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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER: 0-25386
FX ENERGY, INC.
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(Name of registrant issuer in its charter)
NEVADA 87-0504461
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3006 HIGHLAND DRIVE, SUITE 206
SALT LAKE CITY, UTAH 84106
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: TELEPHONE (801) 486-5555
TELECOPY (801) 486-5575
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which
registered
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.001
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
during the past 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K (S 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked price of such common equity, as of February
26, 1999, was $54,665,731.
Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of the latest practicable date. As of February 26, 1999, FX
Energy had outstanding 13,054,503 shares of its common stock, par value $0.001.
FX ENERGY'S DEFINITIVE PROXY STATEMENT IN CONNECTION WITH THE 1999 ANNUAL
MEETING OF STOCKHOLDERS IS INCORPORATED BY REFERENCE IN RESPONSE TO PART III OF
THIS ANNUAL REPORT.
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This report contains statements about the future, sometimes referred to as
"forward-looking" statements. Forward-looking statements are typically
identified by the use of the words "believe," "may," "will," "should,"
"expect," "anticipate," "estimate," "project," "propose," "plan," "intend" and
similar words and expressions. FX Energy intends the forward-looking statements
to be covered by the safe harbor provisions for forward-looking statements
contained in Section 27A of the Securities Act and Section 21E of the Exchange
Act. Statements that describe FX Energy's future strategic plans, goals or
objectives are also forward-looking statements.
Readers of this report are cautioned that any forward-looking statements,
including those regarding FX Energy or its management's current beliefs,
expectations, anticipations, estimations, projections, proposals, plans or
intentions, are not guarantees of future performance or results of events and
involve risks and uncertainties, such as
-The future results of drilling individual wells and other exploration and
development activities;
-Future events that may result in the need for additional capital;
-Fluctuations in prices for oil and gas;
-Uncertainties of certain terms to be determined in the future relating to FX
Energy's oil, gas and mining interests, including exploitation fees, royalty
rates and other matters;
-Future drilling and other exploration schedules and sequences for various
wells and other activities;
-Uncertainties regarding future political, economic, regulatory, fiscal,
taxation and other policies in Poland;
-The future ability of FX Energy to attract strategic partners to share the
costs of exploration, exploitation, development and acquisition activities;
and
-Future plans and the financial and technical resources of strategic partners.
The forward-looking information is based on present circumstances and on FX
Energy's predictions respecting events that have not occurred, which may not
occur or which may occur with different consequences from those now assumed or
anticipated. Actual events or results may differ materially from those
discussed in the forward-looking statements as a result of various factors,
including the risk factors detailed in this report. The forward-looking
statements included in this report are made only as of the date of this report.
FX Energy is not obligated to update such forward-looking statements to reflect
subsequent events or circumstances.
PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
INTRODUCTION
FX Energy is an independent oil and gas exploration, development and
production company focused on oil and gas exploration in the Republic of
Poland. As of January 1, 1999, FX Energy was the largest foreign oil and gas
exploration acreage holder in Poland, in terms of both gross and net acreage,
with exploration rights covering approximately 17.0 million gross acres,
including 13.6 million gross acres of Concessions and options covering
approximately 3.4 million gross acres controlled by the Polish government-owned
Polish Oil & Gas Company ("POGC"). FX Energy has strategic alliances with POGC
and Apache Corporation ("Apache"), a leading U.S. based independent energy
company, to explore for oil and gas, capitalize on development and acquisition
opportunities, obtain project financing and conduct other activities in Poland.
FX Energy is currently focusing its oil and gas exploration activities in Poland
on five project areas; Lublin, Carpathian, Pomeranian, Warsaw West and the
Baltic. Domestically, FX Energy has limited oil production and reserves in
Montana and Nevada, a drilling and well servicing company and oil and gas
exploration prospects in several western states.
Effective January 1, 1999, FX Energy and Apache entered into an agreement
which further defined the relationship between FX Energy and Apache in Poland by
creating an Area of Mutual Interest ("AMI") for a minimum of two years covering
the entire country of Poland, except for the Baltic Project Area, and
established an integrated framework for joint oil and gas exploration,
production, development and acquisition activities.
Under agreements between FX Energy and Apache signed during 1997, 1998 and
early 1999, Apache has agreed to perform certain earning requirements in order
to earn a fifty-percent interest in FX Energy's Lublin and Carpathian project
areas. Under the agreements, Apache has paid FX Energy $950,000 in initial cash
consideration and agreed to pay FX Energy's pro rata share of costs to: (1)
drill ten exploratory wells, including drilling and, if successful, completion
costs for seven exploratory wells in the Lublin Project Area and the costs to
drill (excluding completion costs) three exploratory wells in the Carpathian
Project Area; (2) acquire a minimum of 2,000 kilometers of 2D seismic, including
1,650 kilometers of 2D seismic in the Lublin Project Area and 350 kilometers
of 2D seismic in the Carpathian Project Area; (3) cover all Concession, usufruct
and other leasehold costs during the first three years of the six-year
exploration period of the Lublin and Carpathian project areas; and (4) cover all
general and administrative costs relating to activities in Poland through the
end of 1999. Terms of other agreements between FX Energy and Apache include:
(1) FX Energy and Apache are equal 50/50 partners in the Pomeranian and Warsaw
West project areas; and (2) Apache is the operator of all project areas covered
by the FX Energy and Apache AMI.
During late 1998, Apache commenced drilling two exploratory wells, both of
which were determined to be exploratory dry holes during February 1999, and
completed shooting its minimum requirement of 1,650 kilometers of 2D seismic on
the Lublin Project Area. Apache has committed to drill the remaining five
exploratory wells on the Lublin Project Area by the end of 1999, acquire 350
kilometers of 2D seismic on the Carpathian Project Area during 1999 and 2000 and
drill three exploratory wells by mid-2001 on the Carpathian Project Area, all at
no cost to FX Energy. FX Energy and Apache also plan to commence, on an equal
fifty-percent cost sharing basis, the development of POGC's Lachowice gas
discovery during 1999, exploratory drilling on the Pomeranian Project Area
during 2000 and exploratory drilling on the Warsaw West Project Area during
2001.
FX Energy and Apache entered into agreements (the "Option Agreements") with
POGC during 1997 and 1998 whereby each has an independent, reciprocal right to
participate, in up to a one-third interest each, in hydrocarbon exploration of
POGC controlled areas adjacent to and near the Lublin, Carpathian and Pomeranian
project areas. In turn, POGC has the reciprocal right to participate in
hydrocarbon exploration, in up to a one-third interest determined on a block by
block basis, on the Lublin, Carpathian and Pomeranian project areas. The Option
Agreements cover approximately 3.4 million acres of POGC controlled areas,
including 0.6 million acres on the Lublin Project Area, 1.5 million acres on the
Carpathian Project Area and 1.3 million acres on the Pomeranian Project Area,
and approximately 8.6 million acres of FX Energy/Apache controlled areas,
including 5.0 million acres on the Lublin Project Area, 1.4 million acres on the
Carpathian Project Area and 2.2 million acres on the Pomeranian Project Area.
There are no option agreements with POGC covering the Baltic and Warsaw West
project areas, which are comprised of approximately 2.1 million acres and 2.9
million acres, respectively.
FX Energy uses various terms in this report that are common in the oil and
gas industry but that may not be familiar to all investors. This report
contains a glossary at the end of this section that defines certain of these oil
and gas terms.
References to FX Energy in this report include FX Energy, Inc., its
subsidiaries and the entities or enterprises organized under Polish law in which
FX Energy has an interest and through which FX Energy conducts its activities in
that country.
As discussed, FX Energy has entered into arrangements with POGC and Apache
through which each company has separate rights to participate in various
activities and projects in Poland. For the purposes of presenting information
in this report:
* All gross and net well and acreage positions in Poland assume that
-POGC does not exercise its rights to participate in the portions of
the project areas controlled by FX Energy, except respecting portions
in which it has elected to participate with the interest indicated
prior to the date of this report; and
-FX Energy and Apache each will exercise their respective options to
participate in POGC controlled acreage at 33.3% each.
* All historical production and test data about Poland have been derived
from information furnished by either POGC or the Polish Ministry of
Environmental Protection,Natural Resources and Forestry.
THE REPUBLIC OF POLAND
The Republic of Poland, with a population of about 40 million people,
peacefully asserted its independence in 1989 and adopted a new constitution that
established a parliamentary democracy. Poland's comprehensive economic reform
programs and stabilization measures implemented since 1989 have enabled it to
move toward a free market economy that is currently one of the fastest growing
in eastern Europe, with recent annual growth rates of from 5% to 7%. Poland is
poised to join NATO in the near future and the European Union within five years.
Poland's international trade has also undergone significant change. Its
economic ties have turned from the east to the west, with most of its current
international trade with the countries of the European Union. The Polish
government credits foreign investment as a forceful growth factor, generating
over one-third of the country's total investment and acting as a powerful
restraint on unemployment.
Since the 1850s, when oil was first commercially produced in Poland,
approximately 122 MMBbls of oil and 2.6 Tcf of gas in the southeastern
Carpathian region and 24 MMBbls of oil and 2.3 Tcf of gas in the southwestern
Polish Lowlands have been produced to date. Over the last several decades, the
exploration and development of Poland's oil and gas resources have been hindered
by a combination of foreign influence, a centrally controlled economy, limited
financial resources and a lack of modern exploration technology. Poland
currently imports approximately 98% of its oil, primarily from countries of the
former Soviet Union and the Middle East and approximately 60% of its natural
gas, primarily from countries of the former Soviet Union.
POGC is the largest holder of oil and gas exploration and exploitation
rights in Poland and is the principal petroleum product processor and
distributor, with approximately 40,000 employees. The government of Poland
has announced that it intends to privatize various aspects of POGC. At this
time, no specific plans have been announced respecting the method or timing of
such privatization. See "Risk Factors--Poland's Governmental Regulation."
BUSINESS STRATEGY
FX Energy's strategy is to create a program of lower risk appraisal and
development opportunities to balance against its ongoing high potential
exploration program on its large acreage position in Poland. FX Energy believes
its strategic alliances with Apache and POGC give it significant financial and
operational leverage in its drilling programs as well as enhance its ability to
pursue additional opportunities in Poland. The principal components of FX
Energy's strategy are:
-Focus on Poland. FX Energy believes Poland is an attractive area for oil and
gas exploration and development because of its significant oil and gas
potential from geologically diverse hydrocarbon provinces, rapidly growing
free market economy and competitive regulatory environment. In addition,
Poland provides a relatively modern industrial infrastructure, including
drilling and service companies, pipelines, refineries and railroads. Since
becoming the world's largest oil producer prior to World War I, the
exploration and development of Poland's oil and gas resources have been
hindered by a combination of foreign influence, a centrally controlled
economy, limited financial resources and a lack of modern exploration
technology. As a result, Poland currently imports approximately 98% and 60%
of its oil and gas consumption, respectively. In an effort to reduce its
dependence on imports and to encourage investment, Poland has created an
internationally competitive fiscal regime regarding the development of oil
and gas resources, including a current 6% government royalty and an
exploitation license fee with no back-end governmental participation.
-Leverage High Potential Exploration Program through Strategic Alliances. FX
Energy has focused on acquiring multiple high potential exploration
opportunities on large acreage blocks in Poland. FX Energy uses strategic
alliances to pursue attractive opportunities at a limited direct cost to FX
Energy. For example, to earn an interest in certain of FX Energy's project
areas, Apache has agreed to fund, at no cost to FX Energy, an exploration
drilling program to be completed in 2001, including the drilling of 10 wells
and the acquisition and analysis of new and reprocessed seismic data plus
other costs and fees estimated to total over $50 million. In addition, FX
Energy and Apache are each fifty-percent participants in the Pomeranian and
Warsaw West project areas. FX Energy also has agreements with POGC, which
has historically performed most of the oil and gas exploration and
development in Poland, to access existing geological and geophysical data of
certain project areas.
-Capitalize on Exploitation and Development Opportunities. FX Energy is also
pursuing lower risk appraisal and development drilling opportunities in
Poland. FX Energy is focusing its efforts on acquiring interests on or near
areas containing proven reserves or in areas in which FX Energy believes
modern drilling and production techniques will result in producing wells.
For example, on POGC acreage in the Lachowice Field, FX Energy, in
conjunction with Apache, plans to reenter up to three wells that POGC
previously tested at an average combined production rate of 5.7 MMcf per day
of gas per well and, if warranted, to install production infrastructure and
drill three additional development wells. In addition, FX Energy intends to
participate with Apache in appraisal and development drilling opportunities
which may arise as a result of their ongoing multiple-well exploration
program.
-Expand Activities in Poland. FX Energy intends to continue its strategy of
obtaining acreage and access to attractive opportunities in Poland through
cooperative efforts with POGC. For example, during 1998 FX Energy and
Apache contracted with the Geosynoptics Society of the University of Mining
and Metallurgy at Krakow to undertake a joint study to identify hydrocarbon
development opportunities. FX Energy and Apache have agreed to join as
fifty-percent interest holders in any prospects identified through the study
that they are able to pursue with POGC. FX Energy and Apache intend to focus
their efforts initially in the western Polish Lowlands, which includes areas
where POGC has either Concessions or existing data that may help direct
exploration activities. Similarly, FX Energy, Apache and POGC have agreed to
conduct a geological and geophysical analysis of five blocks covering an
aggregate of approximately 1.3 million acres near the Pomeranian Project Area
in northwest Poland to identify and select exploration objectives. Upon
identifying potential drilling targets, POGC will seek exploration Concession
rights in its name, subject to the option of FX Energy and Apache to
participate in exploration on terms agreed upon by the parties. Neither FX
Energy nor Apache currently has any exploration rights to such prospects.
EXPLORATION AND DEVELOPMENT ACTIVITIES IN POLAND
Polish Project Area Acreage
FX Energy's oil and gas exploration rights in Poland cover five separate
project areas comprised of the following gross acreage components:
FX ENERGY OPTIONS ON POGC TOTAL
CONTROLLED AREAS
-------------- ------------------------ ----------
PROJECT AREA CONCESSION (2) CONCESSION EXCLUSIVE ACREAGE
- -------------- -------------- ---------- --------- ----------
Lublin (1),(3) 5,000,000 600,000 -- 5,600,000
Carpathian 1,400,000 200,000 1,300,000 2,900,000
(1),(3)
Pomeranian 2,200,000 100,000 1,200,000 3,500,000
(1),(4)
Warsaw West 2,900,000 -- -- 2,900,000
(4)
Baltic 2,100,000 -- -- 2,100,000
---------- ------- --------- ----------
Total 13,600,000 900,000 2,500,000 17,000,000
========== ======= ========= ==========
(1)POGC controlled areas include approximately 0.9 million acres of existing
POGC Concessions and approximately 2.5 million acres for which POGC has been
granted the exclusive right to obtain Concessions by the government of
Poland. FX Energy and Apache each have separate options to participate in
the exploration of POGC controlled areas with up to a one-third interest
each. In turn, POGC has an option to participate with up to a one third
interest, determined on a block by block basis, in the exploration of the FX
Energy Concession portion of the respective project areas.
(2)FX Energy and Apache each own an effective fifty-percent beneficial interest
in each of FX Energy's Concessions subject to POGC's participation in the
Lublin, Carpathian and Pomeranian project areas, except the Baltic
Concession, which is owned 100% by FX Energy.
(3)Apache must perform certain obligations to earn an interest in FX Energy's
Lublin and Carpathian Concessions, including, but not limited to, covering
the cost to drill seven exploratory wells on the Lublin Project Area and
three exploratory wells on the Carpathian Project Area. The Carpathian
Project Area's exclusive acreage includes the 0.4 million acre Northern
Carpathian Concession which was applied for during 1998 and is awaiting
approval by the Polish government.
(4)Under terms of the FX/Apache AMI effective January 1, 1999, FX Energy and
Apache are equal fifty-percent partners in FX Energy's Pomeranian Project
Area and Apache's Warsaw West Project Area.
Lublin Project Area
The 5.6 million acre Lublin Project Area is located in central southeast
Poland and comprises twenty four blocks and three partial blocks covering
approximately 5.0 million acres awarded to FX Energy during 1996 and 1997 and
the 0.6 million acre Lublin Option acreage that contains the POGC Concessions
and is governed by an agreement between FX Energy, Apache and POGC dated July
18, 1997.
The Lublin Basin has been explored extensively by POGC in recent years
resulting in the discovery of five fields (Stezyca, Swidnik, Ciecierzyn, Melgiew
and Komarow) which established oil or gas reservoirs in Devonian reef and
Carboniferous sand traps. Additional wells drilled by POGC in the Lublin
Project Area have also encountered oil or gas shows in the Cambrian, Devonian
and Carboniferous formations. Seismic data analyzed to date and correlated with
data from drilling logs and core samples from previous wells show a number of
Carboniferous, Devonian, Cambrian and Triassic leads within the area covered by
the Lublin Project Area.
Lublin Concession
During 1996 and 1997, FX Energy entered into two separate exploration
agreements with the government of Poland respecting its interests in the Lublin
Project Area. The first Lublin Agreement, dated December 20, 1996, covered
approximately 2.0 million acres in eight exploration blocks. Under the first
Lublin Agreement, FX Energy's exploration rights are divided into two successive
three-year phases expiring in three and six years, respectively, after grant of
eight Concessions ("Original 8 Blocks") in the Project Area. FX Energy may
relinquish rights to any Concession blocks after the first three-year phase. To
retain its rights in the Original 8 Blocks, FX Energy must review existing data,
gather at least 500 kilometers of seismic data, commence one exploratory
well during the first three-year phase and commence at least one exploratory
well in each of the retained Concession blocks, excluding the block in which the
initial test is located, by the end of the second three-year phase. FX Energy
must also pay Concession and usufruct fees totaling $220,000 and spend $25,000
per year training Polish citizens.
On July 18, 1997, FX Energy entered into the second Lublin Agreement
covering approximately 3.0 million acres in sixteen exploration blocks
("Additional 16 Blocks"). Under the second Lublin Agreement, FX Energy is
required to acquire 1,150 kilometers of seismic, drill five wells during the
first three years of a six-year exploration term, pay $475,000 in Concession
and usufruct fees and spend $55,000 per year training Polish citizens.
As a result of various agreements signed with Apache during 1997 and 1998,
Apache agreed to earn a fifty percent interest in the Lublin Concession by
paying FX Energy $450,000 in cash and committing to pay FX Energy's pro rata
cost of: (1) drilling and completing seven exploratory wells; (2) acquiring a
minimum of 1,650 kilometers of 2D seismic; (3) all Concession, usufruct and
training fees during the first three years of a six-year exploration period;
and, (4) all of Apache's Polish general and administrative costs through 1999 or
until Apache's earning requirements are completed, whichever is later. Apache
is the operator of the Lublin Concession.
Lublin Option with POGC
The Lublin Option comprises approximately 0.6 million acres of existing
POGC Concessions. On July 18, 1997, POGC granted FX Energy and Apache each an
independent right to participate in up to a one-third interest in exploring the
Lublin Option. In turn, FX Energy and Apache granted POGC an option to
participate in exploratory drilling on the Lublin Concession with up to a one-
third working interest on a block by block basis.
Exploration Activities - Lublin Exploration Program with Apache
FX Energy is cooperating with Apache in developing a comprehensive long-
term exploration and development program for the Lublin Project Area. Apache
has agreed to fund, at no cost to FX Energy, the drilling of seven (3.5 net) of
these exploratory wells on either the Lublin Concession or Lublin Option
acreage. Apache has completed a 2,000 kilometer seismic survey covering
portions of the Lublin Project Area and analyzed, reprocessed and evaluated
approximately 5,400 kilometers of existing seismic data. The seismic data,
together with well log and core analysis data, was used to pick the first two
exploratory well sites of the seven exploratory wells Apache has committed to on
the Lublin Project Area.
During the fourth quarter of 1998, Apache commenced drilling the first two
exploration wells on the Lublin Project Area: the Czernic 277-2 and the
Poniatowa 317-1. The Czernic 277-2 is located on the Lublin Option acreage
within the Lublin Project Area. Although the Czernic 277-2 is not located
within the Lublin Concession, FX Energy and Apache agreed to count the Czernic
277-2 as one of the seven exploratory wells. Accordingly, Apache paid all of FX
Energy's pro rata share of drilling costs for the Czernic 277-2. POGC elected
to participate in the drilling of the Czernic 277-2 with a one-third working
interest. Apache and FX Energy each retained a one-third working interest in
the Czernic 277-2. The Poniatowa 317-1 is located within the Lublin Concession
and is also counted as one of the seven exploratory wells. As such, Apache paid
for all of FX Energy's pro rata drilling costs for the Poniatowa 317-1. POGC
elected to participate in the drilling of the Poniatowa 317-1 with a 5.0%
working interest. Apache and FX Energy each retained a 47.5% working interest
in the Poniatowa 317-1.
On February 16, 1999, the Czernic 277-2 and the Poniatowa 317-1 were
determined to be exploratory dry holes. The Czernic 277-2 was drilled to a
depth of 3,000 meters and the Poniatowa was drilled to a depth of 2,230 meters.
Under terms of various agreements with Apache, all of FX Energy's working
interest costs, including 33.3% for the Czernic 277-2 and 47.5% for the
Poniatowa 317-1, were covered by Apache.
Carpathian Project Area
The 2.9 million acre Carpathian Project Area is located in southern Poland
and comprises the 1.4 million acre Southern Carpathian Concession containing
twelve blocks awarded to FX Energy on October 14, 1997, the approximately 0.4
million acre Northern Carpathian Concession containing parts of three blocks
which was applied for in 1998 and is awaiting government approval and 1.1
million acres of POGC controlled areas which are governed by an agreement
between FX Energy, Apache and POGC dated February 2, 1998.
The Carpathian Project Area is in the Carpathian region, where hydrocarbons
were first discovered in 1854. To date, the Carpathian region is reported to
have produced an estimated 122 MMBbls of oil and 2.6 Tcf of gas from shallow
depths. A limited number of deep wells drilled in recent years by POGC evidence
additional possible reservoir potential within the area. Over the past few
years, there have been several oil and gas discoveries in the Carpathian region
in the Carboniferous, Myocene, Jurassic and Cretaceous formations.
Southern Carpathian Concession
On October 14, 1997, the Polish government awarded FX Energy exclusive
rights to explore for oil and gas on 12 blocks containing approximately 1.4
million acres located in the Southern Region of the Carpathian Mountains. FX
Energy is obligated to acquire 350 kilometers of 2D seismic, drill one well
during the first three years and two additional wells during the second three
years of a six-year exploration period, pay $160,000 in Concession and usufruct
fees and spend $15,000 per year training Polish citizens.
On February 27, 1998, FX Energy signed an agreement with Apache, whereby
Apache agreed to earn a fifty-percent interest in FX Energy's Southern
Carpathian Concession. Under the agreement, Apache paid FX Energy $500,000 in
initial cash consideration and committed to pay FX Energy's pro rata share of
the cost for: (1) drilling three exploratory wells; (2) acquiring 350 kilometers
of seismic; (3) all Concession, usufruct costs and training fees in the first
three years of a six-year exploration period; and, (4) all of Apache's Polish
general and administrative costs through 1998 or until Apache's earning
requirements are completed, whichever is later. Apache is the operator of the
Southern Carpathian Concession. On February 2, 1998, FX Energy, Apache and POGC
signed an agreement whereby FX Energy and Apache each have a fifty-percent
working interest in the Southern Carpathian Concession subject to being reduced
by POGC's election to participate in exploratory drilling on the Southern
Carpathian Concession with up to a one-third working interest on a block by
block basis. FX Energy and Apache each have an independent reciprocal right to
participate in the exploration of POGC's Carpathian Option acreage, an area
which includes 1.5 million acres controlled by POGC, with up to a one-third
working interest each.
Northern Carpathian Concession
In May 1996, FX Energy entered into a Joint Study Agreement with POGC in
order to identify drillable oil and gas prospects in the Carpathian Mountains in
southern Poland where oil and gas exploration rights are controlled by POGC.
As a result of this agreement, FX Energy and Apache, along with POGC, applied
for the 0.4 million acre Northern Carpathian Concession during early 1998. The
Northern Carpathian Concession is located within 1.5 million acres controlled by
POGC in the Carpathian Project Area. FX Energy is currently awaiting Polish
government approval, which is expected in early 1999. As a result of various
agreements, the Company, Apache and POGC will each have a one-third interest in
the Northern Carpathian Concession.
Carpathian Option with POGC
The Carpathian Option comprises approximately 1.5 million acres, including
0.2 million acres of existing POGC Concessions, the 0.4 million acre Northern
Carpathian Concession applied for during 1998 and an additional 0.9 million
acres of POGC controlled areas. On February 2, 1998, POGC granted FX Energy and
Apache each an independent right to participate in up to a one-third interest in
exploring the Carpathian Option. In turn, FX Energy and Apache granted POGC an
option to participate in exploratory drilling on the Southern Carpathian
Concession with up to a one-third working interest on a block by block basis.
Exploration Activities - Carpathian Exploration Program with Apache
Apache is continuing its evaluation of seismic data, well logs and core
samples provided by POGC and has agreed to acquire 350 kilometers of additional
seismic data in the Carpathian Project Area. Based on the existing data, FX
Energy and Apache have identified a large number of possible structural leads
within the Carpathian Project Area. Apache has agreed to fund, at no cost to FX
Energy, the drilling of three exploratory wells in the Carpathian Project Area
by mid-2001. FX Energy and Apache expect to begin the first of three
exploratory wells during 2000.
Development Activities - Lachowice Field
The POGC Carpathian Option includes the Lachowice Field, an undeveloped
gas discovery on a POGC Concession. Between 1982 and 1994 POGC drilled nine
wells in the Lachowice Field, three of which are shut-in gas discoveries that
POGC tested at a combined average rate of 5.7 MMcf of gas per day per well from
10,000-13,000 feet in a Devonian reef structure. On February 26, 1999, FX
Energy, Apache and POGC entered into an agreement to jointly develop the
Lachowice Field with Apache as operator. Under terms of the agreement, the
Company and Apache will pay all of the following costs in order to earn a one-
third interest each in the project: (1) recomplete up to three shut-in gas
wells; (2) drill three additional wells; and, (3) construct gathering and
processing facilities. All costs and net revenues thereafter, including
additional development drilling and lease operating costs, will be shared one-
third each by the Company, Apache and POGC. The project's preliminary work
schedule is as follows: (1) begin testing and recompletion of up to three wells
during the second quarter of 1999; (2) commence additional developmental
drilling as warranted; and, (3) construct facilities and pipeline and commence
production by mid-2000.
