
We are an independent oil and gas exploration, exploitation, development and production company who seeks to invest in energy-based growth opportunities. Our domestic operations are conducted through our wholly-owned subsidiary, Gulf Energy Management Company ("GEM"). GEM's operations consist of exploration, exploitation, development, production and acquisition efforts in the United States, principally in the onshore and offshore Gulf Coast regions of South Texas and Louisiana, as well as coal bed methane exploration and development activities in Indiana and Ohio. We have exposure to Latin American crude oil exploration and production operations through our ownership of approximately 34% of Global Energy Development PLC's ("Global") ordinary shares. Global has exploration, development and production activities in Colombia and exploration activities in Panama and Peru.
During 2005, we were also engaged in minimal energy trading through our investment in International Business Associates, Ltd. ("IBA"), which focuses primarily on trading energy futures or other energy-based contracts, principally in the United States. During 2005, IBA had a low volume of trading activities and was unsuccessful in obtaining trading contracts overseas. In February 2006, IBA redeemed 7,500 shares of our IBA convertible preferred shares along with our 24 shares of IBA common stock in exchange for cash consideration
of $7.5 million. Due to the nature of their business, we can not be certain that IBA will secure trading contracts in the future.
Our consolidated revenues are primarily derived from production from GEM's and Global's oil and gas properties. GEM operates approximately 50% of its natural gas and crude oil properties which are all located in the United States. Global operates 100% of its crude oil producing properties which are all located in Colombia. Our revenues are a function of the oil and gas volumes produced and the prevailing commodity price at the time of production, and certain quality and transportation discounts. The commodity prices for crude oil and natural gas as well as the timing of production volumes have a significant impact on our operating income. From time-to-time, GEM enters into hedging contracts to achieve more predictable cash flows and to reduce exposure to declines in market prices.
As of March 31, 2006, GEM represented 61% of our consolidated oil and gas revenues. During the three months ended March 31, 2006, GEM's oil and gas revenues were comprised of approximately 36% oil sales and 64% natural gas sales. Substantially all of GEM's production is concentrated in five oil and gas fields along the onshore and offshore Texas and Louisiana Gulf Coast.
Revenues from Global are derived solely from Global's Colombian oil production. During the three months ended March 31, 2006, Global produced approximately 78 thousand net barrels of oil in Colombia generating oil revenues of approximately $3.7 million. Global represented approximately 39% of our consolidated oil and gas revenues during the three months ended March 31, 2006. Global's activities in Panama and Peru, thus far, have been limited to technical evaluations of potential exploration areas.
DECONSOLIDATION OF GLOBAL
At December 31, 2005 and March 31, 2006, Harken owned approximately 34% of Global's ordinary shares. At March 31, 2006, Lyford Investments Enterprises Ltd. ("Lyford"), owned 17.01% of the ordinary shares of Global and also beneficially owned approximately 30% of the combined voting power of Harken's common stock. Lyford's representative, Alan Quasha, is the Chairman of Harken's Board of Directors. Harken's direct equity interest of 33.67%, combined with Lyford's 17.01% equity interest in Global and the previous sharing of certain management and administrative functions between Global and Harken, were deemed to provide Harken with the legal power to control the operating policies and procedures of Global as of March 31, 2006, which required Harken to consolidate the operations of Global as of such date.
In April 2006, Global advised Harken that Lyford had sold a portion of its equity interest in Global. As of May 9, 2006 Lyford owned 15.84% of the ordinary shares in Global such that Harken's direct equity interest in Global, combined with Lyford's direct equity interest in Global, has been reduced to less than 50% of Global's outstanding voting securities. Based upon this reduction in ownership and the elimination of shared management and administrative functions between Harken and Global, Harken has determined that it no longer has the legal power to control the operating policies and procedures of Global and that Harken will be required to deconsolidate Global from its consolidated financial statements effective with its current fiscal quarter ending June 30, 2006. We are currently evaluating the impact of both the change in our influence on Global's operations and the future timing and availability of financial information from this entity to determine whether this investment will be carried as a cost or equity investment going forward.
GEM'S OPERATIONS:
As of May 9, 2006, GEM's net domestic production rate was at approximately 7.8 million cubic feet equivalent of natural gas per day. Prior to the hurricanes, GEM's net domestic production rate was approximately 7.6 million cubic feet equivalent of natural gas per day. While we continue to experience production losses as a result of the hurricanes, we have restored and/or enhanced production in other fields. The following field data updates the status of GEM's domestic operations through the end of April 2006:
Lapeyrouse Field, Terrebonne Parish - Louisiana
GEM holds an average non-operated working interest of 8.2% in eight wells in this field. During the first quarter of 2006, GEM has participated in two additional workovers in the field. As a result of these activities, gross field production increased from 20 million cubic feet equivalent to approximately 28 million cubic feet equivalent of natural gas per day. A ninth well, with first production in late March 2006, has experienced some increased water and is currently shut-in for a workover scheduled for May 2006. GEM holds an approximately 39% operated working interest in this ninth well.