Pomeranian Project Area
The 3.5 million acre Pomeranian Project Area is located in northwestern
Poland and consists of the 2.2 million acre Pomeranian Concession covering ten
exploration blocks awarded to FX Energy on October 30, 1997 and the 1.3 million
acre Pomeranian Option acreage on POGC controlled areas pursuant to an agreement
between FX Energy and POGC dated May 20, 1998.
There has been relatively little previous exploration of the area in
northwestern Poland in which the Pomeranian Project Area is located. However,
the Wierzchowa field, which is within the Pomeranian Project Area, is reported
to have produced 14 Bcf of gas at a rate of approximately 5.7 MMcf per well per
day from a Permian structure and stratigraphic tests drilled by the Polish
government are reported to have oil and gas shows from the Devonian horizon.
POGC has made available to FX Energy the existing seismic data and well logs and
cores from the Pomeranian Project Area for reprocessing and analysis. FX Energy
believes that portions of the Pomeranian Project Area and adjacent areas to the
west on POGC controlled acreage are geologically similar to the BMB field to the
southwest on which POGC has drilled approximately 22 producing wells on a 3D
seismic-defined structure. POGC has estimated the BMB field has ultimate
recoverable reserves of 76 MMbls of oil and 349 Bcf of gas.
During February 1998, FX Energy initially granted Apache an option to
acquire a fifty-percent interest in its Pomeranian Project Area in exchange for
Apache's agreement to evaluate and reprocess 1,000 kilometers of seismic.
Following completion of this seismic study in December 1998, Apache exercised
its option to participate in the Pomeranian Project Area by agreeing to pay FX
Energy's pro-rata share of the cost to drill one exploratory well, acquire 600
kilometers of 2D seismic and all Concession costs and other fees during the
first three years of a six year exploration period to earn a fifty-percent
interest in the Pomeranian Project Area. Under terms of a subsequent agreement
signed with Apache in early 1999, FX Energy agreed to eliminate Apache's earning
requirements for the Pomeranian Project Area in exchange for a fifty-percent
interest in Apache's Warsaw West Project Area. FX Energy and Apache are now
each fifty-percent partners in the Pomeranian and Warsaw West project areas.
All costs incurred by either party in the Pomeranian and Warsaw West project
areas before are considered sunk costs for which there will be no equalization
among the parties. Under terms of the Pomeranian Concession, FX Energy and
Apache must acquire a minimum of 600 kilometers of 2D seismic and drill one
exploratory well during the first three years of a six year exploration period,
pay $250,000 in Concession and usufruct fees and $25,000 annually to train
Polish citizens. FX Energy and Apache also granted POGC an option to earn up to
a one-third interest, determined on a block by block basis, in the portions of
the acreage in the Pomeranian Project Area controlled by FX Energy and Apache in
exchange for the right to earn up to a one-third interest each in approximately
1.3 million gross acres controlled by POGC in the Pomeranian Project Area. FX
Energy and Apache expect to commence drill exploratory drilling on the
Pomeranian Project Area during 2000.
Warsaw West Project Area
The 2.9 million acre Warsaw West Project Area is located adjacent to the
northwest section of FX Energy's Lublin Project Area in central Poland and
consists of 13 exploration blocks acquired by Apache during 1997. Effective
January 1, 1999, FX Energy and Apache entered into an agreement whereby FX
Energy became a fifty-percent partner in Apache's Warsaw West Project Area.
During the first three years of a six-year exploration period, FX Energy and
Apache are obligated to acquire a minimum of 1,000 kilometers of 2D seismic,
drill one exploration well, pay $390,000 in Concession and usufruct fees and
spend $25,000 per year training Polish citizens. All costs are to be shared
equally on a fifty-fifty basis between FX Energy and Apache, except for
$195,000 of usufruct fees incurred solely by Apache prior to FX Energy becoming
an equal partner. Apache will be the operator of the Warsaw West Project Area.
FX Energy and Apache expect to commence exploratory drilling on the Warsaw West
Project Area during 2001.
Baltic Project Area
The Baltic Project Area is located onshore near the Baltic Sea and consists
of exploration rights covering approximately 2.1 million net acres in northern
Poland. The Baltic Project Area is part of the Baltic Platform geological
region that covers the southeastern portion of the Baltic Sea, portions of the
bordering onshore areas of northern Poland and areas to the northeast in the
Kaliningrad district of Russia, Lithuania and Latvia. Approximately 34 onshore
and offshore fields have been discovered in the Baltic Platform. Four of the
largest fields in this region reportedly have produced an aggregate of over 150
MMBbls of high grade oil through 1994. During 1997, FX Energy drilled two wells
in the Baltic Project Area to test Cambrian horizons that produce to the north
offshore in the Baltic Sea and in the Kaliningrad district of Russia. Neither
of the wells yielded commercial quantities of hydrocarbons. Under terms of the
Baltic Area usufruct, FX Energy must drill at least one exploratory well during
the first three year phase and one exploratory well during the second three year
phase of a six year exploration period, pay $33,333 per year in Concession fees,
spend $25,000 per year training Polish citizens and relinquish fifty-percent of
the Baltic Project Area's acreage by March 6, 1999. In addition, if the
government does not confirm that the Gladysze #1-A, the second exploratory well
drilled on the Baltic Project Area during the first phase exploration period,
counts as the required exploratory well during the second exploratory phase,
then FX Energy would be required to drop all of the Baltic Project Area's
acreage or commit to drill an additional exploratory well on the Baltic Project
Area by March 2000. The Baltic Project Area is FX Energy's only Project Area in
Poland with mandatory acreage relinquishment provisions. FX Energy expects to
enter into a strategic alliance with an industry partner before undertaking
substantial additional exploration in this area. There can be no assurance FX
Energy will be able to obtain such an industry partner.
Polish Lowlands Study
FX Energy and Apache have agreed with the University of Mining and
Metallurgy, Krakow, to review and evaluate geological data respecting the Polish
Lowlands to identify hydrocarbon appraisal and development opportunities. FX
Energy and Apache are reviewing and evaluating geological data to identify
hydrocarbon appraisal and development opportunities near selected producing
regions of the western portion of the study area. Historically, the Polish
Lowlands has produced approximately 24 MMbls of oil and 2.3 Tcf of gas to date.
FX Energy and Apache expect the study of data from the Polish Lowlands to
provide a source of projects for exploration and exploitation in the future.
While FX Energy and Apache believe their relationship with POGC will provide
opportunities to obtain an interest in projects in the study area, FX Energy and
Apache have no rights to drill or develop acreage in this region and there can
be no assurance that FX Energy and Apache will be able to obtain such rights.
Sudety Project Area
FX Energy has interests to explore for gold and associated minerals in
seven blocks containing approximately 166,000 acres near the city of Zlotorya in
the Sudety region of southwestern Poland. The Zlotorya area has a long
history of gold production, dating back to the fifth century. Gold production
in the Zlotorya area continued through the early twentieth century, but
extraction techniques available at that time made further production
uneconomical. On December 30, 1997, FX Energy entered into an agreement with
Homestake Mining Company ("Homestake"), an international gold mining company, in
which Homestake agreed to pay all of FX Energy's costs relating to the Sudety
Project Area in exchange for an interest in the Project Area. To date, FX
Energy and Homestake have conducted a limited geological, geochemical and
geophysical reconnaissance of the Sudety Project Area.
PROPERTIES IN POLAND
Laws and Contracts Covering Poland Properties
In 1994, Poland adopted the Geological and Mining Law, which specifies the
process for obtaining domestic exploration and exploitation rights. All of FX
Energy's rights in Poland have been awarded pursuant to this law. Under the
Geological and Mining Law, the Concession Authority enters into oil, gas and
mining usufruct agreements that grant the holder the exclusive right to explore
for and exploit the designated hydrocarbons or minerals for a specified period
under prescribed terms and conditions. The holder of the mining usufruct must
also acquire an exploration Concession to obtain surface access to the
exploration area by applying to the Concession Authority and providing the
opportunity for comment by local governmental authorities. If a commercially
viable discovery is made in an exploration Concession area, it is necessary for
the holder of the exploration Concession license to obtain an exploitation
Concession license for a specific term by then applying to the Concession
Authority and negotiating with local government authorities. The holder of a
usufruct and exploration and exploitation Concession licenses must also acquire
rights to use the land from the surface owner.
Oil and Gas Concessions
The Concession Authority has granted FX Energy oil and gas exploration
rights on the Lublin, Carpathian, Pomeranian and Baltic project areas and has
granted Apache oil an gas exploration rights on the Warsaw West Project Area.
The agreements divide these areas into blocks, generally containing
approximately 250,000 acres each. Concession licenses have been acquired for
surface access to all project areas that lie within existing usufructs. The
first three year exploration period begins after the date of the last Concession
signed under each respective usufruct. To date, FX Energy and Apache believe
all material Concession terms have been satisfied.
Each of the oil and gas usufructs divides exploration rights into
successive exploration phases expiring in three and six years, respectively,
after the grant of the last Concession agreements covered by the applicable
usufruct. A number of exploratory wells are required to be drilled during the
first three year and second three year exploration phases, a minimum amount of
2D seismic acquisition must be completed, and other expenditures must be made,
all as set forth in the applicable usufructs, in order to retain an interest in
each usufruct. The dates of the last Concession signed and work commitments for
each of FX Energy's project areas under the usufructs are set forth in the
following table:
WORK COMMITMENT
--------------------------------------
NO. OF DATE OF FIRST THREE SECOND THREE 2D
BLOCKS LAST YEAR PHASE YEAR PHASE SEISMIC
USUFRUCT (1) CONCESSION DRILLING DRILLING (2) ACQUISITION
- --------------- ------ ---------- ---------- ------------- -----------
LUBLIN:
Vistula 8 08/08/97 One well One well per 500 km
block
Lublin Middle 7 06/30/98 Two wells One well per 500 km
block
Block 298. 1 06/30/98 One well Two wells in 150 km
usufruct
Komarow 11 03/04/98 Two wells One well per 500 km
block
SOUTHERN 12 12/31/98 One well Two wells in 350 km
CARPATHIAN usufruct
POMERANIAN 10 12/31/98 One well Two wells in 600 km
usufruct
WARSAW WEST (3) 13 11/13/98 One well Two wells in 1,500 km
usufruct
BALTIC (4) 11 03/07/96 One well One well in None
usufruct
The annual training fees and the aggregate Concession and usufruct fees
over the respective usufruct's six year exploration term, including the net
amounts payable by FX Energy and Apache, are set forth in the following table:
NET CONCESSION/
ANNUAL CONCESSION USUFRUCT FEES
USUFRUCT TRAINING FEES AND USUFRUCT FX ENERGY APACHE
(5)
- -------------- ------------- ------------- --------- --------
LUBLIN:
Vistula $ 25,000 $ 220,000 $ -- $220,000
Lublin Middle 25,000 224,000 -- 224,000
Block 298 5,000 51,000 -- 51,000
Komarow 25,000 200,000 -- 200,000
SOUTHERN 15,000 160,000 -- 160,000
CARPATHIAN
POMERANIAN 25,000 250,000 125,000 125,000
WARSAW WEST 25,000 390,000 97,500 292,500
BALTIC 25,000 200,000 200,000 --
Total $ 170,000 $1,695,000 $ 422,500 $1,272,500
(1) The Baltic Project Area includes one block that is approximately half the
size of the other blocks. The Komarow Concession includes three extra
partial blocks adjacent to the border of Poland and the Ukraine.
(2) FX Energy may terminate its drilling commitments in a block or area by
relinquishing such block or area at the end of the first three year phase.
(3) The 2D seismic acquisition requirements for the West Warsaw Project Area
include 1,000 kilometers during the first three year exploration period and
500 kilometers during the second three year exploration period. 2D seismic
acquisition requirements for all other project areas apply to the first
three year exploration period only.
(4) If the government does not indicate the Gladysze #1-A, the second
exploratory well drilled on the Baltic Project Area during the first phase
exploration period, counts as the required exploratory well during the
second exploratory phase, then FX Energy will be required to commence
drilling an additional exploratory well on the Baltic Project Area by March
2000 or surrender all of the Baltic Project Area's acreage. In any event,
under terms of the Baltic Project Area usufruct, FX Energy must relinquish
fifty-percent of the Baltic Project Area's acreage by March 6, 1999. No
other project areas have required acreage relinquishment provisions.
(5) Annual training fees apply to each year of the six year exploration period.
During 1997 and 1998, Apache contracted with FX Energy to earn a fifty-
percent interest in FX Energy's Lublin and Carpathian project areas. Under
terms of the agreements, Apache has committed to cover all of FX Energy's
pro-rata share of costs in the Lublin Project Area during the first three year
phase to: (1) drill and complete seven exploratory wells; (2) acquire 1,650
kilometers of 2D seismic; (3) cover all annual training fees; and, (4) cover all
Concession and usufruct fees. In the Carpathian Project Area, Apache has
committed to pay for FX Energy's pro-rata share of cost during the three year
phase to: (1) drill three exploratory wells; (2) acquire 350 kilometers of 2D
seismic; (3) cover all annual training fees; and, (4) cover all Concession and
usufruct fees.
On January 29, 1999, FX Energy and Apache completed an agreement whereby
each party has a fifty-percent interest in FX Energy's Pomeranian Project Area
and Apache's Warsaw West Project Area effective January 1, 1999. Cost incurred
by each party prior to the effective date, including $195,000 paid by Apache for
the Warsaw West Project Area, are sunk costs for which no equalization was
provided for between the two parties.
During 1997 and 1998, FX Energy, Apache and POGC entered into option
agreements covering the Lublin, Carpathian and Pomeranian project areas whereby
FX Energy and Apache each has an independent right to participate, with up to a
one third interest, in the exploration of POGC controlled areas within the
Lublin, Carpathian and Pomeranian project areas. In turn, FX Energy and Apache
granted POGC a reciprocal right to participate in the exploration of the FX
Energy and Apache controlled areas within the Lublin, Carpathian and Pomeranian
project areas on a block by block basis.
If a commercially viable discovery of oil were made in any of its project
areas, the Concession owner would be required to apply for an exploitation
Concession, as provided by the usufructs, with a term of 30 years and so long
thereafter as commercial production continues. Upon the grant of the
exploitation Concession, the Concession owner would become obligated to pay a
fee, to be negotiated within the range of 0.01% to 0.5% of the market value of
the estimated recoverable reserves in place, payable in five equal annual
installments. The Concession owner would also be required to pay a royalty on
any production, the amount of which will be set by the Concession Authority,
within a range established on the base royalty rate for the mineral being
extracted. The base royalty rate for oil and gas is currently 6%, but could be
increased unilaterally up to 10% (the current statutory maximum base royalty
rate) by the Council of Ministers. The Concession Authority can set the royalty
rate for any particular commercial production in a range between 50% and 150% of
the base royalty rate, depending on the economic viability of such operation,
but not to exceed the statutory maximum rate. Therefore, with the current base
rate of 6% for oil and gas, the Concession Authority could establish the royalty
rate between 3% and 9%. If, however, the base rate is increased to 10%, the
royalty rate would be between 5% and 15%. The royalty rate may vary for
different producing fields and may be changed from time to time during the
productive life of a field. Local governments in such areas will receive 60% of
any royalties paid on production. The Concession owner could be subject to
significant delays in obtaining the consents of local authorities or satisfying
other governmental requirements prior to obtaining an exploitation license.
FX Energy and Apache Joint Venture
FX Energy and Apache have agreed to conduct joint exploration, appraisal,
development and production activities in the Lublin, Carpathian, Warsaw West and
Pomeranian project areas, with Apache as operator. Even though they will engage
in these projects jointly, they have agreed to treat their respective interests
and obligations as separate, such that each company is responsible for providing
its own funding for joint activities and is entitled to take and sell its share
of hydrocarbons independently of the other. As is customary, they will use
western industry standard joint operating agreement terms to govern their
respective actions, rights and obligations.
FX Energy and Apache have each created Polish subsidiaries to carry out
their joint projects in Poland. FX Energy has created several wholly-owned
spolka z o. o. (a form of limited liability company) to hold all of its
interests in Poland. For example, in the western portion of the Lublin Project
Area containing eight exploration blocks (the "Vistula area"), FX Energy and
Apache are each fifty-percent beneficial participants in a Polish limited
liability company (the "Lublin LLC"), all of the title ownership of which has
been assigned by FX Energy to the Lublin LLC, subject to the terms of their
participation agreement.
In other instances. FX Energy and Apache have paired their interests in
Poland into several spolka jawnas (a form of registered joint operation) to hold
record title to the various usufructs and Concessions. For example, FX Energy
and Apache are each fifty-percent participants in a Polish spolka jawna (the
"Lublin SJ") which has been awarded usufructs and exploration Concessions
covering 16 exploration blocks in the Lublin Project Area, the Southern
Carpathian Concession and the Pomeranian Concession. FX Energy and Homestake
have formed a Polish spolka jawna (the "Sudety SJ"), which holds title to the
various usufructs and Concessions and is conducting activities respecting the
Sudety Project Area.
The ownership structure in Poland may be altered by FX Energy, Apache and
POGC from time to time in response to developments in the Polish legal system to
most accurately reflect their various agreements regarding jointly owned
projects in Poland.
Production, Transportation and Marketing - Poland
To date, FX Energy has had no oil or gas production in Poland and currently
has no agreement or arrangement for the sale, delivery or refining of any oil or
gas that may be produced, including possible production from the Lachowice
Field. Under the principal agreed terms to be incorporated into formal
documents now being negotiated, POGC will purchase gas produced from the
Lachowice Field at a market price under a long term contract. FX Energy
expects that gas and oil produced from its other interests in Poland would be
sold for domestic consumption under marketing arrangements to be negotiated. FX
Energy will be required to obtain governmental approval to export any oil or
gas.
Poland has crude oil pipelines traversing the country and a network of gas
pipelines serving major cities, commercial and industrial areas and many gas
production areas. If substantial oil production were established, Poland has a
well-developed infrastructure of hard-surfaced roads and railways over which FX
Energy believes oil produced could be transported for sale. There are refineries
in Gdansk and Plock in Poland and one in Germany near the western Polish border
which FX Energy believes could process crude oil produced in Poland. FX Energy
may incur expenditures for constructing and operating crude oil transportation
and handling facilities.
Poland's natural gas pipeline network includes a number of lines within the
Lublin, Carpathian, Pomeranian and Warsaw West project areas that possibly could
be connected to transport gas from wells in that area. In the case of the
Lublin Project Area, the city of Lublin, with a population of 350,000, lies near
the center of the Lublin Project Area and within approximately 30 miles of
several exploration leads. If substantial gas production were established, FX
Energy will most likely incur significant expenditures to construct gas
gathering, treatment and transmission lines prior to the delivery and sale of
any such gas.
Gold Concessions - Sudety Project Area
The Concession Authority has entered into mining usufruct agreements with
FX Energy to explore for gold on seven exploration blocks, including three
blocks ("Original 3 Blocks") acquired by FX Energy during 1996 and four blocks
("Additional 4 Blocks") acquired by FX Energy during 1997, on FX Energy's Sudety
Project Area in southeastern Poland. FX Energy obtained Concession licenses for
all seven blocks during 1998.
FX Energy's exploration rights to the Original 3 Blocks expire July 2000,
but are subject to an extension for three additional years. Under the usufruct
terms for the Original 3 Blocks, FX Energy is required to make cash payments
totaling $55,000 during the first year, complete a regional study, pay
Concession fees of $15,000 and spend a minimum of $800,000 exploring the
Original 3 Blocks over four years. FX Energy's exploration rights for the
Additional 4 Blocks expire six years after the grant of Concession licenses for
such blocks. Under the usufruct terms for the Additional 4 Blocks, FX Energy is
required to make cash payments of $30,000 during the first year, pay Concession
fees of $30,000 and spend a minimum of $640,000 exploring the Additional 4
Blocks over six years. FX Energy entered into an agreement with Homestake on
December 30, 1997, in which Homestake agreed to cover all of FX Energy's costs
relating to the Sudety Project Area in order to earn up to a 75% interest in the
Sudety Project Area.
PROPERTIES IN THE UNITED STATES
Domestic Producing Properties
FX Energy currently produces oil domestically in Montana and Nevada. All of
FX Energy's producing properties, except for the Rattlers Butte field (an
exploratory discovery during 1997), were purchased during 1994. In Montana, FX
Energy operates the Cut Bank and Bears Den fields and has an interest in the
Rattlers Butte field, which is operated by an industry partner. In Nevada, FX
Energy operates the Trap Spring and Munson Ranch Fields and has an interest in
the Bacon Flat field, which is operated by an industry partner. At the end of
1998, FX Energy had no producing activities outside the United States.
A summary of FX Energy's average daily production and average net
revenue interest during 1998 is as follows:
AVERAGE DAILY PRODUCTION (BBLS) AVERAGE NET
------------------------------- REVENUE
FIELD GROSS NET INTEREST
- ------------ --------- ------ -----------
Cut Bank 308 264 85.7%
Bears Den 51 20 39.2%
Rattlers 116 6 5.1%
Butte
Trap Spring 20 4 20.0%
Munson Ranch 44 15 34.1%
Bacon Flat 48 6 12.5%
--- ---
Total 587 315
=== ===
Montana Production
Production in the Cut Bank field in northern Montana commenced with the
discovery of oil in the 1940s at an average depth of approximately 2,900 feet.
The Southwest Cut Bank Sand Unit, which is the core of FX Energy's interest in
the field, was originally formed by the Phillips Petroleum Company in 1963. An
initial pilot waterflood program was started in 1964 by Phillips Petroleum
Company and eventually encompassed the entire unit with producing wells on 40
and 80 acre spacing. FX Energy owns an average working interest ranging from
99.5% to 100% in 94 producing oil wells, 38 water injection wells and three
water supply wells in the Cut Bank field.
The Bears Den field in northern Montana was discovered in 1929 and has been
under waterflood since 1990. Oil is produced at an average depth of
approximately 2,430 feet. FX Energy owns a 48.0% working interest in five
producing oil wells, four water injection wells and one water supply well.
The Rattlers Butte field was discovered in central Montana during 1997.
The State #31-8 well was drilled utilizing FX Energy's drilling rig to a depth
of approximately 5,800 feet. The well currently produces approximately 116 Bpd
from the Tyler formation. FX Energy has a 6.25% working interest in the well.
Nevada Production
The Trap Spring field was discovered in 1976. FX Energy produces oil from
fractured volcanics at an average depth of 3,700 feet from six wells with
working interests ranging from 21.6% to 50.0%.
The Munson Ranch field was discovered in 1988. FX Energy produces oil at
an average depth of 3,800 feet from six wells with an average working interest
of 36.0%.
The Bacon Flat field was discovered in 1981. The initial discovery well,
in which FX Energy does not have an interest, produced over 300,000 Bbl during
its seven-year productive life from a depth of approximately 6,000 feet. FX
Energy owns a 16.9% working interest in a different Bacon Flat well, which was
drilled in 1993 to a depth of approximately 5,000 feet.
Production, Transportation and Marketing - Domestic
The following table sets forth FX Energy's average net daily oil
production, average sales price and average production costs associated with
such production during the periods indicated. FX Energy had no gas production
for any of the periods for which information is presented.
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
---- ---- ----
Average daily net oil production (Bbl) 315 346 356
Average sales price (per Bbl) $ 9.78 $16.06 $18.04
Average production costs (per Bbl) (1) $ 9.11 $ 9.82 $ 9.44
(1) Production costs include lifting costs (electricity, fuel, water, disposal,
repairs, maintenance, pumper, transportation and similar items) and
production taxes. Production costs do not include general
and administrative expense, depreciation, depletion, state income taxes or
federal income taxes.
FX Energy sells oil at posted field prices to one of several purchasers in
each of the areas in which it has productive oil wells. For the years ended
December 31, 1998, 1997 and 1996, over 85% of FX Energy's total oil sales were
to CENEX, a regional refiner and marketer. Posted prices are published and are
generally competitive among the various purchasers. The crude oil sales
contracts may be terminated by either party upon 30 days' notice.
Oil prices decreased substantially as compared to the prior year during
1998 and 1997 after increasing during 1996. Oil and gas prices have been and
are likely to continue to be volatile and subject to wide fluctuations in
response to any of the following factors: relatively minor changes in the
supply of and demand for oil and gas; market uncertainty; political conditions
in international oil producing regions; the extent of domestic production and
importation of oil; the level of consumer demand; weather conditions; the
competitive position of oil or gas as a source of energy as compared with coal,
nuclear energy, hydroelectric power and other energy sources; the availability,
proximity and capacity of gathering systems, pipelines and processing
facilities; the refining capacity of prospective oil purchasers; the effect of
federal and state regulation on the production, transportation and sale of oil;
and other factors, all of which are beyond the control or influence of FX
Energy. In addition to adverse oil price volatility, adverse changes in the
market or regulatory environment may also have an adverse effect on FX Energy's
ability to obtain funding from lending institutions, industry participants, the
sale of additional securities and other sources.
Domestic Oil Reserves
All of FX Energy's oil properties containing proved oil reserves are
located in Montana and Nevada. All information set forth in this document
regarding proved reserves, related future net revenues and PV-10 Value is taken
from the report of Larry D. Krause, independent petroleum engineer, Billings,
Montana. Mr. Krause's estimates were based upon the review of production
history and other geological, economic, ownership and engineering data provided
by FX Energy. In accordance with SEC guidelines, FX Energy's estimates of
future net revenues from FX Energy's proved reserves and the PV-10 Value are
made using a sales price of $8.11, the weighted average oil sales price as of
December 31, 1998, the date of such estimate, and are held constant throughout
the life of the properties. No estimates of reserves have been filed with or
included in any report to any other federal agency during 1998.
FX Energy's estimated proved reserves by reserve category as of December
31, 1998 are detailed in the following table:
ESTIMATED DECEMBER 31, 1998
PROVED RESERVES OIL(BBL) PV-10 VALUE (1)
--------------- ---------- ---------------
DEVELOPED PRODUCING
Cut Bank ........... 1,367,000 $ 231,000
Other .............. 33,000 68,000
--------- ----------
Total............ 1,400,000 299,000
DEVELOPED NON-
PRODUCING
Cut Bank ........... 135,000 173,000
Other .............. -- --
--------- ----------
Total............ 135,000 173,000
--------- ----------
Total Developed 1,535,000 472,000
========= ==========
UNDEVELOPED
Cut Bank ........... -- --
Other .............. -- --
--------- ----------
Total Undeveloped. -- --
--------- ----------
TOTAL PROVED RESERVES. 1,535,000 $ 472,000
========= ==========
(1) The operating costs, based on information provided by FX Energy to Larry D.
Krause, represent actual recurring expenses for each of the properties,
held constant for the purposes of the evaluation. See Note 15 to FX
Energy's Consolidated Financial Statements.
The oil reserves assigned to the properties in this evaluation were
determined by analyzing current test data, extrapolating historical production
data and comparing field data with the production history of similar wells in
the area. The current volatility of oil prices provides an element of
uncertainty. Prices may vary significantly from the $8.11 per barrel used in
the reserve study, which in turn may have a significant impact on FX Energy's
calculated PV-10 value. FX Energy reported PV-10 proved developed reserve
values of $0.5 million, $4.0 million and $11.9 million as of December 31, 1998,
1997 and 1996, respectively. FX Energy reported PV-10 proved undeveloped
reserves values of zero, $9.6 million and $23.5 million as of December 31, 1998,
1997 and 1996, respectively. The reserve evaluations utilized prices of $8.11,
$13.80 and $21.00 per barrel as of December 31, 1998, 1997 and 1996,
respectively. The reserve estimates contained in the engineering report are
based on accepted engineering and evaluation principles. The PV-10 Value does
not necessarily represent an estimate of fair market value for the evaluated
properties.
There are numerous uncertainties inherent in estimating quantities of
proved oil reserves. The estimates in this document are based on various
assumptions relating to rates of future production, timing and amount of
development expenditures, oil prices and the results of planned development
work. Actual future production rates and volumes, revenues, taxes, operating
expenses, development expenditures and quantities of recoverable oil reserves
may vary substantially from those assumed in the estimates. Any significant
change in these assumptions, including changes which result from variances
between projected and actual results, could materially and adversely affect
future reserve estimates. In addition, such reserves may be subject to downward
or upward revision based upon production history, results of future development,
prevailing oil prices and other factors. In the event FX Energy's exploration
efforts establish the existence of gas reserves, similar uncertainties will
exist in estimating quantities of such reserves.
Given the current state of depressed oil prices and FX Energy's increased
focus on Polish exploration, FX Energy will not spend any of its capital on the
further development of its domestic oil properties in the foreseeable future
unless oil prices improve substantially or it obtains a strategic partner to
fund a development program. Accordingly, the Company's proved reserves as of
December 31, 1998 include only those reserves attributable to developed
properties.
During 1998, FX Energy recorded an impairment expense of $5,885,000, the
difference between the net book value of its domestic proved developed
properties and the related fair value, determined on a property by property
basis in accordance with generally accepted accounting principles.
Domestic Non-Producing Acreage
During 1996 and 1997, FX Energy acquired 16,875 acres of undeveloped oil
and gas leases in the Williston Basin area of North Dakota. The Williston Basin
area has established oil and gas production from numerous zones, including the
Mississippian, Devonian, Silurian and Ordovician. FX Energy has established
several leads over its acreage and intends to pursue a strategic alliance with
an industry partner to jointly explore the acreage.
Drilling Rig and Well Servicing Equipment
In Montana, FX Energy has a drilling rig capable of drilling up to 6,000
feet, two well servicing rigs and other associated oilfield equipment.
Historically, FX Energy has utilized its drilling rig for third party contract
drilling and its well servicing equipment solely on FX Energy's producing oil
properties in Montana. During 1997, the Company drilled two wells on a day work
contract basis with a retained working interest in both wells. The net
operating profit from drilling the two wells helped offset FX Energy's working
interest cost in each well. During 1998, FX Energy did not retain a working
interest in any of the four wells drilled on a contract basis. In late 1998, FX
Energy began contracting its well servicing equipment on non-company owned
properties in an effort to increase its revenues which had declined
substantially due to depressed oil prices.
DRILLING ACTIVITIES
The following table sets forth the wells drilled and completed by FX Energy
during the years ended December 31, 1998, 1997 and 1996:
YEARS ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
----------- ----------- -------------
GROSS NET GROSS NET GROSS NET
----- ---- ----- ---- ----- -----
DEVELOPMENT WELLS:
Producing ............ -- -- -- -- -- --
Non-producing ......... -- -- -- -- -- --
----- ---- ---- ---- ---- ----
Total ............... -- -- -- -- -- --
----- ---- ---- ---- ---- ----
----- ---- ---- ---- ---- ----
EXPLORATORY WELLS:
Producing (domestic
oil well) ............. -- -- 1.0 0.1 -- --
Non-Producing
Poland .............. -- -- 2.0 1.5 -- --
Domestic ............ -- -- 2.0 1.3 1.0 0.7
----- ---- ---- ---- ---- ----
Total ............. -- -- 5.0 2.9 1.0 0.7
----- ---- ---- ---- ---- ----
----- ---- ---- ---- ---- ----
During late 1998, FX Energy participated in two gross wells (0.8 net) on
the Lublin Project Area, both of which were subsequently determined to be
exploratory dry holes during February 1999.
WELLS AND ACREAGE
As of December 31, 1998, FX Energy had 117 gross and 108 net producing oil
wells, all of which are located in Montana and Nevada.
The following table sets forth FX Energy's gross and net acres of developed
and undeveloped oil and gas leases as of December 31, 1998.
DEVELOPED ACREAGE UNDEVELOPED ACREAGE
------------------ ---------------------
GROSS NET GROSS NET
------- -------- ---------- ---------
UNITED STATES
North Dakota.......... -- -- 16,875 16,875
Montana............... 10,732 10,418 1,150 1,057
Nevada................ 400 128 37 16
------- -------- ---------- ---------
Total.............. 11,132 10,546 18,062 17,948
------- -------- ---------- ---------
POLAND PROJECT AREAS (1),(4)
Lublin (2)............ -- -- 5,000,000 2,500,000
Carpathian (2),(3).... -- -- 1,400,000 700,000
Pomeranian (2)........ -- -- 2,200,000 1,100,000
Baltic................ -- -- 2,100,000 2,100,000
------- -------- ---------- ---------
Total............... -- -- 10,700,000 6,400,000
------- -------- ---------- ---------
TOTAL............. 11,132 10,546 10,718,062 6,417,948
------- -------- ---------- ---------
------- -------- ---------- ---------
(1) All Polish acreage is rounded to the nearest 100,000 acre.
(2) Gives effect to fifty-percent beneficial ownership of Apache in the Lublin,
Carpathian and Pomeranian project areas under FX Energy's joint exploration
arrangements with Apache. Does not give effect to options on POGC
controlled areas containing approximately 0.6 million acres in the Lublin
Project Area, 1.5 million acres in the Carpathian Project Area and 1.3
million acres in the Pomeranian Project Area.
(3) Excludes the Northern Carpathian Concession, an area containing
approximately 0.4 million acres controlled by POGC located within the
Carpathian Project Area, which was applied for during 1998 and is currently
awaiting the Polish government's approval.
(4) Excludes the Warsaw West Project Area, an area covering approximately 2.9
million acres in central Poland for which FX Energy is a fifty-percent
partner with Apache effective January 1, 1999.
OPERATIONAL HAZARDS AND INSURANCE
FX Energy is engaged in the drilling and production of oil and gas, and, as
such, its operations are subject to the usual hazards incident to the industry.
These hazards include blowouts, cratering, explosions, uncontrollable flows of
oil, natural gas or well fluids, fires, pollution, releases of toxic gas and
other environmental hazards and risks. These hazards can cause personal injury
and loss of life, severe damage to and destruction of property and equipment,
pollution or environmental damage and suspension of operations.
To lessen the effects of these hazards, FX Energy maintains insurance of
various types to cover its domestic operations and maintains general liability
coverage for its activities in Poland, even though it currently has no tangible
material assets in Poland. FX Energy has $5.0 million of general liability
insurance. Apache, as the operator of the Lublin, Carpathian, Pomeranian and
Warsaw West project areas, is carrying $25.0 million of general liability
insurance for joint operations on Polish project areas for which FX Energy and
Apache have interests. FX Energy's seismic and drilling contractors are
required to maintain insurance coverage for operations by them in Poland. There
can be no assurance that FX Energy or Apache will be able to continue to obtain
insurance coverage for their current or future activities in Poland, or that any
insurance obtained will provide coverage customary in either the industry or in
the United States, or be comparable to the insurance now maintained by FX Energy
and Apache, or be on favorable terms or at premiums that are reasonable. This
insurance, however, does not cover all of the risks involved in oil and gas
exploration, drilling and production and, if coverage does exist, may not be
sufficient to pay the full amount of such liabilities. FX Energy may not be
insured against all losses or liabilities which may arise from all hazards
because such insurance may not be available at economic rates, the respective
insurance policies may have limited coverage and other factors. For example,
insurance against risks related to violations of environmental laws is not
maintained. The occurrence of a significant adverse event that is not fully
covered by insurance could have a materially adverse effect on FX Energy.
Further, FX Energy cannot assure that it will be able to maintain adequate
insurance in the future at rates it considers reasonable.
GOVERNMENT REGULATION
Poland
FX Energy's activities in Poland are subject to political, economic and
other uncertainties, including the adoption of new laws, regulations or
administrative policies that may adversely affect FX Energy or the terms of its
exploration or production rights; political instability and changes in
government or public or administrative policies; export and transportation
tariffs and local and national taxes; foreign exchange and currency restrictions
and fluctuations; repatriation limitations; inflation; environmental regulations
and other matters. These operations in Poland are subject to the Geological and
Mining Law as well as the Act of January 31, 1994, concerning the Protection and
Management of the Environment, which are the primary statutes governing
environmental protection. Agreements with the government of Poland respecting
FX Energy's project areas create certain standards to be met regarding
environmental protection. The holder of Project Area interests generally is
required to (1) adhere to good international petroleum industry practices,
including practices relating to the protection of the environment; and, (2)
prepare and submit geological work plans, with specific attention to
environmental matters, to the appropriate agency of state geological
administration for its approval prior to engaging in field operations such as
seismic acquisition, exploratory drilling and field-wide development. Poland's
regulatory framework respecting environmental protection is not as fully
developed and detailed as that which exists in the United States. FX Energy
intends that its operations in Poland will be designed to meet good
international petroleum industry practice and, as they develop, Polish
requirements. See "Risk Factors--Factors Relating to Activities in Poland."
United States
State and Local Regulation of Drilling and Production
Exploration and production operations of FX Energy are subject to various
types of regulation at the federal, state and local levels. Such regulation
includes requiring permits for the drilling of wells, maintaining bonding
requirements in order to drill or operate wells, regulating the location of
wells, the method of drilling and casing wells, the surface use and restoration
of properties upon which wells are drilled and the plugging and abandoning of
wells. FX Energy's operations are also subject to various conservation laws and
regulations. These include the regulation of the size of drilling and spacing
units or proration units and the density of wells which may be drilled and the
unitization or pooling of oil and gas properties. In this regard, some states
allow the forced pooling or integration of tracts to facilitate exploration
while other states rely on voluntary pooling of lands and leases. In addition,
state conservation laws establish maximum rates of production from oil and
natural gas wells, generally prohibit the venting or flaring of natural gas and
impose certain requirements regarding the ratability of production. The effect
of these regulations is to limit the amounts of oil and natural gas FX Energy
can produce from its wells and to limit the number of wells or the locations
which FX Energy can drill.
Production of any oil and gas by FX Energy is affected to some degree by
state regulations. Many states in which FX Energy operates have statutory
provisions regulating the production and sale of oil and gas, including
provisions regarding deliverability. Such statutes and related regulations are
generally intended to prevent waste of oil and gas and to protect correlative
rights to produce oil and gas between owners of a common reservoir. Certain
state regulatory authorities also regulate the amount of oil and gas produced by
assigning allowable rates of production to each well or proration unit.
Environmental Regulations
The federal government and various state and local governments have
adopted laws and regulations regarding the control of contamination of the
environment. These laws and regulations may require the acquisition of a permit
by operators before drilling commences, restrict the types, quantities and
concentration of various substances that can be released into the environment in
connection with drilling and production activities, limit or prohibit drilling
activities on certain lands lying within wilderness, wetlands and other
protected areas and impose substantial liabilities for pollution resulting from
FX Energy's operations. These laws and regulations may also increase the costs
of drilling and operation of wells. FX Energy may also be held liable for the
costs of removal and damages arising out of a pollution incident to the extent
set forth in the Federal Water Pollution Control Act, as amended by the Oil
Pollution Act of 1990 ("OPA '90"). In addition, FX Energy may be subject to
other civil claims arising out of any such incident. As with any owner of
property, FX Energy is also subject to clean-up costs and liability for
hazardous materials, asbestos, or any other toxic or hazardous substance that
may exist on or under any of its properties. FX Energy believes that it is in
compliance in all material respects with such laws, rules and regulations and
that continued compliance will not have a material adverse effect on its
operations or financial condition. Furthermore, FX Energy does not believe that
it is affected in a significantly different manner by these laws and regulations
than are its competitors in the oil and gas industry.
The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without regard
to fault or the legality of the original conduct, on certain classes of persons
who are considered to be responsible for the release of a "hazardous substance"
into the environment. These persons include the owner or operator of the
disposal site or sites where the release occurred and companies that disposed or
arranged for the disposal of the hazardous substances. Under CERCLA,
such persons may be subject to joint and several liability for the costs of
cleaning up the hazardous substances that have been released into the
environment, for damages to natural resources and for the costs of certain
health studies. Furthermore, it is not uncommon for neighboring landowners and
other third parties to file claims for personal injury and property damage
allegedly caused by hazardous substances or other pollutants released into the
environment.
The Resource Conservation and Recovery Act ("RCRA") and regulations
promulgated thereunder govern the generation, storage, transfer and disposal of
hazardous wastes. RCRA, however, excludes from the definition of hazardous
wastes "drilling fluids, produced waters and other wastes associated with the
exploration, development, or production of crude oil, natural gas or geothermal
energy." 42 U.S.C. S 6921(b)(2)(A). Because of this exclusion, many of FX
Energy's operations are exempt from RCRA regulation. Nevertheless, FX Energy
must comply with RCRA regulations for any of its operations that do not fall
within the RCRA exclusion.
The OPA '90 and regulations promulgated pursuant thereto imposes a variety
of regulations on responsible parties related to the prevention of oil spills
and liability for damages resulting from such spills. OPA '90 establishes
strict liability for owners of facilities that are the site of a release of oil
into "waters of the United States." While OPA liability more typically applies
to facilities near substantial bodies of water, at least one district court has
held that OPA liability can attach if the contamination could enter waters that
may flow into navigable waters.
Stricter standards in environmental legislation may be imposed on the oil
and gas industry in the future, such as proposals made in Congress and at the
state level from time to time that would reclassify certain oil and natural gas
exploration and production wastes as "hazardous wastes" and make the
reclassified wastes subject to more stringent and costly handling, disposal
and clean-up requirements. The impact of any such changes, however, would not
0likely be any more burdensome to FX Energy than to any other similarly situated
company involved in oil and gas exploration and production.
Federal and Indian Leases
A substantial part of FX Energy's Montana producing properties are operated
under oil and gas leases issued by the Bureau of Land Management or by certain
Indian nations under the supervision of the Bureau of Indian Affairs. These
activities must comply with rules and orders that regulate aspects of the oil
and gas industry, including drilling and operating on leased land and the
calculation and payment of royalties to the federal government or the governing
Indian nation. Operations on Indian lands must also comply with applicable
requirements of the governing body of the tribe involved including, in some
instances, the employment of tribal members. FX Energy believes it is currently
in full compliance with all material provisions of such regulations.
Safety and Health Regulations
FX Energy must also conduct its operations in accordance with various laws
and regulations concerning occupational safety and health. Currently, FX Energy
does not foresee expending material amounts to comply with these occupational
safety and health laws and regulations. However, since such laws and
regulations are frequently changed, FX Energy is unable to predict the future
effect of these laws and regulations.
TITLE TO PROPERTIES
FX Energy relies on sovereign ownership of exploration rights and mineral
interests by the Polish government in connection with FX Energy's activities in
Poland and has not conducted and does not plan to conduct any independent
title examination. FX Energy consults with Polish legal counsel when doing
business in Poland.
Nearly all of FX Energy's United States working interests are held under
leases from third parties. FX Energy typically obtains a title opinion
concerning such properties prior to the commencement of drilling operations. FX
Energy has obtained such title opinions or other third party review on nearly
all of its producing properties and believes that it has satisfactory title to
all such properties sufficient to meet standards generally accepted in the oil
and gas industry. FX Energy's United States properties are subject to common
burdens, including customary royalty interests and liens for current taxes, but
FX Energy has concluded that such burdens do not materially interfere with the
use of such properties. Further, FX Energy believes the economic effects of
such burdens have been appropriately reflected in FX Energy's acquisition cost
of such properties. Title investigation before the acquisition of undeveloped
properties is less thorough than that conducted prior to drilling, as is
standard practice in the industry.
EMPLOYEES AND CONSULTANTS
As of December 31, 1998, FX Energy had 31 employees, consisting of 9 in
Salt Lake City, Utah; 20 in Oilmont, Montana; and two in Houston, Texas. None
of FX Energy's employees are represented by a collective bargaining organization
and FX Energy considers its relationship with its employees to be satisfactory.
In addition to its employees, FX Energy regularly engages technical consultants
to provide specific geological, geophysical and other professional services.
OFFICES AND FACILITIES
FX Energy's executive offices, approximately 3,010 square feet of
office space located at 3006 Highland Drive, Salt Lake City, Utah, are rented at
$2,960 per month under a month to month agreement. FX Energy owns a 16,160
square foot office building located at the corner of Central and Main in
Oilmont, Montana. FX Energy utilizes 4,800 square feet for its field office and
rents the remaining space to unrelated third parties for $880 per month. FX
Energy rents approximately 500 square feet of office space for $1,000 per month
in Warsaw, Poland at Staroscinska 5, 02-516 Warszawa-Centrum, for its Polish
activities.
RISK FACTORS
The business of FX Energy is subject to a number of material risks,
including, but not limited to, the following factors related directly and
indirectly to FX Energy and its activities in Poland:
Factors Relating to FX Energy
History of Operating Losses
From its inception in January 1989 through December 31, 1998, FX Energy
incurred cumulative losses of $22.9 million. FX Energy expects that its
continued exploration activities will continue to result in losses and that its
accumulated deficit will increase. FX Energy reported losses before
extraordinary gains of $10.1 million, $6.7 million and $4.9 million for the
years ended December 31, 1998, 1997 and 1996, respectively. FX Energy
anticipates that it will incur losses through 1999 and possibly beyond,
depending on whether its exploration and development activities in Poland result
in sufficient production to cover related operating expenses. Until sufficient
cash flow from operations can be obtained, it is expected that FX Energy will
need additional capital from offerings of securities and/or the sale of
interests in its properties to fund planned exploration and development programs
in Poland.
Dependence on Activities in Poland
FX Energy has allocated substantially all of its financial, management and
technical resources for its activities in Poland. FX Energy's success will
depend on the results of those activities. This dependence is likely to be
reflected in both the short and long-term performance of FX Energy's common
stock. The market price of the common stock has experienced in the past and may
continue to experience in the future, significant fluctuations based on the
outcome of individual wells and FX Energy's exploration efforts in Poland.
Previously, the price of the common stock declined significantly after FX Energy
announced that each of its first four exploratory wells in Poland were
exploratory dry holes. These fluctuations may be exacerbated because the common
stock, in management's opinion, currently trades to a significant degree on the
potential of FX Energy's current and planned activities in Poland.
The success of FX Energy's efforts in Poland will depend, in addition to
the risks normally associated with the exploration for oil and gas, on its
ability to maintain its relationships with Apache, POGC and agencies and
enterprises of the Polish government and a number of other risks associated with
conducting operations in a foreign country. If FX Energy's activities in Poland
are unsuccessful, the market price of the common stock would likely suffer a
material decline and investors would face the possible loss of all or a
substantial portion of their investment. Because of the preliminary stage of FX
Energy's activities in Poland, no assurance can be given that such activities
will be successful.
Exploration Risks
FX Energy's oil and gas exploration activities involve significant risks in
that:
-There can be no assurance that any well will encounter hydrocarbons;
-There is no way to know in advance of drilling and testing whether any
prospect encountering hydrocarbons will yield oil or gas in sufficient
quantities to be economically viable or cover drilling or completion
costs;
-Several test wells are typically required to explore each prospect or
exploration area;
-FX Energy may continue to incur exploration costs in specific areas even
if initial test wells are plugged and abandoned or, if completed for
production, do not result in production of commercial quantities;
-Drilling operations may be curtailed, delayed or canceled as a result of
numerous factors, including title problems, weather conditions,
compliance with governmental requirements and shortages or delays in the
delivery of equipment; and
-FX Energy has drilled two exploratory wells on the Baltic Project Area
and participated in drilling two exploratory wells on the Lublin Project
Area in Poland, none of which were completed for commercial production
and has participated in eight exploratory test wells in the western
United States, only one of which has resulted in the establishment of
commercial production.
There can be no assurance that FX Energy's exploration efforts will be
successful. Although FX Energy has identified or expects that it will identify
certain structures within its interests that it believes contain oil or gas
reservoirs, there can be no assurance that hydrocarbons are present on such
interests or that any such hydrocarbons can be produced in commercial
quantities. Many of the exploration decisions on the project areas will be
based on third party scientific data, some of which was gathered prior to recent
significant technological advances. Although significant portions of such data
have been reprocessed or otherwise enhanced, there can be no assurance that such
data is as reliable as data gathered either using modern technology or under FX
Energy's supervision.
Dependence on Strategic Alliances
FX Energy is substantially dependent on the presence and performance of its
strategic partners, Apache, POGC, and Homestake. The failure of Apache, POGC or
Homestake to perform its obligations under FX Energy's contracts would most
likely have a material adverse effect on FX Energy and the price of its common
stock. In particular, FX Energy has prepared its exploration budget through
2000 based on the participation of Apache, Homestake and to a limited extent
POGC. In the future, FX Energy may become even more reliant upon the expertise
of its strategic partners. Apache and Homestake have interests in areas outside
of Poland in which FX Energy does not participate. If such separately held
interests should become more promising than interests held with FX Energy in
Poland, Apache or Homestake may focus their efforts and resources elsewhere. In
addition, should FX Energy's relationship with Apache or Homestake deteriorate
or terminate, FX Energy's exploratory programs in Poland may be delayed
significantly. Although FX Energy has rights to participate in activities on
certain POGC controlled acreage, it has no right to initiate such activities.
Further, FX Energy has no interest in the agreements, licenses and grants
governing the exploration, exploitation, development or production of such POGC
controlled acreage. Thus, FX Energy's program in Poland involving POGC
controlled acreage would be adversely affected if POGC should elect not to
pursue activities on such acreage, if the relationship between FX Energy, Apache
and POGC should deteriorate or terminate or if POGC should fail to fulfill the
requirements of or elect to terminate its agreements, licenses or grants.
FX Energy intends to seek potential partners to participate in the
exploration of its Baltic Project Area. Although FX Energy believes it will
be able to locate strategic partners for the Baltic Project Area or as otherwise
needed, there can be no assurance that FX Energy will be successful in obtaining
the participation of any such partner, that the terms of any such arrangement
would be favorable to FX Energy or that such efforts will not delay FX Energy's
exploration and development projects.
Limited Control over Interests
From time to time FX Energy enters into strategic alliances as a means of
conducting its business. These alliances may reduce FX Energy's control over
the operations and the assets in the project areas subject to these alliances.
This is particularly the case in Poland where Apache is the operator under the
agreements relating to joint operations on the Lublin, Carpathian, Pomeranian
and Warsaw West project areas and Homestake is the operator under agreements
pertaining joint operations on the Sudety Project Area.
Required Licenses and Rights
In order to explore, exploit, develop and produce oil and gas in Poland, FX
Energy is required to obtain:
-A mining usufruct agreement from the Concession Authority that gives FX
Energy the exclusive right to explore and exploit the hydrocarbons on
the covered area;
-An exploration Concession from the Concession Authority and local
governmental authorities to obtain surface access to the covered area;
-A grant of surface rights from the surface owner; and
-An exploitation Concession from the Concession Authority and local
governmental authorities to develop and produce oil and gas
Exploration Concessions have been granted for all of FX Energy's oil and
gas exploration project areas in Poland to date. Should FX Energy's exploration
efforts discover commercially viable hydrocarbons in Poland, FX Energy will be
required to negotiate with national and local government officials of Poland
regarding certain of the terms and conditions of the required exploitation
Concessions. This may result in increased costs and delays. These negotiations
would include the determination of a production/exploitation fee within the
range of 0.01% to 0.5% of the market value of the economically recoverable
reserves estimated to be in place, payable in five equal annual installments.
In addition, the local governments having jurisdiction over the production area
must consent to the grant of an exploitation license. FX Energy must also
comply with certain environmental regulations and may need to compile an
environmental impact statement. In addition, before FX Energy can export any oil
or gas from Poland, FX Energy will have to obtain additional governmental
permits, licenses and agreements.
Development Risks
There are no proved reserves and there has not been any commercial
production of oil or gas from acreage controlled by FX Energy and Apache in
Poland. Various agencies of the Polish government have drilled exploratory and
stratigraphic wells on various locations in FX Energy's project areas, but none
of these wells have been completed for production. The first two wells drilled
by FX Energy in the Baltic Project Area and the first two wells in the Lublin
Project Area were exploratory dry holes. If hydrocarbons are discovered, FX
Energy believes several exploration tests may be required to appraise the
potential of any structure that is identified in any of its project areas.
There can be no assurance such tests will be successful. Further, there can be
no assurance that the porosity, permeability or other characteristics of any
reservoir formation will support the production of oil or gas in commercial
quantities.