Main Pass, Plaquemines Parish - Louisiana
Production has been increased to approximately 475 gross barrels of oil per day ("bopd"). GEM has a 90% interest in Main Pass and is the field operator. During the third quarter of 2005, GEM completed a major overhaul and rebuild of an additional compressor for the field. Repair work on a second rental compressor damaged by the hurricane is now completed. Now that both compressors are operational, GEM plans to add additional wells to the gas lift cycle. Gross production for the field is expected to reach approximately 500 bopd after additional wells are gas lifted. GEM continues its geological and geophysical study in the area, utilizing its license to 21 square miles of 3D seismic data, covering the area held by production leases.
Raymondville Field, Willacy and Kenedy Counties - Texas
During the first quarter of 2006, GEM participated in additional recompletions that resulted in a temporary increase in gross production for the field. As previously disclosed, it is expected that field production will resume its decline rate. Currently gross production for this field is approximately 8 million cubic feet equivalent of natural gas per day. GEM has an average 27% non-operated working interest in this field.
Lake Raccourci Field, Lafourche Parish - Louisiana
GEM holds a 40% operated working interest in each of its Lake Raccourci wells. Gross production for this field is approximately 2.8 million cubic feet equivalent of natural gas per day. The State Lease 14589 #2 is currently shut-in, waiting on a workover rig scheduled for the second quarter of 2006. Upon completion of the workover, gross production is expected to return to about 5.0 million cubic feet equivalent of natural gas per day. GEM is presently seeking industry partners to drill a field extension well.
3D Seismic Licenses - Louisiana
GEM continues to evaluate its seismic licenses covering approximately 155 square miles of 3D seismic data in three different surveys across south Louisiana. A number of leads have developed in this continuing study. The process of cataloging and prioritizing the seismic data is ongoing.
South Beach Field, Chambers County - Texas
GEM has a non-operated working interest of 10% in this area. Gross production for this field is approximately 3.7 million cubic feet equivalent of natural gas per day.
Branville Bay Field, Plaquemines Parish - Louisiana
This non-operated property remains 100% shut-in from the hurricanes in late 2005. Repairs to the production facility are underway and production is expected to resume in the second quarter of 2006. GEM has a non-operated working interest of 12.5% in this area.
Point-a-la-Hache Field, Plaquemines Parish - Louisiana
This operated property also remains 100% shut-in. Damages to this field principally affected a leased production barge facility. Repairs to the production barge are expected to be completed in the second quarter 2006. GEM maintains a 25% operated working interest in the area.
Point-au-Fer Field, Terrebonne Parish - Louisiana
In 2005, GEM entered into a Participation Agreement and Joint Operating Agreement covering an area of mutual interest of approximately 56 square miles. In addition, during the fourth quarter of 2005, GEM participated in an acquisition of two wells with production potential, and a central facility. GEM owns a 12.5% non-operated working interest in the area. Two wells were drilled in the first quarter of 2006. The first well has been flow tested at about 2.75 million gross cubic feet equivalent of natural gas per day, and is waiting on hook-up to facilities. The second well has been logged productive and cased. A completion rig is expected in the second quarter of 2006. One workover and recompletion of an existing well is expected to commence in May 2006. A second workover is planned for the late second quarter of 2006. Several prospects have been identified in the area, and GEM expects to have additional drilling and workover activity in this area during 2006.
Allen Ranch Field, Colorado County - Texas
GEM owns an 11.25% non-operated working interest in the area. The initial well, the Hancock Gas Unit # 1, was productive in four sands and has been producing approximately 2.5 million gross cubic feet equivalent of natural gas per day. As a result of the success with the first well, the Hancock Gas Unit # 2 was drilled in October 2005 as an offset to the first well. This second well was logged as productive in the same four sands as the Hancock Gas Unit # 1 well and two deeper zones were also logged as productive. The deeper of the two zones has been fracture stimulated and produced about 5.0 million cubic feet equivalent of natural gas per day. This zone has now been shut-in to test the other productive zone in the well bore and a temporary bridge plug was set above the sand to protect the zone while additional testing continues. The second zone has been perforated and is scheduled for fracture stimulation in the second quarter 2006.
Coalbed Methane Prospects - Indiana and Ohio
In 2005, GEM entered into two significant Exploration and Development Agreements in Indiana and Ohio. Each prospect provides for an area of mutual interest of approximately 400,000 acres. During the first quarter of 2006, GEM has entered into another Exploration and Development Agreement in Ohio. This
prospect provides for an area of mutual interest of approximately 20,000 acres. In each case, the agreements provide for a phased delineation, pilot and development program with corresponding staged expenditures. Contracted third parties with a long track record in successful Coalbed Methane development are providing expert advice for these projects.