Potential Anti-takeover Effects; Blank Check Preferred Stock
FX Energy's certificate of incorporation authorizes FX Energy to issue,
without stockholder approval, one or more classes or series of preferred stock,
having such preferences, powers and relative participating, optional or other
rights (including preferences over the common stock) as FX Energy's Board of
Directors may determine. The terms of one or more classes or series of preferred
stock could be superior to the terms of the common stock, which may adversely
impact the rights of holders of common stock or could have anti-takeover
effects. In addition, FX Energy has adopted a stockholder rights plan. This plan
and the provisions of FX Energy's articles of incorporation, bylaws and the
Nevada Domestic and Foreign Corporation Law may delay, discourage, inhibit,
prevent or render more difficult an attempt to obtain control of FX Energy,
whether by a tender offer, business combination, proxy contest or otherwise.
These other provisions include the classification of the Board of Directors, a
prohibition of stockholder action by less than unanimous written consent and
Nevada Domestic and Foreign Corporation Law restrictions on business
combinations with certain interested parties.
Year 2000
FX Energy has implemented an ongoing program to ensure that its operational
and financial systems will not be adversely affected by year 2000 hardware and
software failures. While FX Energy believes it is taking all appropriate steps
to assure year 2000 compliance, it is dependent substantially on vendor
compliance. In addition to its own computer systems, in connection with its
activities in the United States and in Poland, FX Energy interacts with POGC and
Apache, suppliers, customers, creditors and financial service organizations
domestically and globally who use computer systems. Although FX Energy intends
to interact only with those third parties that have year 2000 compliant computer
systems, it is impossible for FX Energy to monitor all such systems,
particularly those of parties in another country. There can be no assurance
that such systems are year 2000 compliant. If not, such lack of
compliance may have a material adverse impact on FX Energy's business and
operations.
Dependence on Officers and Key Employees
FX Energy is dependent upon Mr. David N. Pierce, President and Chief
Executive Officer, Mr. Andrew W. Pierce, Vice-President and Chief Operating
Officer and other key personnel for its various activities. In addition,
respecting its activities in Poland, FX Energy is dependent on Mr. Jerzy B.
Maciolek, Vice-President of International Exploration, a Polish national who is
instrumental in assisting FX Energy in its operations in Poland. The loss of the
services of any of these individuals may materially and adversely affect FX
Energy. FX Energy has entered into employment agreements with Mr. David N.
Pierce, Mr. Andrew W. Pierce and Mr. Jerzy B. Maciolek. FX Energy does not
maintain key man insurance on any of its employees.
Risks Associated with Growth - Oil and Gas Operations
FX Energy has had limited operations in Poland. If its activities in
Poland are successful, it may experience rapid growth. FX Energy's ability to
manage this growth will depend, in part, upon its ability to attract and retain
quality management and technical personnel. No assurance can be given that FX
Energy will be able to attract or retain such employees or otherwise manage any
potential expansion of its business. The likelihood of FX Energy's success must
be considered in light of the expenses, difficulties, complications and delays
frequently encountered in connection with the early stages of an oil and gas
company. In particular, FX Energy's operations in Poland to date have focused
primarily on the evaluation of prospects and the drilling of four wells, none of
which resulted in commercial production, the acquisition of substantial acreage
and the establishment of strategic alliances with POGC and Apache. FX Energy
has no experience in Poland regarding development, production and marketing of
oil and gas and has not yet completed a well in Poland for production.
Although FX Energy does have experience in these areas in the United States,
there can be no assurance that such experience will assist in its activities in
Poland. Due to the foregoing factors, FX Energy will be dependent on POGC and
Apache for their experience and expertise in such matters.
Possible Requirements for Gas Gathering and Transmissions Systems
If FX Energy's exploration efforts discover natural gas reserves, the
production and sale of such reserves will be dependent upon the availability,
proximity and capacity of drilling contractors with the requisite equipment to
complete the required development wells, gathering systems, pipelines and
processing facilities. Although Poland has a crude oil and natural gas pipeline
network, there can be no assurance that any pipeline will be in close proximity
to any oil or gas reserves that FX Energy may discover or that FX Energy can
obtain access to use such pipeline. Therefore, wells may be temporarily shut-in
for lack of a market or due to the unavailability of pipeline and/or gathering
system capacity. This would correspondingly delay cash flow from FX Energy's
operations. As a result, it is likely that gathering, transmission and
processing facilities would have to be constructed before producing any gas that
may be discovered. If such facilities are required to be constructed, FX Energy
may determine it is not economically feasible to establish natural gas
production even if substantial reserves are identified. There can be no
assurance any amounts budgeted for the construction of gas gathering,
transmission and processing facilities with regard to possible production from
any of FX Energy's project areas in Poland will be sufficient.
Possible Future Need for Additional Capital
FX Energy expects that it will need additional capital to accelerate
planned exploration and development programs in Poland. If exploration of any
of FX Energy's prospects in Poland is successful in proving substantial oil or
gas reserves, FX Energy will require additional capital to fund a multi-well
development program, install oil or gas storage, handling and transportation
facilities or purchase other assets or related investments required to support
large-scale production. FX Energy has no arrangement for any such additional
financing, but may seek required funds from the sale of debt and equity
securities, project financing, strategic alliances with other energy or
financial partners or other arrangements. Obtaining additional financing may
dilute the interest of existing shareholders in FX Energy or FX Energy's
interest in the specific project being financed. There can be no assurance that
additional funds could be obtained or, if obtained, would be on terms favorable
to FX Energy. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Capitalized Costs of Oil and Gas Properties
FX Energy follows the successful efforts method of accounting for its oil
and gas properties. Under this method of accounting, all property acquisition
costs and costs of exploratory and development wells are capitalized when
incurred, pending determination of whether the well has found proved reserves.
If an exploratory well has not found proved reserves, these costs plus the costs
of drilling the well are expensed. The costs of development wells are
capitalized, whether productive or nonproductive. Geological and geophysical
costs on exploratory prospects and the costs of carrying and retaining unproved
properties are expensed as incurred. An impairment allowance is provided to the
extent that capitalized costs of unproved properties, on a property by property
basis, are considered not to be realizable. An impairment loss is recorded if
the net capitalized costs of proved oil and gas properties exceed the aggregate
undiscounted future net revenues determined on a property by property basis.
The impairment loss recognized equals the excess of net capitalized costs over
the related fair value, determined on a property by property basis. During
1998, FX Energy recorded a non-cash impairment charge of $5,885,000 as a result
of writing down its domestic proved developed properties. As a result of the
foregoing, the results of operations of FX Energy for any particular period may
not be indicative of the results that could be expected over longer periods.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Risks of Adverse Weather
A significant portion of FX Energy's exploration and development activities
are subject to periodic interruptions due to weather conditions which may be
quite severe in the areas where such activities are conducted. Heavy
precipitation may make travel to exploration sites or drilling locations
difficult or impossible. Extremely cold temperatures may delay or interrupt
drilling, well servicing, infrastructure construction and production. The
foregoing may reduce production volumes or increase production costs and could
delay FX Energy's planned exploration and development activities.
Factors Relating to the Oil and Gas Industry
Discovery of New Reserves
FX Energy's success will be largely dependent on its ability to discover
new oil and gas reserves, participate in development opportunities or to acquire
proved producing reserves in Poland and the western United States, all of which
involve substantial risks. FX Energy's existing limited reserves in Montana and
Nevada are being depleted by production. Therefore, FX Energy's revenues will
decline unless its reserves are replaced and expanded by successful drilling or
the acquisition of additional reserves. There can be no assurance that FX
Energy's program in Poland will result in the discovery of new reserves to
replace or expand FX Energy's reserves.
Volatility of Commodity Prices and Markets
Oil and gas prices have been and are likely to continue to be volatile and
subject to wide fluctuations in response to the following factors:
-Relatively minor changes in the supply of and demand for oil and gas;
-Market uncertainty;
-Political conditions in international oil and gas producing regions;
-The extent of local production and importation of oil and gas;
-The level of consumer demand;
-Weather conditions affecting production, transportation and consumption;
-The competitive position of oil or gas as a source of energy as compared
with coal, nuclear energy, hydroelectric power and other energy sources;
-The availability, proximity and capacity of gathering systems, pipelines
and processing facilities;
-The refining capacity of prospective oil purchasers;
-The effect of federal and state regulation on the production,
transportation and sale of oil and gas; and
-Other factors beyond the control of FX Energy.
FX Energy cannot control or influence the above factors. Oil prices, for
example, are currently at or near their lowest level in over two decades. In
addition to the direct impact on the prices at which oil or gas may be sold,
adverse changes in the market or regulatory environment would likely have an
adverse effect on FX Energy's ability to obtain funding from lending
institutions, industry participants, the sale of additional securities and other
sources.
Operating Hazards and Uninsured Hazards
FX Energy's oil and gas drilling and production operations are subject to
the usual hazards incidental to the industry. These hazards include blowouts,
cratering, explosions, uncontrollable flows of oil, natural gas or well fluids,
fires, pollution, releases of toxic gas and other environmental hazards and
risks. These hazards can cause personal injury and loss of life, severe damage
to and destruction of property and equipment, pollution or environmental
damage and suspension of operations. To lessen the effects of these hazards, FX
Energy maintains insurance of various types to cover its domestic operations.
FX Energy has $5.0 million of general liability insurance. Apache, as the
operator of the Lublin, Carpathian, Pomeranian and Warsaw West project areas, is
carrying $25.0 million of general liability insurance for joint operations on
project areas for which FX Energy and Apache each have an interest. There can
be no assurance that such insurance can continue to be obtained on reasonable
terms. This insurance, however, does not cover all of the risks involved in oil
and gas exploration, drilling and production. If insurance coverage does exist,
the amount of coverage may not be sufficient to pay the full amount of such
liabilities. FX Energy may not be insured against all losses or liabilities
that may arise from all hazards because such insurance is unavailable at
economic rates, because of limitations on existing insurance coverage or other
factors. For example, FX does not maintain insurance against risks related to
violations of environmental laws. FX Energy would be adversely effected by a
significant adverse event that is not fully covered by insurance. Further, FX
Energy cannot assure that it will be able to maintain adequate insurance in the
future at rates it considers reasonable.
Intense Competition in Oil and Gas Industry
The oil and gas industry is highly competitive. Most of FX Energy's
current and potential competitors have greater financial resources and a greater
number of experienced and trained managerial and technical personnel than FX
Energy. There can be no assurance that FX Energy will be able to compete
effectively with such firms.
United States Governmental Regulation and Taxation
Oil and gas production and exploration are subject to comprehensive
federal, state and local laws and regulations controlling the exploration for
and production and sale of oil and gas and the possible effects of such
activities on the environment. Present and possible future legislation and
regulations could cause additional expenditures, restrictions and delays in FX
Energy's business. The impact of these uncertainties on FX Energy cannot be
predicted and may require FX Energy to limit substantially, delay or cease
operations in some circumstances. FX Energy cannot predict the ultimate effect
of such governmental energy and taxation policies, which are frequently unclear
and unpredictable.
Factors Relating to Activities in Poland
Political Uncertainties
FX Energy's oil and gas exploration, development and production activities
in Poland are and will be subject to ongoing uncertainties and risks, including:
-Political instability and possible changes in government;
-Export and transportation tariffs;
-Local and national tax requirements;
-Expropriation or nationalization of private enterprises and other risks
arising out of foreign government sovereignty over the project areas;
-Possible changes in government personnel, the development of new
administrative policies and practices and political conditions in Poland
may affect the administration of agreements with governmental agencies
or enterprises;
-Possible changes to the laws, regulations and policies applicable to FX
Energy and Apache or the oil and gas industry in Poland in general;
-Uncertainties as to whether the laws and regulations will be applicable
in any particular circumstance;
-Uncertainties as to whether FX Energy and Apache will be able to enforce
their rights in Poland;
-The requirement to demonstrate, to the satisfaction of the Polish
authorities, FX Energy's and Apache's compliance with governmental
requirements respecting exploration expenditures, results of
exploration, environmental protection matters and other factors; and
-The inability to recover previous payments to the Polish government made
under the exploration rights or any other costs incurred respecting
those rights if FX Energy were to lose or cancel its exploration and
exploitation rights at any time.
There can be no assurance that FX Energy will be able to take measures to
provide adequate protection against any of the political uncertainties discussed
above.
Currency Risks
The amounts in FX Energy's agreements with Apache, Homestake, POGC and the
government of Poland relating to FX Energy's activities in Poland are expressed
in United States Dollars. Conversions between United States Dollars and Polish
Zlotys are made on the due date of amounts to be paid or received. Even though
it is likely that sales, if any, of production in Poland would be in the Polish
Zloty equivalent of a United States Dollar amount, FX Energy's activities in
Poland may be affected by fluctuations in exchange rates between the Polish
Zloty, the United States Dollar and other currencies. The exchange rate for the
Polish Zloty was 3.51, 3.51 and 2.85 per United States Dollar as of December 31,
1998, 1997 and 1996, respectively. FX Energy has not hedged its foreign
currency activities in the past and has no future plans to do so. There can be
no assurance that currencies may be convertible at satisfactory rates. In
addition, the official conversion rates between United States and Polish
currencies may not accurately reflect the relative value of goods and services
available or required in Poland. Further, inflation may lead to the devaluation
of the Polish Zloty.
Repatriation of Earnings
FX Energy may be restricted as to the amount, manner or timing of the
repatriation to the United States of earnings from its activities in Poland.
Currently, there are no restrictions on the ability of a Polish entity to repay
debt to a foreign parent corporation or to pay fair market compensation to a
foreign parent corporation for legitimate services. However, Polish limited
liability companies can pay dividends only once annually and only to the extent
of profits, as determined in compliance with Polish accounting and regulatory
requirements and as verified by an audit satisfying Polish professional
standards. Although FX Energy is entitled to a credit against its United States
tax obligations equal to any foreign taxes paid, FX Energy may not be able to
use this credit unless FX Energy owes taxes in the United States.
Limited Exploration and Development Infrastructure
There can be no assurance that FX Energy or Apache will be able to conduct
an effective and efficient exploration program in Poland. Further, the limited
availability of some western exploration, drilling and production equipment,
supplies and services may adversely effect proposed activities. In addition,
the limited availability or limited capacity of oil and gas gathering, storage,
transportation and processing facilities subject FX Energy to certain risks that
could substantially increase the cost of exploration, development and production
activities and reduce potential financial returns.
Lack of Transportation and Marketing Arrangements
Although transportation and marketing arrangements are now being negotiated
respecting activities on the Lachowice Field, FX Energy and Apache have no
transportation, refining or marketing arrangements relating to oil or gas that
may be produced from any of FX Energy's other project areas in Poland. There can
be no assurance that FX Energy or Apache will be able to establish
transportation, refining or marketing arrangements to sell any oil or gas
discovered and produced in Poland on terms favorable to FX Energy or that FX
Energy or Apache will be able to make arrangements for the exportation of oil or
gas if they desire to do so. If FX Energy establishes oil and/or gas reserves,
the production, marketability and ultimate profitability of such natural gas
operations will depend on the availability, proximity and capacity of gathering
systems, pipelines and processing facilities.
Poland's Governmental Regulation
FX Energy's activities in Poland are subject to certain laws and
regulations relating to exploration and development, production, marketing,
transportation and storage of oil and/or gas, including measures relating to the
protection of the environment. Poland's regulatory regime governing these
activities was recently promulgated and is relatively untested. Therefore,
there is little or no administrative or enforcement history or established
practice that can aid FX Energy in evaluating how the regulatory regime will
affect FX Energy's operations. Although FX Energy believes the regulatory
infrastructure currently in place and now being further developed in Poland is
generally consistent with the government's stated purpose of encouraging both
foreign investment and the development of Poland's natural resources, there can
be no assurance that such governmental policy will not change or that new laws
and regulations, administrative practices or policies or interpretations of
existing laws and regulations will not materially and adversely affect FX
Energy's activities in Poland. In certain instances, Poland's laws, policies
and procedures may be changed to conform to the minimum requirements that must
be met before Poland is admitted as a full member of the European Union. The
government of Poland has announced that it intends to privatize various segments
of POGC in the near future. Currently, no specific plans have been announced
respecting the method or timing of such privatization.
Poland's Environmental Regulations
FX Energy's operations are subject to environmental laws and regulations in
Poland that provide for restrictions and prohibitions on spills, releases or
emissions of various substances produced in association with oil and gas
exploration and development. Additionally, if significant quantities of gas are
produced in conjunction with the production of oil, regulations prohibiting the
flaring of gas may inhibit oil production. In such circumstances, the absence
of a gas gathering and delivering system may restrict production or may require
significant expenditures to develop such a system prior to producing oil and
gas. FX Energy or Apache may be required to prepare and obtain approval of
environmental impact assessments by governmental authorities in Poland prior to
commencing certain oil and gas production, transportation and processing
functions.
FX Energy has participated in the drilling of four exploratory wells and
the acquisition of several thousand kilometers of seismic data in Poland, all of
which have not incurred any related material environmental remediation costs to
date. Management believes FX Energy and Apache are currently in material
compliance with all applicable laws and regulations. However, there can be no
assurance of such compliance or that applicable regulations or administrative
policies or practices will not be changed by the Polish government. The cost of
compliance with current regulations or any changes in environmental regulations
could require significant expenditures and breaches of such regulations may
result in the imposition of fines and penalties, any of which may be material.
There can be no assurance that these environmental costs will not have a
material adverse effect on FX Energy's financial condition or results of
operations in the future.
OIL AND GAS TERMS
The following terms have the indicated meaning when used in this Report.
"BPD" means barrels of oil per day.
"BBL" means barrel of oil.
"BCF" means billion cubic feet of natural gas.
"DEVELOPMENT WELL" means a well drilled within the proved area of an oil
or gas reservoir to the depth of a stratigraphic horizon known to be
productive.
"EXPLORATORY WELL" means a well drilled to find and produce oil or gas in
an unproved area, to find a new reservoir in a field previously found to be
productive of oil or gas in another reservoir or to extend a known
reservoir.
"FIELD" means an area consisting of single reservoir or multiple reservoirs
all grouped on or related to the same individual geological structural
feature and/or stratigraphic conditions.
"GROSS" ACRES AND "GROSS" WELLS means the total number of acres or wells,
as the case may be, in which an interest is owned, either directly or
though a subsidiary or other Polish enterprise in which FX Energy has an
interest.
"MBBL" means thousand barrels of oil.
"MMBBL" means million barrels of oil.
"MMCF" means million cubic feet of natural gas.
"MMBOE" means million barrels of oil equivalent.
"NET" means, when referring to wells or acres, the fractional ownership
working interests held by FX Energy, either directly or through a
subsidiary or other Polish enterprise in which FX Energy has an interest,
multiplied by the gross wells or acres.
"PROVED RESERVES" means the estimated quantities of crude oil, natural gas
and natural gas liquids which geological and engineering data demonstrate
with reasonable certainty to be recoverable in future years from known
reservoirs under existing economic and operating conditions, i.e., prices
and costs as of the date the estimate is made. "Proved reserves" may be
developed or undeveloped.
"PV-10 VALUE" means the estimated future net revenue to be generated from
the production of proved reserves discounted to present value using an
annual discount rate of 10%. These amounts are calculated net of estimated
production costs and future development costs, using prices and costs in
effect as of a certain date, without escalation and without giving effect
to non-property related expenses such as general and administrative
expense, debt service, future income tax expense or depreciation, depletion
and amortization.
"RESERVOIR" means a porous and permeable underground formation containing
a natural accumulation of producible oil and/or gas that is confined by
impermeable rock or water barriers and that is distinct and separate from
other reservoirs.
"STRATIGRAPHIC TEST" means a drilling effort, geologically directed, to
obtain information pertaining to a specific geological condition. Such
wells customarily are drilled without the intention of being completed for
hydrocarbon production.
"TCF" means trillion cubic feet of natural gas.
ITEM 3. LEGAL PROCEEDINGS
FX Energy is not a party to any material legal proceedings and no material
legal proceedings have been threatened by FX Energy or, to the best of its
knowledge, against it.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of FX Energy's security holders during
the fourth quarter of the fiscal year ended December 31, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The following table sets forth for the periods indicated the high and low
closing prices for FX Energy's common stock as quoted under the symbol "FXEN"
on the Nasdaq National Market:
LOW HIGH
-------- --------
1999
First Quarter (through February 26 , 1999)...............$ 4.00 $ 9.75
1998
Fourth Quarter...........................................$ 6.50 $ 10.13
Third Quarter............................................. 5.63 9.50
Second Quarter............................................ 8.25 12.81
First Quarter............................................. 6.25 10.50
1997
Fourth Quarter............................................$ 5.75 $ 8.00
Third Quarter............................................. 5.50 9.50
Second Quarter............................................ 5.50 12.13
First Quarter............................................. 9.00 13.25
On February 26, 1999, the closing price per share of the common stock on
the Nasdaq National Market was $4.1875.
The market price for FX Energy's common stock has been volatile in the past
and could fluctuate significantly in response to the results of specific
exploration and development activities, variations in quarterly operating
results, fluctuations in oil and gas prices and changes in recommendations by
securities analysts. In addition, the securities markets regularly experience
significant price and volume fluctuations that are often unrelated or
disproportionate to the results of operations of particular companies. In
particular, securities such as the common stock of companies doing substantially
all of their business in emerging market countries such as Poland are, to
varying degrees, influenced by economic and market conditions in other emerging
market countries. Although economic conditions are different in each country,
investors' reactions to developments in one country may have effects on the
securities of issuers doing business in other countries, including Poland. There
can be no assurance that the trading price of FX Energy's common stock would not
be adversely affected by events elsewhere, especially in emerging market
countries. These broad fluctuations may adversely affect the market price of FX
Energy's common stock.
FX Energy has never paid cash dividends on its common stock and does not
anticipate that it will pay dividends in the foreseeable future. FX Energy
intends to reinvest any future earnings to further expand its business. FX
Energy estimates that, as of February 26, 1998, it had approximately 4,200
stockholders.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of FX Energy for the
five years ended December 31, 1998 are derived from the audited financial
statements and notes thereto of FX Energy, certain of which are included herein.
The selected consolidated financial data should be read in conjunction with FX
Energy's Consolidated Financial Statements and the Notes thereto included
elsewhere herein.
YEARS ENDED DECEMBER 31,
1998 1997 1996 1995 1994
------ ----- ------ ------ ------
STATEMENT OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenues:
Oil sales $1,124 $2,040 $2,346 $1,981 $1,692
Drilling revenue 323 496 75 111 224
Gain on sale of property
interests 467 272 -- 75 --
------ ------ ------ ------ ------
Total revenues: 1,914 2,808 2,421 2,167 1,916
------ ------ ------ ------ ------
Operating Costs and Expenses:
Lease operating costs (1) 1,046 1,239 1,225 1,272 680
Exploration costs (2) 2,127 5,314 3,716 862 651
Domestic proved property
impairment 5,885 -- -- -- --
Drilling costs 240 329 154 141 178
Depreciation, depletion and
amortization 672 635 558 503 422
General and administrative 2,572 2,566 1,715 1,466 816
------ ------ ------ ------ ------
Total operating costs and 12,542 10,083 7,368 4,244 2,747
expenses ------ ------ ------ ------ ------
Operating loss (10,628) (7,275) (4,947) (2,077) (831)
Interest and other income 506 662 370 98 53
Interest expense -- (83) (333) (448) (214)
Minority interest: Non-cash
dividends (3) -- -- -- (93) --
Net loss before income taxes (10,122) (6,696) (4,910) (2,520) (992)
Benefit from (provision for)
income taxes -- -- -- -- --
------ ------ ------ ------ ------
Net loss before extraordinary (10,122) (6,696) (4,910) (2,520) (992)
gain
Extraordinary gain -- 3,076 -- -- --
------ ------ ------ ------ ------
Net loss $(10,122) $ (3,620) $ (4,910) $ (2,520) $ (992)
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Basic and diluted net loss per
common share $ (0.78) $ (0.29) $ (0.49) $ (0.47) $ (0.44)
Weighted average shares
outstanding 12,979 12,597 10,018 5,389 2,229
CASH FLOW STATEMENT DATA:
Net cash used in operating
activities $ (3,109) $ (5,881) $ (3,651) $ (1,030) $ (322)
Net cash provided by (used in)
investing activities 1,083 368 (7,005) (1,489) (4,432)
Net cash provided by (used in)
financing activities (674) 1,679 18,259 2,974 4,587
(1)Includes lease operating expenses and production taxes.
(2)Includes geophysical and geological costs, exploratory dry hole costs, and
non-producing leasehold impairments.
(3)Non-cash dividend on FX Producing convertible preferred stock.
AS OF DECEMBER 31,
---------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------- ------ ------
BALANCE SHEET DATA: (IN THOUSANDS)
Working capital (deficit) $3,965 $8,494 $13,843 $ (278) $(272)
Total assets 8,253 18,555 22,994 10,039 8,436
Long-term debt -- -- 1,500 3,359 4,091
Redeemable FX Producing
preferred stock -- -- -- -- 550
Stockholders' equity 6,920 17,612 20,908 5,224 1,280
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
FX Energy explores for oil, gas and gold in Poland where it has oil and gas
exploration rights in five separate project areas covering approximately 17.0
million gross acres (including 13.6 million gross acres of Concessions and 3.4
million gross acres of options on POGC controlled areas) and approximately
166,000 gross acres of gold exploration rights. In the western United States,
FX Energy produces oil from fields in Montana and Nevada, has a drilling and
well servicing company and approximately 17,000 net acres of undeveloped
leaseholds in the Williston Basin of North Dakota.
From its organization in January 1989 until the first quarter of 1994, FX
Energy generated revenue principally from the sale of oil and gas prospects in
the western United States and management fees from domestic exploration groups
formed by FX Energy. During this period, FX Energy reported substantial
operating losses.
In the second quarter of 1994, FX Energy purchased certain producing oil
properties in Montana and Nevada, well servicing equipment and a drilling rig
capable of drilling up to 6,000 feet. FX Energy then realized increased
operating revenues but continued to report operating losses.
Since 1995, when FX Energy acquired oil and gas exploration rights to
approximately 2.1 million acres in the Baltic Project Area in Poland, FX Energy
has focused an increasing amount of resources and activities towards oil and gas
exploration in Poland. As of January 1, 1999, FX Energy had acquired oil and
gas exploration rights, including Concessions and options on POGC controlled
areas, covering approximately 17.0 million gross acres, resulting in FX Energy
owning the largest gross and net acreage position by a foreign company in
Poland. FX Energy has minimized its financial exposure in Poland by forming
strategic alliances with several industry partners such as Apache, POGC,
Homestake and RWE-DEA.