Indiana Prospect
In September 2005, after the submission of a Phase I core evaluation report by the technical consultant, GEM elected to proceed and fund pilot well drilling under Phase II of the agreement. Due to limited availability of needed equipment, GEM expects the drilling of the pilot wells to occur during the second quarter of 2006.
Ohio Cumberland Prospect
Core samples from the Ohio CBM prospect are being analyzed for gas content, gas composition and characteristics of the coal. Depending on final results, GEM may elect to schedule drilling of pilot wells on its Ohio CBM prospect area during 2006.
Ohio Triangle Prospect
Core samples are expected to be obtained on this third prospect late in the second quarter of 2006. Depending on final results of core analysis, GEM may elect to schedule drilling of pilot wells on this CBM prospect area during 2006.
GLOBAL'S OPERATIONS:
Revenues from Global are derived solely from its Colombian oil production. During the three months ended March 31, 2006, Global increased its revenues compared to the corresponding prior year period due to increased crude oil prices. Global production volumes remained steady during both periods.
In April 2006, Global signed a new exclusive Exploration and Production Concession contract for the Los Sauces area ("Los Sauces Contract") with the National Hydrocarbons Agency of the Republic of Colombia.
The Los Sauces Contract covers approximately 61,600 acres in the Central Llanos region of Colombia where Global already has three contracts, namely the Alcaravan Association contract and the Rio Verde and Los Hatos Exploration and Production Concession contracts. The Los Sauces Contract is contiguous with the northern boundary of the Rio Verde contract.
Global will own 100% of the Los Sauces Contract subject only to an initial 10.5% royalty, with the future size of the royalty to be determined by future production levels. The Los Sauces Contract, effective from March 31, 2006, has a principal term of thirty years divided into an initial six-year exploration phase and a 24-year exploitation and production phase. Under the terms of the Los Sauces Contract, Global must within twelve months reprocess approximately 200 kilometers of existing seismic, acquire and process 50 kilometers of 2D seismic, and drill one exploratory well.
Global can, at its election, proceed to phase 2, twelve months in duration, and drill one exploratory well. Phases 3 to 6, also all optional and twelve months in length, require the drilling of an exploratory well in each phase.
The Los Sauces area has been subject to prior drilling activity by an international oil company over ten years ago at which time the La Totuma #1 well was drilled with reported oil shows. Based upon the existing formation and seismic data, Global has elected to position and drill an exploratory well geologically updip from the existing La Totuma #1 well in the second half of 2006.
CAPITAL STRUCTURE
Effect of Convertible Debt and Equity Instruments on Dilution
As of March 31, 2006, on a consolidated basis, we had cash and short term investments of $40 million and working capital of $38 million (including $4 million cash held by Global). We had approximately $90 million in shareholders' equity at March 31, 2006.
At March 31, 2006, if our remaining outstanding debt, convertible preferred stock and common stock purchase warrants were exercised and/or converted, we would be required to issue the following amounts of our common stock:
Conversion / Shares of Common Exercise Stock Issuable at Instrument Price (a) March 31, 2006 Series M Preferred $ 0.59 8,389,831 Series G1 Preferred $ 12.50 12,800 Series G2 Preferred $ 3.00 33,333 Series L Warrants $ 0.67 3,182,836 Series M Warrants $ 0.57 4,385,965 Common Stock Potentially Issued Upon Conversion / Exercise 16,004,765
CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS
Our consolidated condensed financial statements have been prepared in accordance with United States generally accepted accounting principles ("US GAAP") which requires us to use estimates and make assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Our estimates and assumptions are based on historical experience, industry conditions and various other factors which we believe are appropriate. Actual results could vary significantly from our estimates and assumptions as additional information becomes known. The more significant critical accounting estimates and assumptions are described below.
Asset Retirement Obligations - Our asset retirement obligations represent our best estimate of the fair value of our future abandonment costs associated with our oil and gas properties, including the costs of removal and disposition of tangible equipment, site and environmental restoration. We estimate the fair value of our retirement costs in the period in which the liability is incurred, if a reasonable estimate can be made. The determination of the fair value of an asset retirement obligation generally involves estimating the fair value of the obligation at the end of the property's useful life and then discounting it to present value using our credit adjusted, risk free rate of return. Estimating future asset removal costs is difficult and requires management to make estimates and judgments regarding the expected removal and site restoration costs, timing and present value discount rates. Valuations of the estimated useful life and the fair value of the asset retirement obligation are imprecise since the removal activities will generally occur several years in the future and asset removal technologies and costs are constantly changing, as are political, environmental and safety considerations that may ultimately impact the amount of the obligations.
Derivative Instruments - We are exposed to the risk of fluctuations in crude oil and natural gas prices. To reduce the impact of this risk in earnings and to increase the predictability of our cash flow, from time to time we enter into certain derivative contracts (primarily option floors) for a portion of our North American oil and gas production. As required by Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), we are required to record all derivative contracts at fair value in our balance sheet. Changes in fair value are required to be recorded in income or other comprehensive income, depending on the hedging designation and the hedge effectiveness. Our estimates of fair value are based on market quotes from third parties. While the fair values of our derivatives have fluctuated significantly, our estimates of fair value have historically been consistent with the settlement amounts.
Fair value of our debt and equity transactions -Many of our various debt and equity transactions require us to determine the fair value of a debt or equity instrument in order to properly record the transaction in our financial statements. We historically have utilized independent third parties to assist us in determining the fair value of many of our transactions. Fair value is generally determined by applying widely acceptable valuation models, (e.g., the Black-Scholes valuation model) using the trading price of the underlying instrument or by comparison to instruments with comparable maturities and terms.
Consolidation of variable interest entities - In January 2003, the FASB issued FASB Interpretation No. ("FIN") 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which requires the primary beneficiary of a variable interest entity's ("VIE") activities to consolidate the VIE. FIN 46 defines a VIE as an entity in which the equity investors do not have substantive voting rights and there is not sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The primary beneficiary is the party that absorbs a majority of the expected losses and/or receives a majority of the expected residual returns of the VIE's activities. In December 2003, the FASB issued FIN 46(R), which supercedes and amends certain provisions of FIN 46. While FIN 46(R) retained many of the concepts and provisions of FIN 46, it also provides additional guidance related to the application of FIN 46, provides for certain additional scope exceptions, and incorporates several FASB Staff Positions issued related to the application of FIN 46. As of March 31, 2006, Harken owned less than a majority of the common shares of Global but did possess the legal power to direct the operating policies and procedures of Global through our direct ownership, combined with the 20% ownership by Lyford in Global shares. In addition, Harken has concluded that Global was not a VIE at March 31, 2006 as contemplated by FIN 46(R). During the three months ended March 31, 2006, we had an investment in a VIE named IBA, which we consolidated in accordance with FIN 46(R). See Note 3 - "Investment in International Business Associates, Ltd." in the notes to the Consolidated Condensed Financial Statements for information regarding the consolidation of IBA.
STOCK-BASED COMPENSATION
Adoption of Statement of Financial Accounting Standard No. 123 (As Amended)
Effective January 1, 2006, Harken and its consolidated companies adopted SFAS No. 123 (as amended) "Accounting for Share-Based Compensation" ("SFAS 123(R)") using the modified prospective transition method. In addition, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 "Share-Based Payment" ("SAB 107") in March, 2005, which provides supplemental SFAS 123(R) application guidance based on the views of the SEC. Under the modified prospective transition method, compensation cost recognized in the quarterly period ended March 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted beginning January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In accordance with the modified prospective transition method, results for prior periods have not been restated.
The adoption of SFAS 123(R) resulted in an adjustment for cumulative effect in change in accounting principles on the consolidated condensed statement of operations ended March 31, 2006 for the amount of $868 thousand. This adjustment was recorded as a decrease to Net Income. The Company did not recognize a tax benefit from the cumulative effect adjustment because Global, the only entity impacted by SFAS 123 (R), currently has net operating losses that will prevent any tax benefit being received from any exercised options. In accordance with SFAS 123(R) the company will not recognize the tax benefits and/or credits to additional paid in capital for any additional deduction until the deduction actually reduces the taxes payable.
RECENT ACCOUNTING PRONOUNCEMENTS
On February 16, 2006, the FASB issued Statement 155, "Accounting for Certain Hybrid Instruments- an amendment of FASB Statements No. 133 and 140." The statement amends Statement 133 to permit fair value measurement for certain hybrid financial instruments that contain an embedded derivative, provides additional guidance on the applicability of Statement 133 and 140 to certain financial instruments and subordinated concentrations of credit risk. The new standard is effective for the first fiscal year that ends after September 15, 2006. Harken is currently evaluating the impact this new Standard will have on the Company.
RESULTS OF OPERATIONS
For the purposes of discussion and analysis, we present a summary of our consolidated condensed results of operations followed by a more detailed discussion and analysis of our segments.
Consolidated Condensed Statement of Operations Comparisons Net loss and per-share amounts for each of the periods ended March 31, 2005 and 2006, were as follows: Three Months Ended March 31, (Thousands of dollars, except per-share amounts) 2005 2006 (unaudited) Net loss $ (6,216 ) $ (1,770 ) Net loss attributed to common stock $ (6,610 ) $ (2,974 ) Net loss per share - Basic $ (0.03 ) $ (0.01 ) Diluted $ (0.03 ) $ (0.01 )
The primary components of our net loss for the period ended March 31, 2005 compared to the net loss for the period ended March 31, 2006 are outlined in the table below:
Favorable (Unfavorable) . . .
May 09, 2006
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10-Q: HARKEN ENERGY CORP
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Edgar Online
11:36 a.m. 05/09/2006
(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
The following discussion is intended to assist you in understanding our business and the results of our operations. It should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this report as well as our Annual Report on Form 10-K for the year ended December 31, 2005. Certain statements made in our discussion may be forward looking. Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations. These risks, uncertainties, and other factors include, among others, the risks described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commission, as well as other risks described in this Quarterly Report. Unless the context requires otherwise, when we refer to "we," "us" and "our," we are describing Harken Energy Corporation and its consolidated companies on a consolidated basis.