FX Energy realized net proceeds of $17.6 million from the sale of 3,450,000
shares of common stock in the third quarter of 1996. The proceeds from the
stock offering were used to pay off long-term debt of $3.7 million and to fund
FX Energy's exploration activities for the remainder of 1996 and all of 1997 and
1998. At the end of 1998, FX Energy had $4.7 million in cash and marketable
debt securities with no outstanding long-term debt.
Since its inception in 1989 through 1998, FX Energy has incurred cumulative
net losses of $22.9 million, including net losses of $10.1 million, $3.6
million and $4.9 million for the years ended December 31, 1998, 1997 and 1996,
respectively. FX Energy may continue to incur net losses during 1999 and
beyond, depending on results from its exploration and development activities in
Poland and the western United States.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
FX Energy operates within two segments of the oil and gas industry;
exploration and production ("E&P") and drilling and well servicing ("Drilling");
and within the exploration segment of the mining industry. In Poland, FX Energy
explores for oil, gas and gold. In the western United States, FX Energy has a
limited amount of exploratory acreage (primarily in North Dakota), produces oil
(Montana and Nevada) and has a contract drilling and well servicing company in
northern Montana. Depreciation, depletion and amortization costs ("DD&A")
directly associated with the production and drilling segments are detailed
within the following discussion. General and administrative costs ("G&A"),
interest income, other income, interest expense and income taxes are not
allocated to individual operating segments for management or segment reporting
purposes and are discussed in their entirety following the segment discussion.
Mining, which consists of gold exploration on FX Energy's Sudety Project Area in
Poland, is not considered by management to be a material segment for the periods
ended December 31, 1998, 1997 and 1996. As of the end of 1998, FX Energy had
limited exploratory activity associated with gold exploration in Poland,
including $29,000 spent on gold exploration during 1998 and a gain from the sale
of property interest of $71,000 during 1997.
E&P OPERATIONS - OIL AND GAS
EXPLORATION AND PRODUCTION REVENUES
Oil Revenues
Oil revenues were $1,124,000, $2,040,000 and $2,346,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. During 1998 and 1997, FX
Energy's oil revenues were adversely affected by depressed oil prices and
lower production rates attributable to the natural production declines of FX
Energy's producing properties. A summary of the percentage change in oil
revenues, average oil price and oil production for 1998, 1997 and 1996 is set
forth below:
YEAR ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
OIL REVENUES $1,124,000 $2,040,000 $2,346,000
Percent change versus
prior year -44.90% -13.04% +18.42%
AVERAGE OIL PRICE $9.78 $16.16 $18.04
Percent change versus
prior year -39.48% -10.42% +22.97%
PRODUCTION VOLUMES 114,909 126,271 130,018
(BBLS)
Percent change versus
prior year -9.00% -2.88% -3.70%
Gain on Sale of Property Interests
FX Energy recognized a gain on sale of property interests of $467,000 and
$272,000 for the years ended December 31, 1998 and 1997 respectively. The 1997
gain on sale of property interests of $272,000 includes $71,000 relating to FX
Energy's mining operations, which are excluded from the discussion of the
results of operations by business segment. There was no gain from the sale of
property interests in 1996. During 1998, Apache paid FX Energy $500,000 in
initial cash consideration relating to its participation in the Carpathian
Project Area which was offset by $33,000 of associated costs. During 1997, FX
Energy received $450,000 from Apache in initial cash consideration relating to
its participation in the Lublin Project Area which was offset by $344,000 of
associated costs and $95,000 from the purchase of Lubex Petroleum Company, FX
Energy's wholly owned Polish exploration subsidiary which operates the Original
8 Blocks within FX Energy's Lublin Project Area. The amount of gain on sale of
property interests will continue to vary from year to year, depending on the
timing of completed deals and the amount of up-front cash consideration, if any.
EXPLORATION AND PRODUCTION COSTS
Lease Operating Costs
FX Energy's lease operating costs are composed of normal recurring lease
operating expenses ("LOE") and production taxes. Lease operating costs were
$1,046,000, $1,239,000 and $1,225,000 for the years ended December 31, 1998,
1997 and 1996, respectively.
LOE costs were $966,000, $1,094,000 and $1,059,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. FX Energy initiated a cost
control program in 1996 to limit its LOE costs, primarily by utilizing Company-
owned well servicing equipment on its producing properties. During 1998, 1997
and 1996 FX Energy performed only routine maintenance on its producing
properties and has deferred workovers until the depressed oil price improves.
Lifting cost per barrel was relatively flat during 1998, 1997 and 1996,
amounting to $8.41, $8.66 and $8.15 per barrel, respectively.
Production taxes were $80,000, $145,000 and $166,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. During 1998, 1997 and 1996
production taxes averaged approximately 7.0% of annual oil revenues. The
decrease in the amount of production taxes from year to year is directly
associated with decreased oil prices and decreased oil production from year to
year. Refer to the table in Exploration and Production Revenues - Oil
Revenues for the percentage fluctuations in the average oil price and oil
production for 1998, 1997 and 1996.
DD&A Expense - Producing Operations
DD&A expenses for producing properties were $231,000, $261,000 and $245,000
for the years ended December 31, 1998, 1997 and 1996, respectively. The DD&A
rate per barrel was relatively constant at $2.01, $2.07 and $1.89 for 1998, 1997
and 1996, respectively.
Domestic Proved Property Impairment
As of December 31, 1998, FX Energy's PV-10 value for its domestic proved
properties was approximately $472,000, consisting solely of proved developed
reserves. Due to the current level of depressed oil prices, which FX Energy
expects to continue into the foreseeable future, management determined its
domestic proved undeveloped reserves reported at the end of 1997 will likely not
be developed in the future and subsequently reported only domestic proved
developed reserves at the end of 1998. In accordance with generally accepted
accounting principles, during the third and fourth quarters of 1998, FX Energy
recorded total impairment expense of $5,885,000, which represents the difference
between the net book value of its domestic proved developed properties and the
related fair value, determined on a property by property basis. FX Energy did
not record any impairment expense for its domestic proved properties during 1997
or 1996.
Exploration Costs
FX Energy's exploration costs consist of geological and geophysical costs
("G&G"), exploratory dry holes and non-producing leasehold impairments.
Exploration costs were $2,127,000, $5,314,000 and $3,716,000 for the years ended
December 31, 1998, 1997 and 1996,respectively. The 1998 exploration costs
of $2,127,000 include $29,000 of G&G costs relating to FX Energy's mining
operations, which are excluded from the discussion of the results of operations
for this segment. A comparative discussion of each component of exploration
costs incurred during 1998, 1997 and 1996 follows:
G&G costs were $2,081,000, $1,684,000 and $2,271,000 during the years ended
December 31, 1998, 1997 and 1996, respectively. During 1998, FX Energy incurred
approximately $400,000 of cost relating to its share of the Lublin Project Area
seismic acquisition program with Apache and $75,000 relating to the Polish
Lowlands Study. During 1997, FX Energy completed a seismic survey on Wola, a
POGC Concession in the Southern Carpathian area, costing $210,000. During 1996,
FX Energy completed a seismic survey costing approximately $1,100,000 in the
Baltic Project Area. During the years ended December 31, 1998, 1997 and 1996 FX
Energy spent an average of approximately $1,200,000 annually relating to the
wages and associated expenses for employees and consultants directly engaged in
G&G activities. FX Energy has five project areas for oil and gas exploration in
Poland, including the Warsaw West Project Area obtained January 1, 1999, the
Lublin, Carpathian and Pomeranian project areas obtained primarily in 1997 and
the Baltic Project Area obtained in 1995. G&G costs are expected to continue at
current or higher levels as FX Energy increases its exploratory efforts in
Poland and continues to spend a limited amount on its exploratory acreage in the
western United States.
Exploratory dry hole costs were $17,000, $3,478,000 and $155,000 for the
years ended December 31, 1998, 1997 and 1996, respectively. All of the
exploratory dry hole costs incurred during 1998 were associated with wells
drilled prior to 1998. During 1998, FX Energy participated in drilling two
exploratory dry holes, the Czernic 277-2 and the Poniatowa 317-1, in Poland on
the Lublin Project Area. Both wells were Apache exploratory wells under FX
Energy's agreements with Apache. As such, Apache covered all of FX Energy's
pro-rata share of costs for each well. During 1997, FX Energy drilled four
exploratory dry holes; two in Poland and two in the western United States.
In Poland, FX Energy drilled the Orneta #1, the first exploratory oil well
drilled by a western company in Poland, at a cost of $1,834,000 and the
Gladysze #1-A at a cost of $1,262,000, both of which were on FX Energy's Baltic
Project Area. In the western United States, FX Energy drilled the Murray #12-30
in central Montana at a cost of $222,000 and the Mega Springs Federal #7 in
Nevada at a cost of $160,000. In 1996, FX Energy drilled one exploratory dry
hole in Nevada costing $155,000.
There were no non-producing leasehold impairments during 1998. Non-
producing leasehold impairments were $152,000 and $1,290,000 for the years ended
December 31, 1997 and 1996, respectively. During 1997, FX Energy wrote off
$45,000 relating to its Devil's Basin prospect in Central Montana where the
Murray #12-30 was drilled, $78,000 relating to its Mega Springs Prospect in
Nevada where the Mega Springs Federal #7 was drilled and $29,000 relating to its
Horse Trap prospect in Wyoming where FX Energy no longer has drilling plans.
In 1996, FX Energy wrote off its Lake Valley prospect in Nevada at a cost of
$1,290,000. Non-producing leasehold impairments will vary from period to period
based on FX Energy's determination that capitalized costs of unproved
properties, on a property by property basis, are not realizable.
Extraordinary Gain - Baltic Project Area
As of December 31, 1996, FX Energy had $1,500,000 of long-term debt
associated with advances received from RWE-DEA relating to RWE-DEA's commitment
to earn a fifty-percent interest in FX Energy's Baltic Project Area. During
1997, RWE-DEA advanced FX Energy an additional $1,576,000, bringing the total
amount of such advances to $3,076,00, all of which FX Energy recorded as notes
payable prior to the Polish government approving RWE-DEA's participation in FX
Energy's Baltic Project Area. On June 30, 1997, after the Polish government had
previously approved RWE-DEA's participation in the Baltic Project Area, RWE-DEA
elected not to earn an interest in FX Energy's Baltic Project Area. FX Energy
was not contractually obligated to pay back any funds previously advanced by
RWE-DEA. Accordingly, FX Energy eliminated its long-term debt associated with
the RWE-DEA advances and recognized an extraordinary gain of $3,076,000 for the
year ended December 31, 1997. FX Energy did not record any extraordinary gains
during 1998 or 1996.
DRILLING AND WELL SERVICING OPERATIONS
Drilling Revenues
Drilling revenues were $323,000, $496,000 and $75,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. During 1998, FX Energy's
drilling revenues consisted of $262,000 from drilling four wells in northern
Montana on a day work contract basis and $61,000 of well servicing revenue
resulting from contracting FX Energy's well servicing equipment to third
parties. FX Energy had previously utilized its well servicing equipment solely
on its Company-owned properties. During 1997, FX Energy drilled two wells on a
day work contract basis resulting in revenues of $424,000 and $72,000 from the
Murray #12-30 and the State #31-8, respectively. In addition to the drilling
revenues received, FX Energy had a 27.69% working interest in the Murray #12-30,
a dry hole and a 6.25% working interest in the State #31-8, an oil discovery. A
gross operating profit before DD&A from drilling operations of $167,000 was
realized during 1997, consisting of $220,000 from drilling both wells, less
$53,000 in downtime costs. The drilling net profit helped offset the combined
working interest well cost of $242,000 that FX Energy incurred on these wells.
FX Energy drilled one well during 1996, resulting in revenues of $75,000.
Drilling revenues will continue to fluctuate year to year based on the number,
timing and retained working interest of wells drilled and the degree of emphasis
on utilizing well servicing equipment on Company owned properties.
Drilling Costs
Drilling costs were $240,000, $329,000 and $154,000 for the years
ended December 31, 1998, 1997 and 1996, respectively. During 1998, FX Energy
drilled four wells costing a total of $157,000 on a day work contract basis,
incurred $20,000 of cost relating to contract well servicing and $63,000 on
downtime costs, all of which resulted in a total gross profit before DD&A
expense of $83,000. During 1997, FX Energy drilled two wells on a day work
contract basis costing a total of $275,000 and incurred $54,000 of downtime
costs, all of which resulted in a gross profit before DD&A expense of $167,000.
During 1996, FX Energy drilled one well on a day work contract basis costing
$47,000 and incurred $107,000 of downtime, resulting in a net loss before DD&A
expense of $79,000. Drilling costs will continue to fluctuate year to year
based on the number, timing and retained working interest of wells drilled and
the degree of emphasis on utilizing well servicing equipment on Company owned
properties.
DD&A Expense - Drilling and Well Servicing Operations
DD&A expenses for drilling and well servicing equipment were $322,000,
$289,000 and $260,000 for the years ended December 31, 1998, 1997 and 1996,
respectively. FX Energy spent $156,000, $210,000 and $133,000 on upgrading its
drilling and well servicing equipment during 1998, 1997 and 1996, respectively.
DD&A expense was progressively higher year to year due to prior year capital
additions being depreciated in succeeding years.
RESULTS OF OPERATIONS - NON-SEGMENTED INFORMATION
G&A Costs
G&A costs were $2,572,000, $2,566,000 and $1,715,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. G&A costs incurred during 1998
were substantially unchanged as compared to 1997. FX Energy incurred
substantially more G&A costs associated with its expanded Polish activities
during 1997 as compared to 1996, principally as a result of forming three new
Polish exploration subsidiaries; Karpaty Petroleum Company, Lubex Petroleum
Company and Sudety Mining Company. During 1996, FX Energy incurred G&A costs
associated with its Polish activities on the Baltic Project Area only. G&A
expenses are expected to continue at current or higher levels as FX Energy
further expands its presence in Poland.
DD&A Expense - Corporate
DD&A expenses for corporate activities were $118,000, $85,000 and $53,000
for the years ended December 31, 1998, 1997 and 1996, respectively. During 1998
and 1997, FX Energy spent approximately $116,000 on software to upgrade its
accounting and exploration software systems and $68,000 on additional computer
equipment, which resulted in progressively higher DD&A expense for 1998 and
1997.
Interest and Other Income
Interest and other income were $506,000, $662,000 and $370,000 for the
years ended December 31, 1998, 1997 and 1996, respectively. FX Energy's cash
and marketable debt securities balance was $4.7 million, $8.5 million and $13.8
million as of December 31, 1998, 1997 and 1996, respectively. Interest and
other income was lower in 1998 as compared to 1997 due to lower average cash and
marketable debt security balances. FX Energy received net proceeds of $17.6
million from a public stock offering in the third quarter of 1996, which
resulted in substantially higher cash balances for the remainder of 1996 and all
of 1997. FX Energy earned interest income of $492,000, $616,000 and $333,000
during 1998, 1997 and 1996, respectively.
Interest Expense
FX Energy had no interest expense during the year ended December 31,
1998. During the years ended December 31, 1997 and 1996, FX Energy incurred
interest expense of $83,000 and $333,000, respectively. Interest expense was
lower during 1997 due to a lower average outstanding amount of long-term debt in
1997 as compared to 1996. FX Energy's long-term debt of $3,702,000 was paid off
in August 1996 using net proceeds from a public stock offering. FX Energy had
long-term debt associated with RWE-DEA of $1,500,000 as of December 31, 1996 and
received $1,576,000 in additional funding from RWE-DEA during the first six
months of 1997, all of which was recorded as long-term debt. However, upon RWE-
DEA's election not to earn an interest in the Baltic Project Area on June 30,
1997, FX Energy eliminated its long-term debt associated with RWE-DEA and
recognized an extraordinary gain of $3,076,000. As of December 31, 1998, FX
Energy had no long-term debt.
Income Taxes
FX Energy incurred net operating losses in 1998, 1997 and 1996 which can be
carried forward to offset future taxable income. Statement of Financial
Accounting Standards (SFAS) No. 109 requires that a valuation allowance be
provided if it is more likely than not that some portion or all of a deferred
tax asset will not be realized. FX Energy's ability to realize the benefit of
its deferred tax asset will depend on the generation of future taxable income
through profitable operations and the expansion of FX Energy's exploration and
development activities. The market and capital risks associated with achieving
the above requirement are considerable, resulting in FX Energy's conclusion that
a full valuation allowance be provided. Accordingly, FX Energy did not
recognize any tax benefit in its consolidated statement of operations for the
years ended December 31, 1998, 1997 or 1996.
Net Loss
FX Energy incurred net losses of $10,122,000, $3,620,000 and $4,910,000 for
the years ended December 31, 1998, 1997 and 1996, respectively. The net loss
in 1998 was due principally to a domestic proved property impairment of
$5,885,000, G&G costs of $2,109,000 and a 44.9% decline in oil prices coupled
with a 9.0% decline in oil production. The net loss in 1997 was due principally
to G&G costs of $1,684,000, an exploratory dry hole costing $1,262,000 drilled
without an outside partner and leasehold impairments of $152,000, all of which
resulted in expenditures without any substantial offsetting revenues. The net
loss in 1996 was due principally to G&G costs of $2,271,000 and lease
impairments of $1,290,000.
CAPITALIZED COSTS FOR UNPROVED OIL AND GAS PROPERTIES
FX Energy follows the successful efforts method of accounting for its oil
and gas properties. Under this method of accounting, all property acquisition
costs and costs of exploratory and development wells are capitalized when
incurred, pending determination of whether the well has found proved reserves.
If an exploratory well has not found proved reserves, these costs plus the costs
of drilling the well are expensed. The costs of development wells are
capitalized, whether productive or nonproductive. Geological and geophysical
costs on exploratory prospects and the costs of carrying and retaining unproved
properties are expensed as incurred. An impairment allowance is provided to the
extent that capitalized costs of unproved properties, on a property by property
basis, are considered not to be realizable. An impairment loss is recorded if
the net capitalized costs of proved oil and gas properties exceed the aggregate
undiscounted future net revenues determined on a property by property basis.
The impairment loss recognized equals the excess of net capitalized costs over
the related fair value, determined on a property by property basis. As a result
of the foregoing, the results of operations of FX Energy for any particular
period may not be indicative of the results that could be expected over longer
periods.
POLISH PROJECT AREAS
FX Energy and Apache AMI
Effective January 1, 1999, FX Energy and Apache entered into an agreement
which further defined the relationship between FX Energy and Apache in Poland by
establishing an AMI covering the entire country of Poland, except for the Baltic
Project Area, for oil and gas exploration, production, development and
acquisition activities for a period of two years.
Under agreements between FX Energy and Apache signed during 1997, 1998 and
early 1999, Apache has agreed to perform certain earning requirements in order
to earn a fifty-percent interest in FX Energy's Lublin and Carpathian project
areas. A summary of the items for which Apache must pay all of FX Energy's pro-
rata share of costs during the first three years of a six year exploration
period to earn a fifty-percent interest in the Lublin and Carpathian project
areas is as follows:
PROJECT AREA
-----------------------------------------
LUBLIN CARPATHIAN TOTAL
--------- ----------- ---------
Drilling costs 7 wells 3 wells 10 wells
Completion costs (1) 7 wells -- 7 wells
2D seismic 1,650 km 350 km 2,000 km
Concession and usufruct $ 695,000 $ 160,000 $ 855,000
fees
Annual training costs $ 80,000 $ 15,000 $ 95,000
(2)
G&A costs incurred in All through All through All through
Poland (3) 1999 1999 1999
(1)Should an exploratory well discover commercial reserves, Apache will be
required to pay FX Energy's pro-rata share of completion costs for
exploratory wells drilled on the Lublin Project Area. FX Energy must pay for
its pro-rata share of any completion costs for exploratory wells drilled on
the Carpathian Project Area.
(2)Annual training cost amounts reflect expenditures required to be spent each
year.
(3)FX Energy will not incur any of its pro-rata share of Apache's Polish G&A
costs on the Lublin or Carpathian project areas until after Apache fulfills
its exploratory well drilling requirements on each of the respective project
areas or the end of 1999, whichever is later.
Under other terms of the FX Energy and Apache AMI, FX Energy and Apache are
equal fifty-fifty partners in the Pomeranian and Warsaw West project areas and
Apache is the operator of all project areas covered by the FX Energy and Apache
AMI.
During late 1998, Apache commenced drilling the first two exploratory
wells, which were subsequently determined to be exploratory dry holes during
February 1999, and completed shooting its minimum requirement of 1,650
kilometers of 2D seismic on the Lublin Project Area. Apache expects to drill
the remaining five exploratory wells on the Lublin Project Area by the end of
1999, acquire 350 kilometers of 2D seismic on the Carpathian Project Area during
1999 and 2000 and drill three exploratory wells by mid-2001 on the Carpathian
Project Area.
Option Agreements with FX Energy, Apache and POGC
FX Energy and Apache entered into agreements (the "Option Agreements") with
POGC during 1997 and 1998 whereby each has an independent reciprocal right to
participate, with up to a one-third interest, in hydrocarbon exploration of POGC
controlled areas adjacent to and near the Lublin, Carpathian and Pomeranian
project areas. In turn, POGC has the reciprocal right to participate in
hydrocarbon exploration, with up to a one-third interest determined on a block
by block basis, on the Lublin, Carpathian and Pomeranian project areas. The
Option Agreements cover approximately 3.4 million acres of POGC controlled
areas, including 0.6 million acres on the Lublin Project Area, 1.5 million acres
on the Carpathian Project Area and 1.3 million acres on the Pomeranian Project
Area and approximately 8.6 million acres of FX/Apache controlled areas,
including 5.0 million acres on the Lublin Project Area, 1.4 million acres on the
Carpathian Project Area and 2.2 million acres on the Pomeranian Project Area.
The Warsaw West and Baltic project areas, containing approximately 2.9 million
and 2.1 million acres, respectively, are not subject to any option agreements
between FX Energy, Apache or POGC.
Sudety Project Area Agreement with Homestake
Homestake and FX Energy entered into a strategic alliance during 1997 to
jointly explore for gold on FX Energy's Sudety Project Area with Homestake as
operator. Under terms of the agreement, Homestake paid FX Energy $212,000 and
agreed to fund all Concession costs, usufruct costs and future exploration
costs, including spending a minimum of $1,100,000 during 1998 and 1999 exploring
the Sudety Project Area. Should Homestake propose to construct a mine, FX
Energy may elect (on a mine by mine basis) to convert its interest into a six
percent net smelter return royalty or a seven and one half percent net proceeds
interest, both at no cost to FX Energy, or into a twenty-five percent working
interest by paying back costs according to a predetermined formula.
Baltic Project Area Agreement with RWE-DEA
In May 1996, RWE-DEA and FX Energy entered into an agreement to jointly
explore for oil and gas on FX Energy's Baltic Project Area. RWE-DEA was
entitled to earn a fifty-percent interest in the Baltic Project Area by paying
FX Energy $250,000 in cash, $1,100,000 for a seismic survey, the first
$1,000,000 of the initial exploratory well's cost and fifty-percent of the cost
of the second exploratory well on the Baltic Project Area with FX Energy as
operator.
Formal approval by the Polish government was required to effect the fifty-
fifty ownership between FX Energy and RWE-DEA in the Baltic Project Area. Prior
to the Polish government's approval in June 1997, FX Energy recorded all funds
received from RWE-DEA as a long-term notes payable. Through June 30, 1997, RWE-
DEA advanced FX Energy $3,076,000 to fund its agreed upon share of costs
incurred in the Baltic Project Area. On June 30, 1997, RWE-DEA elected to not
fund its fifty-percent share of the second exploratory well. As a result, RWE-
DEA forfeited its right to earn a fifty-percent interest in the Baltic Project
Area. FX Energy was not obligated to repay any of the advances it had received
from RWE-DEA. As a result, FX Energy eliminated its long-term notes payable
associated with RWE-DEA and recognized an extraordinary gain of $3,076,000.
During 1997, FX Energy drilled the Orneta #1 and the Gladysze #1-A wells in
the Baltic Project Area at a cost of $1,834,000 and $1,262,000, respectively,
both of which were dry holes. The Orneta #1 was drilled with RWE-DEA as a
partner and the Gladysze #1-A was drilled without an industry partner. Future
exploration efforts in the Baltic Project Area will depend on whether or not FX
Energy is able to execute a strategic alliance with an industry partner.
LIQUIDITY AND CAPITAL RESOURCES
Historically, FX Energy has relied primarily on proceeds from the sale of
equity securities to fund its operating and investing activities. During 1998,
1997 and 1996, FX Energy received net proceeds from the sale of its securities,
net of redemptions, of $166,000, $253,000 and $20,443,000, respectively. FX
Energy also benefits from funds provided by other participants in drilling
groups formed by it to undertake specific drilling or other exploration
activities.
Operating Activities
FX Energy used net cash of $3,109,000, $5,881,000 and $3,651,000 to fund
its operating activities during 1998, 1997 and 1996, respectively. During 1998,
a major portion of FX Energy's net cash used in operating activities resulted
from spending $2,127,000 on exploration costs, which was comprised of $2,110,000
of G&G costs and $17,000 of exploratory dry hole costs. The net cash used in
operating activities during 1998 was $2,772,000 less than the amount used during
1997. During 1997, a major portion of FX Energy's net cash used in operating
activities resulted from spending $5,314,000 on exploration costs, which was
comprised primarily of $1,713,000 of G&G costs, $3,478,000 of dry hole costs and
$123,000 of non-producing leasehold impairments. The net cash used in operating
activities during 1997 was $2,230,000 higher than the amount used during 1996.
During 1996, FX Energy utilized its net cash used in operating activities to
fund additional exploration and G&A costs associated with expanding its
activities in Poland.