OVERVIEW
We are an independent oil and gas exploration, exploitation, development and production company who seeks to invest in energy-based growth opportunities. Our domestic operations are conducted through our wholly-owned subsidiary, Gulf Energy Management Company ("GEM"). GEM's operations consist of exploration, exploitation, development, production and acquisition efforts in the United States, principally in the onshore and offshore Gulf Coast regions of South Texas and Louisiana, as well as coal bed methane exploration and development activities in Indiana and Ohio. We have exposure to Latin American crude oil exploration and production operations through our ownership of approximately 34% of Global Energy Development PLC's ("Global") ordinary shares. Global has exploration, development and production activities in Colombia and exploration activities in Panama and Peru.
During 2005, we were also engaged in minimal energy trading through our investment in International Business Associates, Ltd. ("IBA"), which focuses primarily on trading energy futures or other energy-based contracts, principally in the United States. During 2005, IBA had a low volume of trading activities and was unsuccessful in obtaining trading contracts overseas. In February 2006, IBA redeemed 7,500 shares of our IBA convertible preferred shares along with our 24 shares of IBA common stock in exchange for cash consideration
of $7.5 million. Due to the nature of their business, we can not be certain that IBA will secure trading contracts in the future.
Our consolidated revenues are primarily derived from production from GEM's and Global's oil and gas properties. GEM operates approximately 50% of its natural gas and crude oil properties which are all located in the United States. Global operates 100% of its crude oil producing properties which are all located in Colombia. Our revenues are a function of the oil and gas volumes produced and the prevailing commodity price at the time of production, and certain quality and transportation discounts. The commodity prices for crude oil and natural gas as well as the timing of production volumes have a significant impact on our operating income. From time-to-time, GEM enters into hedging contracts to achieve more predictable cash flows and to reduce exposure to declines in market prices.
As of March 31, 2006, GEM represented 61% of our consolidated oil and gas revenues. During the three months ended March 31, 2006, GEM's oil and gas revenues were comprised of approximately 36% oil sales and 64% natural gas sales. Substantially all of GEM's production is concentrated in five oil and gas fields along the onshore and offshore Texas and Louisiana Gulf Coast.
Revenues from Global are derived solely from Global's Colombian oil production. During the three months ended March 31, 2006, Global produced approximately 78 thousand net barrels of oil in Colombia generating oil revenues of approximately $3.7 million. Global represented approximately 39% of our consolidated oil and gas revenues during the three months ended March 31, 2006. Global's activities in Panama and Peru, thus far, have been limited to technical evaluations of potential exploration areas.
DECONSOLIDATION OF GLOBAL
At December 31, 2005 and March 31, 2006, Harken owned approximately 34% of Global's ordinary shares. At March 31, 2006, Lyford Investments Enterprises Ltd. ("Lyford"), owned 17.01% of the ordinary shares of Global and also beneficially owned approximately 30% of the combined voting power of Harken's common stock. Lyford's representative, Alan Quasha, is the Chairman of Harken's Board of Directors. Harken's direct equity interest of 33.67%, combined with Lyford's 17.01% equity interest in Global and the previous sharing of certain management and administrative functions between Global and Harken, were deemed to provide Harken with the legal power to control the operating policies and procedures of Global as of March 31, 2006, which required Harken to consolidate the operations of Global as of such date.
In April 2006, Global advised Harken that Lyford had sold a portion of its equity interest in Global. As of May 9, 2006 Lyford owned 15.84% of the ordinary shares in Global such that Harken's direct equity interest in Global, combined with Lyford's direct equity interest in Global, has been reduced to less than 50% of Global's outstanding voting securities. Based upon this reduction in ownership and the elimination of shared management and administrative functions between Harken and Global, Harken has determined that it no longer has the legal power to control the operating policies and procedures of Global and that Harken will be required to deconsolidate Global from its consolidated financial statements effective with its current fiscal quarter ending June 30, 2006. We are currently evaluating the impact of both the change in our influence on Global's operations and the future timing and availability of financial information from this entity to determine whether this investment will be carried as a cost or equity investment going forward.
GEM'S OPERATIONS:
As of May 9, 2006, GEM's net domestic production rate was at approximately 7.8 million cubic feet equivalent of natural gas per day. Prior to the hurricanes, GEM's net domestic production rate was approximately 7.6 million cubic feet equivalent of natural gas per day. While we continue to experience production losses as a result of the hurricanes, we have restored and/or enhanced production in other fields. The following field data updates the status of GEM's domestic operations through the end of April 2006:
Lapeyrouse Field, Terrebonne Parish - Louisiana
GEM holds an average non-operated working interest of 8.2% in eight wells in this field. During the first quarter of 2006, GEM has participated in two additional workovers in the field. As a result of these activities, gross field production increased from 20 million cubic feet equivalent to approximately 28 million cubic feet equivalent of natural gas per day. A ninth well, with first production in late March 2006, has experienced some increased water and is currently shut-in for a workover scheduled for May 2006. GEM holds an approximately 39% operated working interest in this ninth well.
Main Pass, Plaquemines Parish - Louisiana
Production has been increased to approximately 475 gross barrels of oil per day ("bopd"). GEM has a 90% interest in Main Pass and is the field operator. During the third quarter of 2005, GEM completed a major overhaul and rebuild of an additional compressor for the field. Repair work on a second rental compressor damaged by the hurricane is now completed. Now that both compressors are operational, GEM plans to add additional wells to the gas lift cycle. Gross production for the field is expected to reach approximately 500 bopd after additional wells are gas lifted. GEM continues its geological and geophysical study in the area, utilizing its license to 21 square miles of 3D seismic data, covering the area held by production leases.
Raymondville Field, Willacy and Kenedy Counties - Texas
During the first quarter of 2006, GEM participated in additional recompletions that resulted in a temporary increase in gross production for the field. As previously disclosed, it is expected that field production will resume its decline rate. Currently gross production for this field is approximately 8 million cubic feet equivalent of natural gas per day. GEM has an average 27% non-operated working interest in this field.
Lake Raccourci Field, Lafourche Parish - Louisiana
GEM holds a 40% operated working interest in each of its Lake Raccourci wells. Gross production for this field is approximately 2.8 million cubic feet equivalent of natural gas per day. The State Lease 14589 #2 is currently shut-in, waiting on a workover rig scheduled for the second quarter of 2006. Upon completion of the workover, gross production is expected to return to about 5.0 million cubic feet equivalent of natural gas per day. GEM is presently seeking industry partners to drill a field extension well.
3D Seismic Licenses - Louisiana
GEM continues to evaluate its seismic licenses covering approximately 155 square miles of 3D seismic data in three different surveys across south Louisiana. A number of leads have developed in this continuing study. The process of cataloging and prioritizing the seismic data is ongoing.
South Beach Field, Chambers County - Texas
GEM has a non-operated working interest of 10% in this area. Gross production for this field is approximately 3.7 million cubic feet equivalent of natural gas per day.
Branville Bay Field, Plaquemines Parish - Louisiana
This non-operated property remains 100% shut-in from the hurricanes in late 2005. Repairs to the production facility are underway and production is expected to resume in the second quarter of 2006. GEM has a non-operated working interest of 12.5% in this area.
Point-a-la-Hache Field, Plaquemines Parish - Louisiana
This operated property also remains 100% shut-in. Damages to this field principally affected a leased production barge facility. Repairs to the production barge are expected to be completed in the second quarter 2006. GEM maintains a 25% operated working interest in the area.
Point-au-Fer Field, Terrebonne Parish - Louisiana
In 2005, GEM entered into a Participation Agreement and Joint Operating Agreement covering an area of mutual interest of approximately 56 square miles. In addition, during the fourth quarter of 2005, GEM participated in an acquisition of two wells with production potential, and a central facility. GEM owns a 12.5% non-operated working interest in the area. Two wells were drilled in the first quarter of 2006. The first well has been flow tested at about 2.75 million gross cubic feet equivalent of natural gas per day, and is waiting on hook-up to facilities. The second well has been logged productive and cased. A completion rig is expected in the second quarter of 2006. One workover and recompletion of an existing well is expected to commence in May 2006. A second workover is planned for the late second quarter of 2006. Several prospects have been identified in the area, and GEM expects to have additional drilling and workover activity in this area during 2006.
Allen Ranch Field, Colorado County - Texas
GEM owns an 11.25% non-operated working interest in the area. The initial well, the Hancock Gas Unit # 1, was productive in four sands and has been producing approximately 2.5 million gross cubic feet equivalent of natural gas per day. As a result of the success with the first well, the Hancock Gas Unit # 2 was drilled in October 2005 as an offset to the first well. This second well was logged as productive in the same four sands as the Hancock Gas Unit # 1 well and two deeper zones were also logged as productive. The deeper of the two zones has been fracture stimulated and produced about 5.0 million cubic feet equivalent of natural gas per day. This zone has now been shut-in to test the other productive zone in the well bore and a temporary bridge plug was set above the sand to protect the zone while additional testing continues. The second zone has been perforated and is scheduled for fracture stimulation in the second quarter 2006.
Coalbed Methane Prospects - Indiana and Ohio
In 2005, GEM entered into two significant Exploration and Development Agreements in Indiana and Ohio. Each prospect provides for an area of mutual interest of approximately 400,000 acres. During the first quarter of 2006, GEM has entered into another Exploration and Development Agreement in Ohio. This
prospect provides for an area of mutual interest of approximately 20,000 acres. In each case, the agreements provide for a phased delineation, pilot and development program with corresponding staged expenditures. Contracted third parties with a long track record in successful Coalbed Methane development are providing expert advice for these projects.