Investing Activities
FX Energy received net cash from investing activities of $1,083,000 and
$368,000 during 1998 and 1997, respectively, and used net cash of $7,005,000
during 1996 to fund its investing activities. During 1998, FX Energy spent
$441,000 on additions to properties, received $506,000 of proceeds from sale of
property interests and received a net amount of $1,011,000 relating to investing
in marketable debt securities. The net cash received from investing activities
during 1998 was $715,000 higher than the amount received during 1997. During
1997, FX Energy spent a net amount of $1,531,000 on additions to properties,
which was partially offset by the net amount of $1,536,000 FX Energy received
relating to investing in marketable debt securities. The net cash received
from investing activities during 1997 was $7,373,000 higher than the amount used
in 1996. During 1996, FX Energy spent $1,457,000 on additions to properties,
$164,000 on additions to other assets, realized $110,000 from asset sales and
invested a net amount of $5,494,000 in marketable debt securities.
Financing Activities
FX Energy used net cash to fund financing activities of $674,000 during
1998 and received net cash of $1,679,000 and $18,259,000 during 1997 and 1996,
respectively, from its financing activities. During 1998, FX Energy advanced
$840,000 to officers and received $166,000 from the exercise of warrants and
options on its common stock. The cash used in financing activities during 1998
was $2,353,000 lower than the amount received during 1997. During 1997, FX
Energy advanced $150,000 to an officer, realized $1,576,000 in advances from
RWE-DEA and $253,000 from the exercise of warrants and options on its common
stock. The cash received in financing activities during 1997 was $16,580,000
lower than the amount received in 1996. During 1996, FX Energy received
$1,518,000 in proceeds from long-term debt ($1,500,000 relating to RWE-DEA),
paid off all of its other long-term debt totaling $3,702,000 and realized net
proceeds of $20,443,000 from sale of securities.
Strategic Alliances
FX Energy has benefited and anticipates that it will continue to benefit
from strategic alliances with industry or financial partners to provide funding
and expertise, which helps reduce FX Energy's financial exposure and risk.
During the period of 1995 through 1998, FX Energy estimates that its strategic
partners have paid or committed to carry approximately $23,800,000 of FX
Energy's share of costs in various projects. In 1997, Apache committed to cover
approximately $15,000,000 of FX Energy's cost relating to exploring its Lublin
Project Area over approximately three years in exchange for a fifty-percent
percent interest in the project. During early 1998, Apache committed to
cover approximately $6,000,000 of FX Energy's cost relating to exploring the
Southern Carpathian Project Area over approximately three years in exchange for
a fifty-percent percent interest in the project. Also, during 1997, Homestake
committed to paying approximately $1,000,000 of FX Energy's cost over
approximately two years relating to gold exploration on the Sudety Project Area
in Poland. RWE-DEA committed approximately $1,600,000 to cover FX Energy's cost
relating to the Baltic Project Area during 1996 and 1997. Other industry
partners committed approximately $200,000 to cover FX Energy's costs in other
projects during 1995 and 1996.
Credit Facility
In June 1994, FX Energy established a $5.0 million bank credit facility
with Bank One, Texas, NA, primarily to finance the acquisition of producing oil
properties in Montana and Nevada. During the third quarter of 1996, FX Energy
used proceeds from a public offering to pay off its existing bank debt of
$3,565,000. FX Energy subsequently revised its credit facility with Bank One in
May 1997 to provide for an initial borrowing base of $3,000,000 and a revolving
commitment of $100,000. FX Energy did not utilize the credit facility during
1998 or 1997 and subsequently terminated the credit facility at the end of 1998.
Working Capital
FX Energy had working capital of $3,965,000, $8,494,000 and $13,843,000 as
of December 31, 1998, 1997 and 1996, respectively. Working capital as of
December 31, 1998 was $4,529,000 lower as compared to the end of 1997, primarily
due to cash used in operating and financing activities of $3,783,000 and
additions to properties of $441,000 during 1998. Working capital was $5,349,000
lower as of December 31, 1997 as compared to the end of 1996, primarily due to
the net cash used for operating activities of $5,881,000 during 1997. The
higher amount of working capital at the end of 1996 was attributable to the net
amount of $20,443,000 received from the sale of securities during 1996.
CAPITAL REQUIREMENTS
FX Energy had $4.7 million of cash and marketable securities with no long-
term debt as of December 31, 1998, an amount which FX Energy expects to be
sufficient to fund its 1999 exploration and operating requirements. However, FX
Energy does intend to seek additional capital to fund its activities in the
Lachowice Field, and, as warranted, development activities on new Polish
projects that FX Energy may enter into in the future and on existing projects in
Poland if exploration funded by Apache results in discoveries warranting
development.
Exploration Capital Requirements
During 1999, FX Energy expects to have substantially all the cost of its
share of exploration activities covered by Apache and other industry partners.
The primary focus for 1999 is expected to be in the Lublin Project Area, where
Apache is expected to complete its requirement to drill the remaining five of
seven exploratory wells, all at no cost to FX Energy, to earn a fifty-percent
interest in the Lublin Project Area. In the Carpathian Project Area, Apache is
expected to commence drilling the first of three exploratory wells in late 1999,
at no cost to FX Energy, which are required for Apache to earn a fifty-percent
interest in the Carpathian Project Area. Initial exploratory efforts, which
include new 2D seismic acquisition and the first exploratory well, are expected
to occur in 2000 on the Pomeranian Project Area and in 2001 on the Warsaw West
Project Area, where FX Energy and Apache are equal partners. Additional
exploration of the Baltic Project Area has been deferred until FX Energy
attracts another strategic partner. In the Sudety Project Area, Homestake is
paying for all gold exploration costs during 1999 in accordance with its 1997
agreement with FX Energy.
Due to the current state of depressed oil prices and its focus on Poland,
FX Energy expects to incur minimal exploration expenditures on its domestic
operations during 1999.
Development Capital Requirements
Development activity on the Lachowice Field is expected to commence during
the second quarter of 1999, with initial production scheduled for 2000. FX
Energy expects to spend approximately $300,000 per well for its pro-rata share
of costs to re-enter and recomplete up to three shut-in gas wells during 1999,
$2.3 million per well to drill three additional development wells during 2000
and $1.3 million for production facilities during 2000. The Lachowice Field
Development Agreement, the first joint development agreement signed by western
companies with POGC, established a legal framework for similar oil and gas
development deals with POGC. Under the AMI agreement with Apache, FX Energy and
Apache are now aggressively pursuing a series of such opportunities with POGC.
FX Energy intends to seek additional funding for the Lachowice Field, and, as
warranted, each Polish development project it may inter into in the future.
Due to the current state of depressed oil prices and its focus on Poland,
FX Energy expects to incur minimal developmental expenditures on its domestic
operations during 1999 and 2000.
Other Capital Requirement Considerations
The allocation of FX Energy's capital among the categories of anticipated
expenditures is discretionary and will depend upon future events that cannot be
predicted. Such events include the actual results and costs of future
exploration and development drilling activities. Consistent with previous
practice, FX Energy may obtain partial funding for its exploration and potential
development activities through strategic arrangements with industry or financial
partners.
In addition to FX Energy's own expenditures and strategic alliances already
established, FX Energy expects it will continue to benefit from funding provided
through its other exploration and development arrangements with strategic
partners. In forming strategic alliances with industry or financial partners,
FX Energy intends to seek reimbursement of all or a portion of the costs
incurred by FX Energy in identifying the prospect, obtaining initial exploration
rights and generating an initial exploration plan. FX Energy's ability to form
strategic alliances with industry or funding partners is dependent on the oil
and gas potential of specific prospect areas, perceived political or business
risks of the country and region in which the prospect is located, prevailing
prices and other conditions in the oil and gas industry in particular and the
energy industry in general and other factors which FX Energy is unable to
control or predict.
If the 1999 exploration activities in Poland funded by Apache result in one
or more discoveries that warrant development, FX Energy will likely require
additional capital to fund its share of costs to undertake a multi-well
development program, install oil and/or gas facilities, build pipelines and
purchase other investments required to support large-scale production. In
addition to its current activities underway, FX Energy is actively seeking
additional exploratory, development and property acquisition opportunities in
cooperation with POGC and Apache, which may also require additional capital. FX
Energy has no current arrangement for any such additional financing, but may
seek required funds from the sale of additional securities, project financing,
sale of partial property interests, strategic alliances with other energy or
financial partners or other arrangements, all of which may dilute the interest
of existing shareholders in FX Energy or FX Energy's interest in the specific
project financed. There can be no assurance that additional funds could be
obtained or, if obtained, would be on terms favorable to FX Energy.
In order to maintain its interest in the Lublin, Carpathian, Pomeranian,
Warsaw West, Baltic and Sudety project areas, FX Energy is required to make
certain annual payments and meet certain exploration commitments. FX Energy has
budgeted sufficient funds and obtained financial commitments from Apache and
Homestake to meet all of such obligations through at least December 31, 1999.
FX Energy also maintains its interests in leases in the United States not held
by production by making annual lease payments, which are not material in amount.
See "Items 1. and 2. Description of Business and Properties."
CHANGING PRICES, CURRENCY EXCHANGE RATES AND INFLATION
FX Energy's revenues and the value of its oil properties have been and will
continue to be affected by changes in oil prices. FX Energy's ability to obtain
exploration and/or development capital through strategic alliances with other
energy firms and attract additional capital, if required, through the sale of
securities or borrowings on attractive terms are also affected by oil prices.
Such prices are subject to substantial seasonal and other fluctuations that are
beyond the ability of FX Energy to control or predict. In the past, FX Energy
has not hedged its oil production and has no future plans to do so.
Although certain of FX Energy's costs and expenses are affected by the
level of inflation, inflation did not have a significant effect on FX Energy's
operations during 1998, 1997 or 1996. FX Energy customarily contracts for goods
and services, including those related to seismic surveys and drilling, in US
dollars to reduce the potential impact of inflation within Poland. FX Energy's
activities in Poland may be affected by the rates of inflation in Poland and
other countries. Poland has experienced gradually decreasing inflation rates,
estimated at approximately 11%, 13% and 18% during 1998, 1997 and 1996,
respectively.
The amounts in FX Energy's agreements with Apache, Homestake and its other
strategic partners and the government of Poland relating to FX Energy's
activities in Poland are expressed in U.S. dollars. Nevertheless, FX Energy's
activities in Poland may be affected by fluctuations in exchange rates between
the Polish Zloty, the U.S. dollar and other currencies. The exchange rate for
the Polish Zloty was 3.51, 3.51 and 2.85 per U.S. dollar as of December 31,
1998, 1997 and 1996, respectively. In the past, FX Energy has not hedged its
foreign currency activities and has no future plans to do so.
YEAR 2000
FX Energy uses computers principally for administrative functions such as
word processing, accounting, management reporting and financial forecasting. FX
Energy also uses computers for scientific functions such as map making,
geological interpretations and geophysical analysis. Substantially all of FX
Energy's principal computer systems have been purchased since 1996. FX Energy's
core software systems (accounting, internet, word processing and spreadsheet)
and vendors are certified as year 2000 compliant.
An ongoing program has been implemented by FX Energy to ensure that its
operational and financial systems will not be adversely affected by year 2000
software failures. In addition to its own computer systems, in connection with
its activities in the United States and in Poland, FX Energy interacts with
suppliers, customers, creditors and financial service organizations domestically
and globally which use computer systems. FX Energy is surveying all of the
major businesses FX Energy interacts with during the normal course of business
and is requesting a certification of year 2000 compliance from each of them.
Substantially all of FX Energy's core vendors (banking, insurance, stock market-
makers, strategic partners, oil purchasers, communications, etc.) have either
already certified that they are year 2000 compliant or indicated they have a
program underway to become year 2000 compliant before the year 2000.
FX Energy intends to modify or replace those systems, if any, which
are not year 2000 compliant. It is impossible for FX Energy to monitor all such
systems, particularly those of parties in another country. There can be no
assurance that such systems will not have material adverse impacts on FX
Energy's business and operations. FX Energy estimates that the cost to
redevelop, replace or repair its technology will not be material and has not
expended any significant costs to date.
OTHER MATTERS
FX Energy has reviewed all recently issued, but not yet adopted, accounting
standards in order to determine their effects, if any, on the results of
operations or financial position of FX Energy. Based on that review, FX Energy
believes that none of these pronouncements will have a significant effect on
current or future earnings or operations.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
MARKET RISK
FX Energy's major market risk exposure continues to be the price it
receives for oil produced from its domestic properties. Realized pricing is
primarily driven by the prevailing worldwide price of oil applicable to the
United States, subject to gravity and other adjustments for the actual oil sold.
Historically, oil prices have been volatile and unpredictable. Price volatility
is expected to continue. See "Item 1. and 2. Business and Properties: Risk
Factors Relating to the Oil and Gas Industry - Volatility of Commodity Prices
and Markets. "
FX Energy does not engage in any hedging activities to protect itself
against market risks associated with oil and gas price fluctuations, although it
may elect to do so if it achieves significant production in Poland.
FOREIGN CURRENCY RISK
FX Energy has entered into various agreements in Poland, primarily in U.S.
Dollars or the U.S. dollar equivalent of the Polish Zloty. FX Energy conducts
its day to day business on this basis as well. The Polish Zloty is subject to
exchange rate fluctuations that are beyond the control of FX Energy. The
exchange rate for the Polish Zloty was 3.51, 3.51 and 2.85 per U.S. dollar as of
December 31, 1998, 1997 and 1996, respectively. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations:
Changing Prices, Currency Exchange Rates and Inflation."
FX Energy does not now and does not intend in the foreseeable future to
engage in hedging transactions to protect itself against currency risks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of FX Energy, including the accountant's report,
are included beginning at page F-1 immediately following the signature page of
this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
FX Energy and its auditors have not disagreed on any items of accounting
treatment or financial disclosure.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF REGISTRANT
The information from the definitive proxy statement for the 1999 annual
meeting of stockholders under the caption "PROPOSAL NO. 1. ELECTION OF
DIRECTORS: Executive Officers, Directors and Nominees" and "Compliance with
Section 16(a) of the Exchange Act" is incorporated herein by reference.
The Company is dependent upon Mr. David N. Pierce, President and Chief
Executive Officer, Mr. Andrew W. Pierce, Vice President and Chief Operating
Officer, and other key personnel for its various activities. In addition, with
respect to its activities in Poland, the Company is dependent on Mr. Jerzy
B. Maciolek, Vice President of International Exploration, a Polish national who
is instrumental in assisting the Company in its operations in Poland. The loss
of the services of any of these individuals may materially and adversely affect
the Company. The Company has entered into employment agreements with Mr. David
N. Pierce, Mr. Andrew W. Pierce and Mr. Maciolek. The Company does not maintain
key man insurance on any of its employees.
ITEM 11. EXECUTIVE COMPENSATION
The information from the definitive proxy statement for the 1999 annual
meeting of stockholders under the caption " PROPOSAL NO. 1. ELECTION OF
DIRECTORS: Executive Compensation" is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information from the definitive proxy statement for the 1999 annual
meeting of stockholders under the caption "PROPOSAL NO. 1. ELECTION OF
DIRECTORS: Security Ownership of Certain Beneficial Owners and Management" is
incorporated herein by reference.
As of December 31, 1998, the Company had issued and outstanding warrants
and options to purchase an aggregate of up to 3,684,239 shares of common stock
at exercise prices ranging from $1.50 to $10.25 per share, with a weighted
average exercise price of $7.23 per share. Of those warrants and options,
2,776,200 shares of common stock are issuable on the exercise of options held by
officers and directors of the Company at exercise prices ranging from $1.50 to
$10.25 per share, with a weighted average exercise price of $6.83 per share,
including options to purchase 820,797 shares that are not fully vested. The
existence of such warrants and options may prove to be a hindrance to future
financing by the Company, and the exercise of such warrants and options may
further dilute the interests of all other stockholders. The possible future
resale of common stock issuable on the exercise of such warrants and options
could adversely affect the prevailing market price of the common stock.
Further, the holders of options and warrants may exercise them at a time when
the Company would otherwise be able to obtain additional equity capital on terms
more favorable to the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information from the definitive proxy statement for the 1999 annual
meeting of stockholders under the caption "PROPOSAL NO. 1. ELECTION OF
DIRECTORS: Certain Relationships and Related Transactions" is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report or incorporated
herein by reference.
1. Financial Statements.
(See Consolidated Financial Statements beginning at page F-1.)
2. Supplemental Schedule.
Financial Statement Schedules are omitted because they are inapplicable or
the required information is otherwise included in the accompanying Financial
Statements and the notes thereto.
3. Exhibits.
The following exhibits are included as part of this report:
EXHIBIT SEC
REFERENCE
NUMBER NUMBER TITLE OF DOCUMENT LOCATION
- ------- --------- ---------------------------------------- ---------------
Item 3. Articles of Incorporation and Bylaws
- ---------------------------------------------------
3.1 3 Restated and Amended Articles of Incorporated by
Incorporation Reference(11)
3.2 3 Bylaws Incorporated by
Reference(1)
Instruments Defining the Rights of
Item 4. Security Holders
- ---------------------------------------------------
4.1 4 Specimen Stock Certificate Incorporated by
Reference(1)
4.2 4 Form of Designation of Rights, Incorporated by
Privileges, and Preferences of Series A Reference(14)
Preferred Stock
4.3 4 Form of Rights Agreement dated as of Incorporated by
April 4, 1997, between FX Energy and Reference(14)
Fidelity Transfer Corp.
Item 10. Material Contracts
- ---------------------------------------------------
10.1 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(3)
and Frontier Poland Exploration and
Producing Company, Sp. z o.o. dated
August 22, 1995, relating to Blocks 51,
52, 71, 72, 91, 92, 93, 111, 112, and
113 (Baltic)
10.2 10 Amendment No. 1 to Mining Usufruct Incorporated by
Agreement dated August 15, 1996 (Baltic) Reference(4)
10.3 10 Amendment No. 2 to Mining Usufruct Incorporated by
Agreement dated August 22, 1996 (Baltic) Reference (15)
10.4 10 Form of Concession dated December 20, Incorporated by
1995, relating to Baltic Concessions Reference(5)
granted pursuant to the Mining Usufruct
Agreement dated August 15, 1996, with
related schedule
10.5 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(10)
and Lubex Petroleum Company Sp. z o.o.
dated December 20, 1996, relating to
Concession blocks 255, 275, 295, 316,
336, 337, and 338 (Lublin)
10.6 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(12)
and Apache Poland Sp. z o.o. and FX
Energy Poland Sp. z o.o. (East),
commercial partnership dated October 14,
1997, related to Concession blocks 257,
258, 277, 278, 297, 317, and 318
(Lublin)
10.7 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(12)
and Apache Poland Sp. z o.o. and FX
Energy Poland Sp. z o.o. (East),
commercial partnership dated October 14,
1997, related to Concession block 298
(Lublin)
10.8 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(12)
and Apache Poland Sp. z o.o. and FX
Energy Poland Sp. z o.o. (East),
commercial partnership dated October 14,
1997, related to Concession blocks 319,
320, 339, 340, 340A, 359, 360, 360A,
379, 380, and 380A (Lublin)
10.9 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(12)
and Gasex Production Company Sp. z o.o.
and Company, commercial partnership
dated October 14, 1997, related to
Concession blocks 410, 411, 412, 413,
414, 415, 430, 431, 432, 433, 452 and
453 (Western Carpathian)
10.10 10 Mining Usufruct Agreement between the Incorporated by
State Treasury of the Republic of Poland Reference(12)
and FX Energy Poland Sp. z o.o. and
Partners, commercial partnership dated
October 30, 1997, related to Concession
blocks 85, 86, 87, 88, 89, 105,108, 109,
129, and 149, in northwestern Poland
(Pomeranian)
10.11 10 Option Agreement dated July 18, 1997, Incorporated by
between Polish Oil and Gas Company, FX Reference(12)
Energy, and Apache Overseas, Inc.
10.12 10 Participation Agreement dated effective Incorporated by
as of April 16, 1997, between Apache Reference(13)
Overseas, Inc., and FX Energy,
pertaining to the Lublin Concessions
10.13 10 Letter Agreement dated February 27, Incorporated by
1998, between FX Energy and Apache Reference (15)
Overseas, Inc., regarding modification
to all agreements for acreage in Poland
under established area of mutual
interest.
10.14 10 Participation Agreement dated effective Incorporated by
February 27, 1998, between FX Energy and Reference (15)
Apache Overseas, Inc., pertaining to the
Western Carpathian Concession
10.15 10 Participation Option Agreement dated Incorporated by
effective February 27, 1998, between FX Reference (15)
Energy and Apache Overseas, Inc.,
pertaining to the Pomeranian Concession
10.16 10 Prospect Agreement between Apache Poland Incorporated by
Sp. z o.o., and FX Energy Poland Sp. z Reference (18)
o.o., dated April 17, 1998.
10.17 10 Option Agreement dated effective as of Incorporated by
February 2, 1998, between POGC, FX Reference (15)
Energy, Inc., and Apache Overseas, Inc.,
pertaining to the Western Carpathian
Concessions
10.18 10 Option Agreement dated March 5, 1998, Incorporated by
effective as of April 16, 1997, between Reference (17)
FX Energy, Inc., Apache Overseas, Inc.,
and POGC, relating to FX Energy's
Carpathian Area Concessions.
10.19 10 Option Agreement between FX Energy Incorporated by
Poland Sp. z o.o., and POGC dated Reference (19)
effective May 20, 1998, relating to
Pomeranian Concessions
10.20 10 Agreement dated October 21, 1996, Incorporated by
between Sudety Mining Company Sp. z o.o. Reference (9)
and the State Treasury of the Republic
of Poland, for the establishment of the
mining usufruct for the purpose of gold
exploration in the Sudety Concessions
10.21 10 Earn-In and Exploration Letter of Intent Incorporated by
dated June 13, 1997, between FX Energy Reference (12)
and Homestake Mining Company of
California
10.22 10 Form of Mining Usufruct Agreement Incorporated by
between the State Treasury of the Reference (15)
Republic of Poland and FX Energy Poland
Sp. z o.o. Commercial Partnership, dated
October 16, 1997, relating to Sudety
Concession blocks 43, 63, 64, 65, with
related schedule.
10.23 10 Earn-in, Exploration, and Joint Venture Incorporated by
Agreement between Homestake Mining Reference (15)
Company of California and FX Energy
effective December 31, 1997, regarding
exploration for precious metals in the
Republic of Poland
10.24 10 Agreement between Apache Overseas, Inc., This Filing
and FX Energy dated effective January 1,
1999, pertaining to oil and gas
operations in Poland
10.25 10 Agreement on Cooperation in the This Filing
Lachowice Area between POGC, Apache
Overseas, Inc., Apache Poland, Sp. Z
o.o., FX Energy, Inc., and FX Energy
Poland Sp. Z o.o., dated Febrruary 26,
1999
10.26 10 Frontier Oil Exploration Company 1995 Incorporated by
Stock Option and Award Plan* Reference(4)
10.27 10 Form of FX Energy, Inc., 1996 Stock Incorporated by
Option and Award Plan* Reference(10)
10.28 10 Form of FX Energy, Inc., 1997 Stock This Filing
Option and Award Plan*
10.29 10 Form of FX Energy, Inc., 1998 Stock This Filing
Option and Award Plan*
10.30 10 Employment Agreements between FX Energy Incorporated by
and each of David Pierce and Andrew Reference(1)
Pierce, effective January 1, 1995*
10.31 10 Amendments to Employment Agreements Incorporated by
between FX Energy and each of David Reference(8)
Pierce and Andrew Pierce, effective May
30, 1996*
10.32 10 Form of Stock Option with related Incorporated by
schedule (D. Pierce and A. Pierce) * Reference(1)
10.33 10 Form of Stock Option granted to D. Incorporated by
Pierce and A. Pierce* Reference(1)
10.34 10 Form of Non-Qualified Stock Option with Incorporated by
related schedule* Reference(4)
10.35 10 Letter Agreement dated effective August Incorporated by
3 , 1995, between Lovejoy Associates, Reference(4)
Inc., and FX Energy re: Financial
Consulting Engagement*
10.36 10 Letter Agreement dated effective August Incorporated by
3, 1995, between Lovejoy Associates, Reference(4)
Inc., and FX Energy re: Indemnification
10.37 10 Non-Qualified Stock Option granted to Incorporated by
Thomas B. Lovejoy* Reference(4)
10.38 10 Letter Agreement dated effective Incorporated by
December 31, 1997, between FX Energy and Reference (15)
Lovejoy Associates, Inc., re: Extension
of Consulting Engagement*
10.39 10 Employment Agreement between FX Energy Incorporated by
and Jerzy B. Maciolek* Reference(8)
10.40 10 Addendum to Employment Agreement between Incorporated by
FX Energy and Jerzy B. Maciolek* Reference (15)
10.41 10 Second Addendum to Employment Agreement Incorporated by
between FX Energy and Jerzy B. Maciolek* Reference (15)
10.42 10 Employment Agreement between FX Energy Incorporated by
and Scott J. Duncan* Reference (15)
10.43 10 Form of Indemnification Agreement Incorporated by
between FX Energy and certain directors, Reference(10)
with related schedule*
10.44 10 Form of Option granted to executive Incorporated by
officers and directors, with related Reference(10)
schedule*
10.45 10 Memorandum of Understanding regarding Incorporated by
officer loans (reformed June 19, 1998) Reference (16)
10.46 10 Limited Recourse Promissory Note of Incorporated by
David N. Pierce in the amount of Reference (16)
$950,954 (reformed June 19, 1998)
10.47 10 Pledge and Security Agreement between FX Incorporated by
Energy, Inc. and David N. Pierce Reference (16)
(reformed June 19, 1998)
10.48 10 Agreement to Hold Collateral between FX Incorporated by
Energy, Inc. and David N. Pierce and Reference (16)
Kruse, Landa & Maycock as agent to hold
collateral (reformed June 19, 1998)
10.49 10 Limited Recourse Promissory Note of Incorporated by
Andrew W. Pierce in the amount of Reference (16)
$769,924 (reformed June 19, 1998)
10.50 10 Pledge and Security Agreement between FX Incorporated by
Energy, Inc. and Andrew W. Pierce Reference (16)
(reformed June 19, 1998)
10.51 10 Agreement to Hold Collateral between FX Incorporated by
Energy, Inc. and Andrew W. Pierce and Reference (16)
Kruse, Landa & Maycock as agent to hold
collateral (reformed June 19, 1998)
Item 21 Subsidiaries of the Registrant
- ----------------------------------------------------------
21.1 Schedule of Subsidiaries Incorporated by
Reference (15)
Item 23 Consents of Experts and Counsel
- ----------------------------------------------------------
23.1 23 Consent of PricewaterhouseCoopers LLP, This Filing
independent accountants
23.2 23 Consent of Larry D. Krause, Petroleum This Filing
Engineer
Item 27 Financial Data Schedule
- ----------------------------------------------------------
27.1 27 Financial Data Schedule This Filing
* Identifies each management contract or compensatory plan or arrangement
required to be filed as an exhibit.