Indiana Prospect
In September 2005, after the submission of a Phase I core evaluation report by the technical consultant, GEM elected to proceed and fund pilot well drilling under Phase II of the agreement. Due to limited availability of needed equipment, GEM expects the drilling of the pilot wells to occur during the second quarter of 2006.
Ohio Cumberland Prospect
Core samples from the Ohio CBM prospect are being analyzed for gas content, gas composition and characteristics of the coal. Depending on final results, GEM may elect to schedule drilling of pilot wells on its Ohio CBM prospect area during 2006.
Ohio Triangle Prospect
Core samples are expected to be obtained on this third prospect late in the second quarter of 2006. Depending on final results of core analysis, GEM may elect to schedule drilling of pilot wells on this CBM prospect area during 2006.
GLOBAL'S OPERATIONS:
Revenues from Global are derived solely from its Colombian oil production. During the three months ended March 31, 2006, Global increased its revenues compared to the corresponding prior year period due to increased crude oil prices. Global production volumes remained steady during both periods.
In April 2006, Global signed a new exclusive Exploration and Production Concession contract for the Los Sauces area ("Los Sauces Contract") with the National Hydrocarbons Agency of the Republic of Colombia.
The Los Sauces Contract covers approximately 61,600 acres in the Central Llanos region of Colombia where Global already has three contracts, namely the Alcaravan Association contract and the Rio Verde and Los Hatos Exploration and Production Concession contracts. The Los Sauces Contract is contiguous with the northern boundary of the Rio Verde contract.
Global will own 100% of the Los Sauces Contract subject only to an initial 10.5% royalty, with the future size of the royalty to be determined by future production levels. The Los Sauces Contract, effective from March 31, 2006, has a principal term of thirty years divided into an initial six-year exploration phase and a 24-year exploitation and production phase. Under the terms of the Los Sauces Contract, Global must within twelve months reprocess approximately 200 kilometers of existing seismic, acquire and process 50 kilometers of 2D seismic, and drill one exploratory well.
Global can, at its election, proceed to phase 2, twelve months in duration, and drill one exploratory well. Phases 3 to 6, also all optional and twelve months in length, require the drilling of an exploratory well in each phase.
The Los Sauces area has been subject to prior drilling activity by an international oil company over ten years ago at which time the La Totuma #1 well was drilled with reported oil shows. Based upon the existing formation and seismic data, Global has elected to position and drill an exploratory well geologically updip from the existing La Totuma #1 well in the second half of 2006.
CAPITAL STRUCTURE
Effect of Convertible Debt and Equity Instruments on Dilution
As of March 31, 2006, on a consolidated basis, we had cash and short term investments of $40 million and working capital of $38 million (including $4 million cash held by Global). We had approximately $90 million in shareholders' equity at March 31, 2006.
At March 31, 2006, if our remaining outstanding debt, convertible preferred stock and common stock purchase warrants were exercised and/or converted, we would be required to issue the following amounts of our common stock:
Conversion / Shares of Common Exercise Stock Issuable at Instrument Price (a) March 31, 2006 Series M Preferred $ 0.59 8,389,831 Series G1 Preferred $ 12.50 12,800 Series G2 Preferred $ 3.00 33,333 Series L Warrants $ 0.67 3,182,836 Series M Warrants $ 0.57 4,385,965 Common Stock Potentially Issued Upon Conversion / Exercise 16,004,765
CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS
Our consolidated condensed financial statements have been prepared in accordance with United States generally accepted accounting principles ("US GAAP") which requires us to use estimates and make assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Our estimates and assumptions are based on historical experience, industry conditions and various other factors which we believe are appropriate. Actual results could vary significantly from our estimates and assumptions as additional information becomes known. The more significant critical accounting estimates and assumptions are described below.
Asset Retirement Obligations - Our asset retirement obligations represent our best estimate of the fair value of our future abandonment costs associated with our oil and gas properties, including the costs of removal and disposition of tangible equipment, site and environmental restoration. We estimate the fair value of our retirement costs in the period in which the liability is incurred, if a reasonable estimate can be made. The determination of the fair value of an asset retirement obligation generally involves estimating the fair value of the obligation at the end of the property's useful life and then discounting it to present value using our credit adjusted, risk free rate of return. Estimating future asset removal costs is difficult and requires management to make estimates and judgments regarding the expected removal and site restoration costs, timing and present value discount rates. Valuations of the estimated useful life and the fair value of the asset retirement obligation are imprecise since the removal activities will generally occur several years in the future and asset removal technologies and costs are constantly changing, as are political, environmental and safety considerations that may ultimately impact the amount of the obligations.