(1) Incorporated by reference from the registration statement on Form SB-2, SEC
File No. 33-88354-D.
(2) Incorporated by reference from the report on Form 8-K dated August 16,
1995.
(3 Incorporated by reference from the report on Form 8-K dated August 22,
1995.
(4) Incorporated by reference from the quarterly report on Form 10-Q for the
quarter ended September 30, 1995.
(5) Incorporated by reference from the annual report on Form 10-K for the year
ended December 31, 1995.
(6) Incorporated by reference from the reports on Form 8-K dated May 3, 1996.
(7) Incorporated by reference from the report on Form 8-K dated May 21, 1996.
(8) Incorporated by reference from the registration statement on Form S-1, SEC
File No.333-05583.
(9) Incorporated by reference from the report on Form 8-K dated October 1,
1996.
(10) Incorporated by reference from the annual report on Form 10-KSB for the
year ended December 31, 1996.
(11) Incorporated by reference from the proxy statement respecting the 1997
annual meeting of shareholders.
(12) Incorporated by reference from the quarterly report on Form 10-QSB for the
quarter ended September 30, 1997.
(13) Incorporated by reference from the report on Form 8-K dated August 6, 1997.
(14) Incorporated by reference from the report on Form 8-K dated April 4, 1997.
(15) Incorporated by reference from the annual report on Form 10-KSB for the
year ended December 31, 1997.
(16) Incorporated by reference from the annual report on Form 10-Q for the
quarter ended March 31,1998, as amended on Form 10-Q/A filed July 15, 1998.
(17) Incorporated by reference from the report on Form 8-K dated March 23, 1998.
(18) Incorporated by reference from the report on Form 8-K dated April 20, 1998.
(19) Incorporated by reference from the report on Form 8-K dated June 2, 1998.
(b) REPORTS ON FORM 8-K.
During the quarter ended December 31, 1998, FX Energy did not file any
reports on Form 8-K.
SIGNATURES
In accordance with section 13 or 15(d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: March 3, 1999. FX ENERGY, INC.
(Registrant)
By /s/ David N. Pierce, President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the date indicated.
Dated: March 3, 1999
/s/ David N. Pierce, Director
and President
(Principal Executive and
Financial Officer)
/s/ Andrew W. Pierce, Director,
Vice President (Principal
Operations Officer)
/s/ Scott J. Duncan, Director,
Vice President Investor
Relations and Secretary
/s/ Dennis L. Tatum, Vice
President and Treasurer
(Principal Accounting Officer)
/s/ Jerzy B. Maciolek, Vice
President International
Exploration and Director
/s/ Thomas B. Lovejoy, Director
/s/ Peter L. Raven, Director
/s/ Jay W. Decker, Director
Report of Independent Accountants
To the Stockholders and Board of Directors
of FX Energy, Inc., and Subsidiaries:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows, and stockholders' equity
present fairly, in all material respects, the consolidated financial position of
FX Energy, Inc., and Subsidiaries (the "Company") as of December 31, 1998 and
1997, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
Salt Lake City, Utah
February 26, 1999
FX ENERGY, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 1998 and 1997
1998 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $1,811,780 $4,511,919
Investment in marketable debt securities 2,929,914 3,940,582
Receivables:
Accrued oil sales 95,064 200,414
Joint interest and other receivables 240,102 587,473
Interest receivable 86,258 43,561
Inventory 68,327 67,382
Other current assets 66,053 87,013
------------ ------------
Total current assets 5,297,498 9,438,344
Property and equipment, at cost:
Oil and gas properties (successful efforts
method):
Proved 1,605,279 7,358,552
Unproved 1,178,408 1,169,521
Other property and equipment 2,494,688 2,253,750
------------ ------------
5,278,375 10,781,823
Less accumulated depreciation, depletion and
amortization (2,679,441) (2,021,175)
------------ ------------
Net property and equipment 2,598,934 8,760,648
------------ ------------
Other assets:
Certificates of deposit 356,500 356,500
------------ ------------
Total other assets 356,500 356,500
------------ ------------
Total assets $8,252,932 $18,555,492
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 420,906 $ 654,809
Accrued liabilities 911,950 289,139
------------ ------------
Total current liabilities 1,332,856 943,948
Commitments (Notes 2 and 11)
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000
shares authorized; 1998 and 1997: no shares
outstanding -- --
Common stock, $.001 par value, 30,000,000
shares authorized; 1998: 13,054,503 shares
issued and outstanding; 1997: 12,661,881
shares issued and outstanding 13,055 12,662
Notes receivable from officers (1,304,527) --
Additional paid-in capital 31,112,861 30,377,852
Accumulated deficit (22,901,313) (12,778,970)
------------ ------------
Total stockholders' equity 6,920,076 17,611,544
------------ ------------
Total liabilities and stockholders' equity $8,252,932 $18,555,492
------------ ------------
------------ ------------
The accompanying notes are an integral part of these consolidated financial
statements
FX ENERGY, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
------------ ------------ -----------
Revenues:
Oil sales $ 1,123,511 $ 2,040,233 $2,345,634
Drilling revenue 322,769 496,158 75,472
Gain on sale of property interests 466,891 272,234 --
------------ ------------ -----------
Total revenues 1,913,171 2,808,625 2,421,106
------------ ------------ -----------
Operating costs and expenses:
Lease operating costs 966,732 1,094,043 1,059,441
Production taxes 79,602 145,372 166,090
Geological and geophysical costs 2,109,375 1,683,753 2,271,208
Exploratory dry hole costs 17,422 3,478,456 155,279
Impairments 5,885,042 152,105 1,289,610
Drilling costs 240,061 328,820 154,178
Depreciation, depletion and 671,277 634,559 557,910
amortization
General and administrative 2,572,212 2,565,690 1,714,625
------------ ------------ -----------
Total operating costs and expenses 12,541,723 10,082,798 7,368,341
------------ ------------ -----------
Operating loss (10,628,552) (7,274,173) (4,947,235)
------------ ------------ -----------
Other income (expense):
Interest and other income 506,209 661,665 370,421
Interest expense -- (83,273) (332,882)
------------ ------------ -----------
Total other income (expense) 506,209 578,392 37,539
------------ ------------ -----------
Net loss before extraordinary gain (10,122,343) (6,695,781) (4,909,696)
Extraordinary gain (Note 2) -- 3,076,242 --
------------ ------------ -----------
Net loss $(10,122,343) $(3,619,539) $(4,909,696)
------------ ------------ -----------
------------ ------------ -----------
Basic and diluted net loss per share
Net loss before extraordinary gain $ (0.78) $ (0.53) $ (0.49)
Extraordinary gain -- 0.24 --
------------ ------------ -----------
Net Loss $ (0.78) $ (0.29) $ (0.49)
------------ ------------ -----------
------------ ------------ -----------
Basic and diluted weighted average
number of shares outstanding 12,978,900 12,596,977 10,018,337
------------ ------------ -----------
------------ ------------ -----------
The accompanying notes are an integral part of these consolidated financial
statements
FX ENERGY, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
------------- ------------ -------------
Cash flows from operating activities:
Net loss $(10,122,343) $(3,619,539) $(4,909,696)
Adjustments to reconcile net loss to
net cash used in operating activities:
Extraordinary gain -- (3,076,242) --
Depreciation, depletion and
amortization 671,277 634,559 557,910
Impairments 5,885,042 28,515 1,289,610
Gain on sale of property interests (466,891) (272,234) --
Exploratory dry hole costs -- 210,205 --
Common stock and options issued for
services 119,375 70,625 147,750
Interest income from officer loans (64,170) -- --
Increase (decrease) from changes in:
Receivables 260,024 (147,678) (132,606)
Inventory (945) (47,166) (4,265)
Other current assets 20,960 (19,530) (32,948)
Accounts payable and accrued
liabilities 588,908 357,752 (567,173)
------------- ------------ -------------
Net cash used in operating
activities (3,108,763) (5,880,733) (3,651,418)
------------- ------------ -------------
Cash flows from investing activities:
Additions to oil and gas properties (179,765) (1,136,935) (1,198,431)
Additions to other property and equipment (260,877) (394,291) (258,769)
Net change in other assets -- 25,000 (164,100)
Proceeds from sale of property interests 506,000 340,152 100,000
Proceeds from sale of equipment 6,928 13,051 9,700
Employee advances -- (15,000) --
Purchase of marketable debt securities (6,578,332) (3,940,582) (6,278,595)
Proceeds from maturities of marketable
debt securities 7,589,000 5,476,574 784,757
------------- ------------ -------------
Net cash provided by (used in)
investing activities 1,082,954 367,969 (7,005,438)
------------- ------------ -------------
------------- ------------ -------------
Cash flows from financing activities:
Proceeds from long-term debt -- 1,575,992 1,518,179
Repayment of long-term debt -- -- (3,702,142)
Loans to officers (840,357) (150,000) --
Proceeds from issuance of common stock,
options and warrants, net of offering
costs 166,027 252,777 20,443,012
------------- ------------ -------------
Net cash provided by (used in)
financing activities (674,330) 1,678,769 18,259,049
------------- ------------ -------------
Increase (decrease) in cash (2,700,139) (3,833,995) 7,602,193
Cash and cash equivalents at beginning
of year 4,511,919 8,345,914 743,721
------------- ------------ -------------
Cash and cash equivalents at end of year $1,811,780 $4,511,919 $8,345,914
------------- ------------ -------------
------------- ------------ -------------
The accompanying notes are an integral part of these consolidated financial
statements
FX ENERGY, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
for the years ended December 31, 1998, 1997 and 1996
Preferred Stock Common Stock
--------------- --------------- Officers'
Notes
Par Par Paid-in Receiv- Accumulated
Shares Value Shares Value Capital able Deficit
---------- ------ ---------- -------- ------------- ------------ ---------------
Balance at January 1, 1996 137,500 $138 7,898,995 $7,899 $9,466,127 $ -- (4,249,735)
Common stock issuedfor cash, net of
offering costs of $2,028,547 -- -- 3,978,504 3,978 19,612,154 -- --
Exercise of warrants and options -- -- 419,004 419 826,461 -- --
Conversion of preferred stock
into common stock (137,500) (138) 137,500 138 -- -- --
Common stock issued for services -- -- 57,451 57 147,693 -- --
Common stock issued for oil and gas
properties -- -- 1,093 1 2,185 -- --
Net loss -- -- -- -- -- -- (4,909,696)
---------- ------ ---------- -------- ------------- ------------ ---------------
Balance at December 31, 1996 -- -- 12,492,547 12,492 30,054,620 -- (9,159,431)
Exercise of warrants and options -- -- 159,334 160 252,617 -- --
Common stock issued for services -- -- 10,000 10 70,615 -- --
Net loss -- -- -- -- -- -- (3,619,539)
---------- ------ ---------- -------- ------------- ------------ ---------------
Balance at December 31, 1997 -- -- 12,661,881 12,662 30,377,852 -- (12,778,970)
Exercise of warrants and options -- -- 382,622 383 615,644 -- --
Common stock issued for services -- -- 10,000 10 119,365 -- --
Officers' notes receivable -- -- -- -- -- (1,304,527) --
Net loss -- -- -- -- -- -- (10,122,343)
---------- ------ ---------- -------- ------------- ------------ ---------------
Balance at December 31, 1998 -- $ -- 13,054,503 $13,055 $ 31,112,861 $(1,304,527) $(22,901,313)
---------- ------ ---------- -------- ------------- ------------ ---------------
---------- ------ ---------- -------- ------------- ------------ ---------------
The accompanying notes are an integral part of these consolidated financial
statements
FX ENERGY, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies:
Organization
FX Energy, Inc., a Nevada corporation and its subsidiaries (collectively
hereinafter referred to as the "Company") operate in the oil, gas and
mining industries in Poland and the oil and gas industry in the United
States. In Poland, the Company explores for oil, gas and gold and is
engaged in oil and gas development and acquisition activities. In the
United States, the Company is engaged in producing, exploring and
developing oil and gas properties and operates a drilling and well
servicing company.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries and the Company's undivided interests in
Poland. All significant inter-company accounts and transactions have been
eliminated in consolidation. At December 31, 1998, the Company owned 100%
of the voting common stock or other equity securities of its subsidiaries.
Inventory
Inventory consists primarily of tubular supplies and other well equipment
and is valued at the lower of average cost or market.
Oil and Gas Properties
The Company follows the successful efforts method of accounting for its
oil and gas operations. Under this method of accounting, all property
acquisition costs and costs of exploratory and development wells are
capitalized when incurred, pending determination of whether an individual
well has found proved reserves. If it is determined that an exploratory
well has not found proved reserves, the costs of drilling the well are
expensed. The costs of development wells are capitalized whether productive
or nonproductive.
Geological and geophysical costs on exploratory prospects and the costs of
carrying and retaining unproved properties are expensed as incurred. An
impairment allowance is provided to the extent that capitalized costs of
unproved properties, on a property-by-property basis, are considered to be
not realizable. Depletion, depreciation and amortization ("DD&A") of
capitalized costs of proved oil and gas properties is provided on a
property-by-property basis using the unit-of-production method. The
computation of DD&A takes into consideration restoration, dismantlement and
abandonment costs and the anticipated proceeds from equipment salvage. The
estimated restoration, dismantlement and abandonment costs are expected to
be offset by the estimated residual value of lease and well equipment.
An impairment loss is recorded if the net capitalized costs of proved oil
and gas properties exceed the aggregate undiscounted future net revenues
determined on a property-by-property basis. The impairment loss recognized
equals the excess of net capitalized costs over the related fair value
determined on a property by property basis. (see Note 14)
Gains and losses are recognized on sales of entire interests in proved and
unproved properties. Sales of partial interests are generally treated as a
recovery of costs.
Other Property and Equipment
Other property and equipment, including drilling and well servicing
equipment, are stated at cost. Depreciation of other property and
equipment is calculated using the straight-line method over the estimated
useful lives (ranging from 3 to 40 years) of the respective assets. The
cost of normal maintenance and repairs is charged to operating costs and
expensed as incurred. Material expenditures that increase the life of an
asset are capitalized and depreciated over the estimated remaining useful
life of the asset. The cost of other property and equipment sold, or
otherwise disposed of and the related accumulated depreciation are removed
from the accounts and any gain or loss is reflected in current operations.
Other property and equipment (gross) is summarized as follows:
Estimated
December 31, Useful Life
--------------------
1998 1997 (in years)
--------- --------- ------------
Other property and equipment: (In thousands)
equipment:
Drilling and well servicing equipment $ 1,771 $ 1,628 6
equipment
Trucks 188 175 5
Building 80 80 40
Office equipment 456 371 3 to 6
-------- --------
Total $ 2,495 $ 2,254
-------- --------
-------- --------
Concentration of Credit Risk
The majority of the Company's receivables are within the oil and gas or
mining industries, primarily from the purchasers of its oil (see Note 12)
and its industry partners. The receivables are not collateralized. To
date, the Company has experienced minimal bad debts. The majority of the
Company's cash and cash equivalents is held by three financial institutions
in Utah, Montana and New York.
Cash Equivalents and Statement of Cash Flows
The Company considers all highly-liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Non-cash
transactions not reflected in the consolidated statements of cash flows
include the following:
Years Ended December 31,
----------------------------
1998 1997 1996
-------- -------- ---------
Non-cash transactions: (In thousands)
Bonus applied to stock option exercise by
officers $ 200 $ -- $ --
officers
Notes receivable from officers due to
stock option exercise 250 -- --
Conversion of the Company's preferred
stock into common stock -- -- 138
Additions to oil and gas properties
financed with trade accounts payable -- -- 23
Additions to other property and equipment
financed with long-term leases -- -- 18
Additions to oil and gas properties from
the issuance of common stock -- -- 2
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Interest $ -- $ 534 $ 239
Taxes -- -- --
Income Taxes
Deferred income taxes are provided for the difference between the tax basis
of an asset or liability and its reported amount in the financial
statements. Such difference will result in taxable or deductible amounts
in future years when the reported amount of the asset or liability is
recovered or settled, respectively.
Reclassifications
Certain balances in the 1997 and 1996 financial statements have been
reclassified to conform to the current year presentation. These changes
had no effect on total assets, total liabilities, stockholders' equity or
net loss.
Foreign Operations
The Company's investments and operations in Poland are comprised of U.S.
Dollar expenditures.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Net Loss Per Share
Basic earnings per share is computed by dividing the net loss by the
weighted average number of common shares outstanding. Diluted earnings per
share is computed by dividing the net loss by the sum of the weighted
average number of common shares and the effect of dilutive unexercised
stock options and warrants and convertible preferred stock. Options and
warrants to purchase 3,684,239 shares of common stock at prices ranging
from $1.65 to $10.25 per share were outstanding at December 31, 1998.
Options and warrants to purchase 3,707,694 and 3,164,028 shares of common
stock at prices ranging from $1.10 to $10.25 per share were outstanding at
December 31, 1997 and 1996, respectively. No options or warrants were
included in the computation of diluted earnings per share for the years
ended December 31, 1998, 1997 or 1996 because the effect would have been
antidilutive.
2. Investment in Poland:
Poland Oil and Gas Exploration Agreements - General
The Company has five oil and gas exploration project areas in Poland:
Lublin, Carpathian, Pomeranian Warsaw West and the Baltic. All five
project areas contain acreage under which the Company and/or Apache
Corporation ("Apache") have entered into exploration agreements
("usufructs") with the government of Poland (the "Concession" acreage) with
a six year exploration term coupled with 30 year exploitation rights for
any commercial hydrocarbon discoveries. The Lublin, Carpathian and
Pomeranian project areas also contain acreage controlled by the Polish Oil
and Gas Company ("POGC"), for which the Company and Apache have the right
to participate with POGC in exploring for hydrocarbons (the "Option"
acreage). The Option acreage includes existing POGC Concessions and areas
the Polish government has reserved exclusively for POGC.
The Company has entered into various agreements regarding its exploration
and development activities in Poland. A brief summary of several of the
agreements follows:
FX Energy and Apache AMI
On January 29, 1999, the Company and Apache created an Area of Mutual
Interest ("AMI") covering the entire country of Poland, except for the
Company's Baltic Project Area. The AMI is effective January 1, 1999 for a
period of two years. Under terms of the AMI, the Company and Apache must
offer each other an equal fifty-percent interest in any new exploration,
production, acquisition or other project activities conducted within
Poland. (see Note 16)
As a result of various agreements signed with Apache during 1997, 1998 and
through February 26, 1999, Apache agreed to earn a fifty-percent interest
in the Lublin and Carpathian project areas by paying the Company $950,000
in cash and committing to pay the Company's pro-rata share of costs for:
(1) drilling and completing seven exploratory wells in the Lublin Project
Area and drilling (excluding completion costs) three wells in the
Carpathian Project Area; (2) acquiring a minimum of 1,650 kilometers of 2D
seismic in the Lublin Project Area and acquiring a minimum of 350
kilometers of 2D seismic in the Carpathian Project Area; (3) all
Concession, usufruct and training fees during the first three years of the
six year exploration period in the Lublin and Carpathian project areas;
and, (4) all of Apache's Polish general and administrative costs through
1999 in all project areas. In the Pomeranian and Warsaw West project areas,
the Company and Apache are equal fifty-percent partners. Apache does not
own an interest in Baltic Project Area. Apache is the operator of all
jointly owned project areas. (see Note 16)
On February 16, 1999, the Company announced the Czernic 277-2 and the
Poniatowa 317-1, the first two of seven exploratory wells to be drilled on
the Company's Lublin Project Area under the Apache Exploration Program,
were determined to be exploratory dry holes. Apache covered all of the
Company's pro-rata working interest share of costs for both wells,
including 33.33% for the Czernic 277-2 and 47.5% for the Poniatowa 317-1.
(see Note 16)
Option Agreements between the Company, Apache and POGC
As a result of various agreements between the Company, Apache and POGC
signed during 1997, 1998 and through February 26, 1999, the Company and
Apache's working interest in the Lublin, Carpathian and Pomeranian project
areas is subject to being reduced by POGC's option to participate for up to
a one-third working interest on a block by block basis in each respective
project area. In turn, the Company and Apache each have an independent
reciprocal right to participate in the exploration of the POGC controlled
areas in each of the respective project areas with up to a one-third
working interest each. Should POGC elect to participate in any of the
Company's Concessions, the Company's and Apache's interest will be reduced
in equal proportions. The Company does not have any option agreements with
POGC covering the Warsaw West or Baltic project areas. (see Note 16)
Lachowice Field Development with Apache and POGC
On February 26, 1999 the Company and Apache entered into an agreement with
POGC whereby the Company and Apache will each earn a one-third interest in
POGC's Lachowice Field, which is located within the Company's Carpathian
Project Area. Under terms of the agreement, the Company and Apache will
pay all of the following costs in order to earn a one-third interest each
in the project: (1) recomplete up to three shut-in gas wells; (2) drill
three additional wells; and, (3) construct gathering and processing
facilities. All costs and net revenues thereafter, including additional
development drilling and lease operating costs, will be shared one-third
each by the Company, Apache and POGC. Apache will be the operator of the
Lachowice Field. (see Note 16)
Baltic Project Area
On May 3, 1996, the Company entered into a agreement with RWE-DEA
Aktiengesellschaft fur Mineraloel und Chemie, Hamburg, Germany ("RWE-DEA")
to jointly explore the Baltic Project Area. Under terms of the Agreement,
RWE-DEA had the right to earn a fifty-percent interest in the Baltic
Project Area by paying the Company $250,000 in cash, paying the first
$1,100,000 for a 2D seismic survey, the first $1,000,000 of cost relating
to the initial exploratory well to be drilled at a location to be
designated by RWE-DEA and fifty-percent of the cost relating to the second
exploratory well at a location designated by the Company. Polish
government approval was required to approve RWE-DEA's participation in the
Baltic Project Area by purchasing fifty-percent of Warmia Petroleum
Company, Sp z o.o. ("Warmia"), a wholly owned subsidiary of the Company
which holds the Baltic Project Area. The Company obtained a $2.5 million
Irrevocable Standby Letter of Credit whereby the Company agreed to refund
RWE-DEA all advanced funds should the Polish government disapprove RWE-
DEA's purchase of fifty-percent of Warmia. The Irrevocable Standby Letter
of Credit expired on January 31, 1997 and the Polish government approved
RWE-DEA's purchase of fifty-percent of Warmia in June 1997. RWE-DEA had
advanced Warmia $3,076,000 through June 30, 1997 to fund exploration
activity on the Baltic Project Area which the Company had recorded as a
long-term note payable.
Prior to drilling the second well on the Baltic Project Area, RWE-DEA had
advanced the Company all funds required to date under the Agreement,
including funding the first $1,000,000 of costs relating to the Orneta #1,
the initial exploratory well drilled on the Baltic Project Area which was
plugged and abandoned as a dry hole in April 1997 at a gross cost of
$1,834,000. On June 30, 1997, RWE-DEA elected to not fund its fifty-
percent share of the Gladysze #1-A, the second exploratory well drilled on
the Baltic Project Area, which resulted in the termination of RWE-DEA's
right to earn a fifty-percent interest in the Baltic Project Area.
The Gladysze #1-A was drilled without RWE-DEA as a participant and was
subsequently plugged and abandoned as a dry hole in September 1997 at a
gross cost of $1,262,000. Upon termination of RWE-DEA's right to earn a
fifty-percent interest in the Baltic Project Area, the Company eliminated
its long-term notes payable relating to RWE-DEA and recognized an
extraordinary gain of $3,076,000.
At December 31, 1998, the Company had approximately $461,000 of capitalized
leasehold costs related to the Baltic Project Area. The Company is
currently seeking a strategic partner to participate in further exploration
of the Baltic Project Area.
Gold Exploration - Sudety Project Area
On December 30, 1997, Homestake Mining Company ("Homestake") and the
Company signed an agreement to jointly explore for gold on the Company's
gold Concessions in Poland. Under terms of the agreement, Homestake has
the right to earn at least a seventy-five percent interest in the Sudety
Project Area by paying the Company $212,000 in cash and funding all future
exploration costs. Homestake also agreed to spend at least $500,000 per
year with a minimum commitment of $1,100,000 during the initial two year
period. In the event Homestake elects to construct one or more mines, the
Company may elect to retain a six percent net smelter return royalty, or a
7.5 percent net proceeds interest, both at no cost to the Company, or to
retain a twenty-five percent interest by reimbursing Homestake certain
costs according to a predetermined formula. The Company may make such
elections on a mine by mine basis.
Homestake has fulfilled its minimum work and spending requirements under
its agreement with the Company for 1998.
3. Performance Bond Deposits:
As of December 31, 1998, the Company had a replacement bond to a federal
agency in the amount of $463,000 which was collateralized by a certificate
of deposit in the amount of $231,500 and $125,000 in certificates of
deposit covering performance bonds in various states. During 1997, the
state of Wyoming relinquished a $25,000 bond which terminated the Company's
bonding requirement in the state.
4. Investment in Marketable Debt Securities:
The Company follows the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." In accordance with SFAS No.
115, the Company has classified all of its marketable debt securities as
held-to-maturity because the Company has both the intent and ability to
hold these investments until they mature. At December 31, 1998, the
Company's held-to-maturity securities consisted of corporate bonds with
remaining contractual maturities of less than twelve months and the
carrying amount of these investments approximated market value.
5. Accrued Liabilities:
The Company's accrued liabilities as of December 31, 1998 and 1997 are
composed of the following:
As of December 31,
-------------------
1998 1997
-------- -------
(In thousands)
Compensation costs 699 200
Seismic costs 131 --
Other costs 82 89
-------- -------
Total 912 289
-------- -------
-------- -------
6. Long-term Debt:
In August 1996, the Company repaid the outstanding debt incurred in the
1994 purchase of assets by two of the Company's wholly owned subsidiaries,
FX Producing and FX Drilling. In May 1997, the Company amended its bank
credit facility whereby a borrowing base of $3,000,000 was established,
subject to being reduced by $25,000 per month effective June 1, 1997. The
Company did not utilize the credit facility and subsequently terminated the
credit facility during the year ended December 31, 1998.