Derivative Instruments - We are exposed to the risk of fluctuations in crude oil and natural gas prices. To reduce the impact of this risk in earnings and to increase the predictability of our cash flow, from time to time we enter into certain derivative contracts (primarily option floors) for a portion of our North American oil and gas production. As required by Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), we are required to record all derivative contracts at fair value in our balance sheet. Changes in fair value are required to be recorded in income or other comprehensive income, depending on the hedging designation and the hedge effectiveness. Our estimates of fair value are based on market quotes from third parties. While the fair values of our derivatives have fluctuated significantly, our estimates of fair value have historically been consistent with the settlement amounts.
Fair value of our debt and equity transactions -Many of our various debt and equity transactions require us to determine the fair value of a debt or equity instrument in order to properly record the transaction in our financial statements. We historically have utilized independent third parties to assist us in determining the fair value of many of our transactions. Fair value is generally determined by applying widely acceptable valuation models, (e.g., the Black-Scholes valuation model) using the trading price of the underlying instrument or by comparison to instruments with comparable maturities and terms.
Consolidation of variable interest entities - In January 2003, the FASB issued FASB Interpretation No. ("FIN") 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which requires the primary beneficiary of a variable interest entity's ("VIE") activities to consolidate the VIE. FIN 46 defines a VIE as an entity in which the equity investors do not have substantive voting rights and there is not sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The primary beneficiary is the party that absorbs a majority of the expected losses and/or receives a majority of the expected residual returns of the VIE's activities. In December 2003, the FASB issued FIN 46(R), which supercedes and amends certain provisions of FIN 46. While FIN 46(R) retained many of the concepts and provisions of FIN 46, it also provides additional guidance related to the application of FIN 46, provides for certain additional scope exceptions, and incorporates several FASB Staff Positions issued related to the application of FIN 46. As of March 31, 2006, Harken owned less than a majority of the common shares of Global but did possess the legal power to direct the operating policies and procedures of Global through our direct ownership, combined with the 20% ownership by Lyford in Global shares. In addition, Harken has concluded that Global was not a VIE at March 31, 2006 as contemplated by FIN 46(R). During the three months ended March 31, 2006, we had an investment in a VIE named IBA, which we consolidated in accordance with FIN 46(R). See Note 3 - "Investment in International Business Associates, Ltd." in the notes to the Consolidated Condensed Financial Statements for information regarding the consolidation of IBA.
STOCK-BASED COMPENSATION
Adoption of Statement of Financial Accounting Standard No. 123 (As Amended)
Effective January 1, 2006, Harken and its consolidated companies adopted SFAS No. 123 (as amended) "Accounting for Share-Based Compensation" ("SFAS 123(R)") using the modified prospective transition method. In addition, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 "Share-Based Payment" ("SAB 107") in March, 2005, which provides supplemental SFAS 123(R) application guidance based on the views of the SEC. Under the modified prospective transition method, compensation cost recognized in the quarterly period ended March 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted beginning January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In accordance with the modified prospective transition method, results for prior periods have not been restated.
The adoption of SFAS 123(R) resulted in an adjustment for cumulative effect in change in accounting principles on the consolidated condensed statement of operations ended March 31, 2006 for the amount of $868 thousand. This adjustment was recorded as a decrease to Net Income. The Company did not recognize a tax benefit from the cumulative effect adjustment because Global, the only entity impacted by SFAS 123 (R), currently has net operating losses that will prevent any tax benefit being received from any exercised options. In accordance with SFAS 123(R) the company will not recognize the tax benefits and/or credits to additional paid in capital for any additional deduction until the deduction actually reduces the taxes payable.
RECENT ACCOUNTING PRONOUNCEMENTS
On February 16, 2006, the FASB issued Statement 155, "Accounting for Certain Hybrid Instruments- an amendment of FASB Statements No. 133 and 140." The statement amends Statement 133 to permit fair value measurement for certain hybrid financial instruments that contain an embedded derivative, provides additional guidance on the applicability of Statement 133 and 140 to certain financial instruments and subordinated concentrations of credit risk. The new standard is effective for the first fiscal year that ends after September 15, 2006. Harken is currently evaluating the impact this new Standard will have on the Company.
RESULTS OF OPERATIONS
For the purposes of discussion and analysis, we present a summary of our consolidated condensed results of operations followed by a more detailed discussion and analysis of our segments.
Consolidated Condensed Statement of Operations Comparisons Net loss and per-share amounts for each of the periods ended March 31, 2005 and 2006, were as follows: Three Months Ended March 31, (Thousands of dollars, except per-share amounts) 2005 2006 (unaudited) Net loss $ (6,216 ) $ (1,770 ) Net loss attributed to common stock $ (6,610 ) $ (2,974 ) Net loss per share - Basic $ (0.03 ) $ (0.01 ) Diluted $ (0.03 ) $ (0.01 )
The primary components of our net loss for the period ended March 31, 2005 compared to the net loss for the period ended March 31, 2006 are outlined in the table below:
Favorable (Unfavorable) . . .
May 09, 2006
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