7. Income Taxes:
The Company recognized no income tax benefit from the losses generated
during the years ended December 31, 1998, 1997 and 1996.
The components of the net deferred tax asset as of December 31, 1998 and
1997 are as follows:
December 31,
------------------
1998 1997
-------- --------
(In thousands)
Deferred tax liability:
Property and equipment basis differences $ (962) $ (940)
Deferred tax asset:
Net operating loss carryforwards 9,437 6,993
Impairment of oil and gas properties 2,196 --
Other 14 78
Valuation allowance (10,685) (6,131)
-------- --------
Net deferred tax asset $ -- $ --
-------- --------
-------- --------
The change in the valuation allowance during the years ended December 31,
1998, 1997 and 1996 is as follows:
December 31,
-----------------------------
1998 1997 1996
--------- -------- --------
(In thousands)
Balance, beginning of year $ (6,131) $ (3,868) $ (1,526)
Increase due to property and
equipment basis differences 22 24 397
Increase due to impairment of oil
and gas properties (2,196) -- --
Decrease (increase) due to
investment in Warmia -- 661 (661)
Increase due to net operating loss (2,444) (2,876) (2,072)
Other 64 (72) (6)
--------- -------- --------
Balance, end of year $(10,685) $ (6,131) $ (3,868)
--------- -------- --------
--------- -------- --------
SFAS No. 109 requires that a valuation allowance be provided if it is more
likely than not that some portion or all of a deferred tax asset will not
be realized. The Company's ability to realize the benefit of its deferred
tax asset will depend on the generation of future taxable income through
profitable operations and expansion of the Company's oil and gas producing
activities. The risks associated with that growth requirement are
considerable, resulting in the Company's conclusion that a full valuation
allowance be provided.
At December 31, 1998, the Company had net operating loss ("NOL")
carryforwards of approximately $25,301,000 available to offset future
taxable income, of which approximately $18,749,000 expires from 2008
through 2012 and $6,552,000 expires in 2018. The utilization of these
carryforwards against future taxable income may become subject to an
annual limitation if there is a change in ownership. $6,164,000 of the NOL
carryforward relates to tax deductions resulting from the exercise of stock
options during 1998, 1997 and 1996. The tax benefit from adjusting the
valuation allowance related to this portion of the NOL carryforward will be
credited to additional paid-in capital.
8. Related Party Transactions:
As of December 31, 1997, the Company had outstanding advances to an officer
of the Company totaling $150,000. This amount was reflected in joint
interest and other receivables at December 31, 1997.
During February 1998, the Company advanced an additional $50,000 to the
officer, bringing the total of such advances to $200,000. The advances
were originally evidenced by a note payable to the Company with interest at
7.7% payable on or before December 31, 1998.
On February 17, 1998, two of the Company's officers exercised options that
were to expire on May 6, 1998, to purchase 150,000 shares each of the
Company's common stock at a price of $1.50 per share. The officers paid for
the cost of their option exercise by utilizing a $100,000 bonus awarded to
each of the officers in 1997 and signing a full recourse note payable to
the Company for $125,000 each originally due, with interest at 7.7%, by
December 31, 1998. The closing price of the Company's common stock was
$7.375 per share on February 17, 1998. The foregoing option exercises
resulted in taxable income at ordinary rates to each executive of $881,250,
the amount by which the market price of the stock as of the date of
exercise exceeded the exercise price for the 150,000 shares purchased,
notwithstanding the fact that the transaction generated no cash with which
the executives could pay such taxes. In order to assist such
executives in meeting their income tax and other obligations so that they
would not be required to raise funds through the premature sale of the
Company's common stock in the trading market before the opportunity for the
Company to realize results from currently planned exploratory drilling, the
disinterested directors unanimously approved interim loans to such
individuals to assist them in meeting their short-term obligations.
On April 10, 1998, in consideration of the agreement of the two officers
not to sell the Company's common stock in market transactions, the Company
agreed to $1,270,000 in additional advances to such officers through April
15, 1999. The total advance commitment to such officers by the Company
under the new agreement, including prior loan amounts, is $1,720,000. All
amounts due from such officers, including amounts for the exercise of
options and prior advances discussed above, are now repayable, with
interest at 7.7% from the date of the separate advances, in cash or by the
delivery of the Company's common stock, by December 31, 1999. The loans
are evidenced by limited recourse promissory notes. The repayment of
$125,000 under each loan, the amount of the balance of the exercise price
of the options, is a full recourse obligation under the note. To the
extent of all amounts in excess of $125,000 in principal and interest, the
notes are non-recourse and are collateralized by shares of the Company's
common stock valued at $7.375 per share, which equals the amount of the
loans. Both of the officers agreed to not sell any of the Company's common
stock until the announcement of the results of either the first two
exploratory wells in Poland or the first commercially successful well in
Poland, whichever occurs later, or December 31, 1998. Thereafter, the
Company may demand payment of the obligations on 45 days' written notice,
in which case the officers may elect to repay the obligation by paying cash
or tendering the shares of the Company's common stock pledged as security
or other shares with a current market value equal to the amount due.
The loans may be prepaid by the executives at any time and any payments
shall be first applied against the full recourse obligations of the loan.
As of December 31, 1998, notes receivable from officers, including
interest, was $1,304,527, which is classified as a component of
stockholders' equity in the Consolidated Balance Sheets.
9. Common Stock Issuable, Stock Options and Warrants:
Common Stock Issuable
In connection with the purchase of the Company's producing oil properties
and well servicing equipment in 1994, the Company agreed to issue to the
sellers up to 400,000 shares of Company common stock in semi-annual
increments of 50,000 shares each beginning October 1, 1994 on the
attainment of certain levels of oil production from the properties
acquired. Production levels from October 1, 1994 through April 1, 1998
were not attained. No additional shares were issued and the Company has no
further obligations under the agreement.
Stock Options
On August 31, 1995, the Company adopted the 1995 Stock Option and Award
Plan (the "95 Plan"). The 95 Plan replaced the 1994 Employee Incentive
Plan under which no options were issued. The 95 Plan was approved by the
stockholders of the Company at the 1996 annual meeting. A maximum of
500,000 shares, subject to adjustment for certain events of dilution, is
available for grant under the 95 Plan. As of December 31, 1998, 497,500
shares had been granted under the 95 Plan.
On November 5, 1996, the board of directors approved adoption of the 1996
Stock Option and Award Plan (the "96 Plan"), which was approved by the
Company's stockholders at the 1997 annual meeting. A maximum of 500,000
shares, subject to adjustment for certain events of dilution, is available
for grant under the 96 Plan. As of December 31, 1998, 402,167 shares had
been granted under the 96 Plan.
On December 1, 1997, the board of directors approved adoption of the 1997
Stock Option and Award Plan (the "97 Plan"), which was approved by the
Company's stockholders at the 1998 annual meeting. A maximum of 500,000
shares, subject to adjustment for certain events of dilution, is available
for grant under the 97 Plan. As of December 31, 1998, 486,000 shares had
been granted under the 97 Plan.
On December 1, 1998, the board of directors approved adoption of the 1998
Stock Option and Award Plan (the "98 Plan"), which will be submitted to the
Company's stockholders for approval at the 1999 annual meeting. A maximum
of 500,000 shares, subject to adjustment for certain events of dilution, is
available for grant under the 98 Plan. On adopting the 98 Plan, the board
of directors approved the grant of options to purchase an aggregate of
158,000 shares.
The 95 Plan, 96 Plan, 97 Plan and 98 Plan (the "Plans") are each
administered by a committee (the "Committee") consisting of the board of
directors or a committee thereof. At its discretion, the Committee may
grant stock options to any employee, including officers, in the form of
incentive stock options ("ISOs"), as defined in the Internal Revenue Code,
or options which do not qualify as ISOs or stock awards. In addition to
the options granted under the Plans, the Company also issues non-qualified
options outside the Plans. Options granted under these Plans have terms
ranging from five to seven years and vest over periods ranging from the
date of grant to three years.
As of December 31, 1998, the Company had options outstanding under the
Plans as well as from other individual grants. The Company applies APB
Opinion No. 25 and related interpretations in accounting for options
granted under the Plans and for other option agreements. Had compensation
cost for the Company's options been determined based on the fair value at
the grant dates consistent with SFAS No. 123, the Company's net loss and
loss per share would have been increased to the pro forma amounts indicated
below:
Years Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
(In thousands, except per share amounts)
Net Loss:
As Reported $ (10,122) $ (3,620) $ (4,910)
Pro Forma (11,680) (5,991) (7,614)
Basic and Diluted Net Loss
Per Share:
As Reported $ (0.78) $ (0.29) $ (0.49)
Pro Forma (0.90) (0.48) (0.76)
The effects of applying SFAS No. 123 are not necessarily representative of
the effects on the reported net income or loss for future years.
The fair value of each option granted during 1998, 1997 and 1996 is
estimated on the date of grant using the Black-Scholes option pricing
model. The following weighted-average assumptions were utilized for the
Black-Scholes valuation: (1) expected volatility of 76.2%, 80.4% and
108.3% for 1998, 1997 and 1996, respectively; (2) expected lives ranging
from four to seven years; (3) risk-free interest rates at the date of grant
ranging from 4.44% to 6.43%; and, (4) dividend yield of zero for each year.
The following table summarizes fixed option activity for the years ended
December 31, 1998, 1997 and 1996:
December 31,
-------------------------------------------------------------
1998 1997 1996
------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Avgerage
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
Fixed Options:
Outstanding at
beginning of year 3,357,500 $4.473 2,732,834 $3.710 2,595,000 $2.541
Granted 480,000 8.875 725,500 7.203 508,834 8.467
Exercised (303,000) 1.500 (78,334) 1.698 (369,000) 2.008
Canceled (120,833) 8.400 (22,500) 9.486 (2,000) 1.500
---------- -------- ---------- -------- ---------- --------
Outstanding at end
of year 3,413,667 $6.590 3,357,500 $4.473 2,732,834 $3.710
---------- -------- ---------- -------- ---------- --------
---------- -------- ---------- -------- ---------- --------
Options exercisable
at year-end 2,329,012 $6.970 2,242,000 $3.878 1,799,084 $3.315
---------- -------- ---------- -------- ---------- --------
---------- -------- ---------- -------- ---------- --------
Weighted-average
fair value of
options granted
during the year $3.930 $4.458 $7.451
The following table summarizes information about fixed stock options
outstanding at December 31, 1998:
Options Outstanding Options Exercisable
----------------------------------- ----------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Number Average
Exercise Outstanding Life Exercise Exercisable Exercise
Prices at 12/31/98 (in years) Price at 12/31/98 Price
- -------------- ----------- ------------ --------- ------------ --------
$ 1.500 178,000 1.668 $ 1.500 178,000 $ 1.500
3.000 1,700,000 3.531 3.000 1,500,000 3.000
5.750 - 7.250 537,000 5.869 6.665 183,011 6.653
8.250 - 8.875 992,667 6.092 8.690 466,001 8.839
10.250 6,000 6.129 10.250 2,000 10.250
----------- -------------
Total 3,413,667 5.787 $ 5.180 2,329,012 $ 6.970
----------- -------------
----------- -------------
Warrants
The following table summarizes changes in outstanding warrants during the
years ended December 31, 1998, 1997 and 1996:
Shares Price Range
------------------- -------------
Warrants:
Outstanding at January 1, 1996 331,198 $1.10 - 3.00
Exercisable at January 1, 1996 331,198 1.10 - 3.00
---------
---------
Warrants granted as commission to
brokers; expiring August 6, 2001 150,000 6.90
Warrants exercised during 1996 (50,004) 1.10 - 3.00
----------
Outstanding at December 31, 1996 431,194 1.10 - 6.90
Exercisable at December 31, 1996 281,194 1.10 - 3.00
---------
---------
Warrants exercised during 1997 (81,000) 1.10 - 2.60
----------
Outstanding at December 31, 1997 350,194 1.10 - 6.90
Exercisable at December 31, 1997 350,194 1.10 - 6.90
---------
---------
Warrants exercised during 1998 (79,622) 1.10 - 2.60
----------
Outstanding at December 31, 1998 270,572 1.65 - 6.90
----------
----------
---------
Exercisable at December 31, 1998 270,572 $1.65 - 6.90
---------
---------
10. Issuance of Preferred Stock:
The Company is authorized to issue up to 5,000,000 shares of preferred
stock.
In 1993 and 1994, the Company issued a total of 1,500,000 shares of
preferred stock in a private placement at $1.00 per share. Each share of
preferred stock was convertible into one share of common stock and had a
liquidation preference equal to $1.00 per share. During the year ended
December 31, 1995, 1,362,500 preferred shares were converted into the same
number of common shares resulting in 137,500 preferred shares of stock
outstanding at December 31, 1995. During the year ended December 31, 1996,
the 137,500 preferred shares were converted into the same number of common
shares resulting in no preferred shares of stock outstanding at December
31, 1996, 1997 or 1998.
11. Commitments:
Employment Agreements
Effective January 1, 1995, the Company entered into three-year employment
agreements with David N. Pierce and Andrew W. Pierce, each of whom is an
officer and director. The agreements provide for initial annual
compensation of $120,000 and $96,000, respectively, with annual
increases of at least 7.5%, as determined by the board of directors or the
compensation committee. Each employment agreement, as amended, provides
that on the initiation of the first test well in the Baltic Project Area,
which commenced in late January 1997, the executive employee was entitled
to receive a $100,000 bonus that may, at the election of the officer, be
applied against the exercise of options to purchase common stock or paid in
cash upon termination of employment with the Company. The Company accrued
$200,000 at December 31, 1997 to reflect this obligation. On February 17,
1998, each officer exercised options to purchase common stock and applied
their respective bonuses awarded to him in 1997 towards the exercise price
(see Note 8). The terms of such employment agreements are automatically
extended for an additional year on the anniversary date of each such
agreement. In the event of termination of employment resulting from a
change in control of the Company not approved by the Board of Directors,
each of the two officers would be entitled to a termination payment equal
to 150% of his annual salary at the time of termination and the value of
previously granted employee benefits, including stock options and stock
awards.
On July 1, 1996, the Company entered into a three-year employment agreement
with Jerzy B. Maciolek, who is an officer of the Company, providing for an
initial annual salary of $96,000 with an annual increase to be determined
by the Company's board of directors or the compensation committee. The
employment agreement also provides for annual incentive bonuses of up to
$100,000, payable in cash, stock or options and a $100,000 bonus to be
issued annually on May 12, 1998, 1999 and 2000 to be applied against
future stock option exercises. In the event such bonuses are earned, but
not used by Mr. Maciolek and his employment with the Company is terminated,
the Company must pay the bonus to Mr. Maciolek in cash. In the event the
employment contract is terminated by the Company, other than for cause,
or by Mr. Maciolek for cause or because of a change in control of the
Company, Mr. Maciolek is entitled to a termination payment equal to any
accrued but unpaid salary and unreimbursed expenses and benefits plus his
salary for the remaining term of the employment agreement. Additionally,
all options held by Mr. Maciolek shall immediately vest and not be
forfeited. The agreement will automatically be extended for an additional
one year upon each anniversary date of the effective date unless otherwise
terminated pursuant to the terms thereof.
Consulting Agreement
The Company entered into a consulting agreement, effective August 3, 1995,
with a director's consulting company under which it advises the Company
respecting future financing alternatives, identifying possible sources of
debt and equity financing, with particular emphasis on funding for the
Company's Polish activities and the Company's relationship with the
investment community at a fee of $10,000 per month commencing October 15,
1995 and continuing through December 31, 1997. The agreement was extended
through December 31, 1998 at a rate of $15,000 per month for January and
February 1998 and a subsequent rate of $17,000 per month thereafter. The
agreement expired on December 31, 1998 and was extended for one year at the
same rate of $17,000 per month with payments due in 1999 under the contract
deferred until such time as the Company secures additional funding.
Polish Exploration Agreements
The Company is committed to the following obligations, presented on a gross
basis, in Poland to retain its exploratory Concession acreage:
Exploratory Wells
---------------------
First
Beginning Three Second
of Year Year 2D Concession
Explora- Explora- Explora- Seismic Annual and
Project tion Whole tion tion Acquisi- Training Aggregate
Area Period Blocks Phase Phase tion Fees (5) Fees (6)
---------------- ---------- ------ -------- ------------ -------- --------- -----------
Lublin (1) (2) Various(7) 24 6 1 per block 1,650 km $ 80,000 $ 675,000
Carpathian (2) 12/31/98 12 1 2 350 km 15,000 160,000
Pomeranian (3) 12/31/98 10 1 2 600 km 25,000 250,000
Warsaw West (3) 11/13/98 13 1 2 1,500 km 25,000 390,000
Baltic (4) 03/07/96 10 1 1 None 25,000 200,000
(1)The Company must drill an exploratory well in each undrilled block during
the second three year phase or relinquish the undrilled block at the end of
the exploration term. The Lublin Project Area includes the Block 298
usufruct, which includes only one exploration block, which has a requirement
to drill two exploratory wells during the second three year phase. All other
Lublin Project Area usufructs require the drilling of one well per block
during the second three year phase.
(2)Apache has agreed to cover all of the Company's drilling, seismic, annual
training fees, Concession, and usufruct fees during the first three year
phase to earn a fifty percent interest in the Lublin and Carpathian project
areas.
(3)The Company and Apache are equal partners in the Pomeranian and Warsaw West
project areas.
(4)The Company has a 100%interest in the Baltic Project Area.
(5)Annual training costs are for each year during the entire six year
exploration term.
(6)Concession and usufruct fees are payable on various terms over the first
three year exploration term, except the Baltic Project Area, which is
payable in equal installments of $33,333 per year over six years.
(7)The Lublin Project Area consists of four usufructs, the Vistula, Lublin
Middle, Block 298, and Komarow which have exploration periods beginning
August 8, 1997, June 30, 1998, June 30, 1998 and March 4, 1998,
respectively.
12. Business Segments:
During 1998, the Company adopted Statement of Financial Accounting
Standards ("FAS") 131, Disclosure about Segments of an Enterprise and
Related Information. FAS 131 supersedes FAS 14, Financial Reporting for
Segments of a Business Enterprise. The adoption of FAS 131 did not affect
results of the Company's results of operations or financial position, but
did affect the disclosure of segment information. The Company operates
within two segments of the oil and gas industry: exploration and production
("E&P") and drilling and well servicing ("Drilling") and within the
exploration segment of the mining industry. For segment and management
reporting purposes the Company's mining segment is not material and is
excluded from the discussion herein.
The Company's revenues associated with its E&P activities are comprised of
oil sales from its producing properties in Montana and Nevada and gains on
the sale of partial property interests of the Company's exploratory
properties in Poland. For the years ended December 31, 1998, 1997 and
1996, over 85% of the Company's total oil sales were to one purchaser
located in Montana. The Company believes this purchaser could be replaced,
if necessary, without a loss in revenue. E&P operating costs are comprised
of: (1) exploration costs, including geological and geophysical costs,
exploratory dry holes and non-producing leasehold impairments; and, (2)
production costs which include lease operating expenses and production
taxes. Substantially all exploration costs applied to the Company's
operations in Poland and all lease operating costs applied to the Company's
domestic production. The Company's revenues associated with its drilling
activities are comprised of contract drilling and well servicing fees
generated by the Company's drilling rig and other well servicing equipment
in Montana. Drilling operating costs are comprised of direct costs
associated with its drilling and well servicing operations. DD&A directly
associated with a respective segment is disclosed within that segment. The
Company does not allocate current assets, general and administrative
expenses, income taxes, interest expense, interest income or other income
to its operating segments for management and segment reporting purposes.
All material inter-company transactions between the Company's business
segments are eliminated for management and segment reporting purposes.
Information on the Company's operations by business segment area for the
years ended December 31, 1998, 1997 and 1996 is summarized as follows:
Year Ended December 31, 1998
--------------------------------
E&P Drilling Total
--------- ---------- --------
Operations Summary: (In thousands)
Revenues (1) $ 1,590 $ 323 $ 1,913
Cash operating costs (2) 3,025 240 3,265
Non-cash operating costs (3) 119 -- 119
--------- ---------- --------
Operating income or (loss) before (1,554) 83 (1,471)
DD&A
Depreciation, depletion, & 231 322 553
amortization
--------- ---------- --------
Operating loss $ (1,785) $ (239) $ (2,024)
--------- ---------- --------
--------- ---------- --------
Identifiable net property and
equipment:
Non-producing leaseholds - Poland $ 461 $ -- $ 461
Non-producing leaseholds - United
States 717 -- 717
Producing properties 463 -- 463
Equipment and other -- 780 780
--------- ---------- --------
Total 1,641 $ 780 $ 2,421
--------- ---------- --------
--------- ---------- --------
Property and equipment capital
expenditures: $ 180 $ 156 $ 336
(1) E&P revenues include $1,123,000 generated in the United States and
$467,000 generated in Poland.
(2) Excludes $29,000 of exploratory costs relating to the Company's gold
Concessions.
(3) Includes Company common stock issued for services of $119,000 and
excludes non-cash impairment charge of $5,885,000 for domestic proved
properties.
Year Ended December 31, 1997
--------------------------------
E&P Drilling Total
--------- ---------- --------
Operations Summary: (In thousands)
Revenues (1) $ 2,242 $ 496 $ 2,738
Cash operating costs 6,455 329 6,784
Non-cash operating costs (2) 99 -- 99
--------- ---------- --------
Operating income or (loss) before (4,312) 167 (4,145)
DD&A
Depreciation, depletion, & 261 289 550
amortization
--------- ---------- --------
Operating loss $ (4,573) $ (122) $ (4,695)
--------- ---------- --------
--------- ---------- --------
Identifiable net property and
equipment:
Non-producing leaseholds - Poland $ 461 $ -- $ 461
Non-producing leaseholds - United 709 -- 709
States
Producing properties 6,447 -- 6,447
Equipment and other -- 935 935
--------- ---------- --------
Total net assets $ 7,617 $ 935 $ 8,552
--------- ---------- --------
--------- ---------- --------
Property and equipment capital $ 860 $ 210 $ 1,070
expenditures:
(1) E&P revenues include $2,040,000 generated in the United States and
$202,000 generated in Poland. Excludes $71,000 gain from sale of
property interest relating to the Company's gold Concessions in Poland.
(2) Includes Company common stock issued for services of $70,000 and a
non-cash impairment charge of $29,000 for a lease in Wyoming acquired
prior to 1997.
Year Ended December 31, 1996
--------------------------------
E&P Drilling Total
--------- ---------- --------
Operations Summary: (In thousands)
Revenues (1) $ 2,346 $ 75 $ 2,421
Cash operating costs 3,651 154 3,805
Non-cash operating costs (2) 1,290 -- 1,290
--------- ---------- --------
Operating loss before DD&A (2,595) (79) (2,674)
Depreciation, depletion, &
amortization 245 260 505
--------- ---------- --------
Operating loss $(2,840) $(339) $ (3,179)
--------- ---------- --------
--------- ---------- --------
Identifiable net property and
equipment:
Non-producing leaseholds - Poland $ 394 $ -- 394
Non-producing leaseholds - United
States 132 -- 132
Producing properties 6,521 -- 6,521
Equipment and other -- 998 998
--------- ---------- --------
Total net assets $ 7,047 $ 998 $ 8,045
--------- ---------- --------
--------- ---------- --------
Property and equipment capital
expenditures: $ 1,288 $ 133 $ 1,421
(1) All E&P revenues during 1996 were from operations in the United
States.
(2) Includes a non-cash impairment charge of $1,290,000 for a lease in
Nevada acquired prior to 1996.
A reconciliation of the segment information to the consolidated totals for
the years ended December 31, 1998, 1997 and 1996 follows:
Year Ended December 31,
1998 1997 1996
--------- ---------- --------
Revenues: (In thousands)
Reportable segments $ 1,913 $ 2,738 $ 2,421
Non-reportable segments -- 71 --
--------- ---------- --------
Total consolidated revenues $ 1,913 $ 2,809 $ 2,421
Operating Loss:
Reportable segments $(2,024) $ (4,695) $ (3,179)
Expense or (revenue) adjustments:
Non-reportable segments 29 (71) --
Impairment of domestic proved
property 5,885 -- --
General and administrative expenses 2,572 2,566 1,715
Corporate DD&A 118 85 53
Other 1 (1) --
--------- ---------- --------
Consolidated net operating loss $(10,629) $ (7,274) $ (4,947)
Net Property and Equipment:
Reportable segments $ 2,421 $ 8,552 $ 8,045
Corporate assets 178 209 139
-------- ---------- --------
Net property and equipment $ 2,599 $ 8,761 $ 8,184
Property and Equipment Capital
Expenditures:
Reportable segments $ 336 $ 1,070 $ 1,421
Corporate assets 105 461 36
-------- ---------- --------
Net property and equipment capital
expenditures $ 441 $ 1,531 $ 1,457
13. Quarterly Financial Data (Unaudited):
During the year ended December 31, 1998, the Company incurred a domestic
proved property impairment of $5,885,000, of which $5,640,000 and $245,000
was recorded during the third and fourth quarters, respectively. During
the year ended December 31, 1997, the Company incurred dry hole costs of
$1,834,000 for the Orneta #1 and $1,262,000 for the Gladysze #1-A, which
were incurred primarily during the first and third quarters, respectively.
Also, during 1997, the Company recorded an extraordinary gain of $3,076,000
relating to RWE-DEA, which was recorded primarily in the second quarter.
Summary quarterly information for the years ended December 31, 1998 and
1997 is as follows:
For the 1998 Quarter Ended
--------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ---------- ---------
(In thousands, except per share amounts)
Revenues $416 $ 426 $ 272 $ 99
Operating loss (1,949) (6,511) (1,465) (704)
Net loss $ (1,858) $ (6,392) $ (1,353) $ (519)
Basic and diluted net
loss per common share $ (.15) $ (.49) $ (.10) $ (.04)
For the 1997 Quarter Ended
--------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ---------- ---------
(In thousands, except per share amounts)
Revenues $ 759 $ 899 $ 572 $ 579
Operating income or
(loss) (1,653) (2,256) (1,417) (1,948)
Net income or (loss)
before extraordinary (1,278) (1,779)
gain (1,958) (1,681)
Net income or (loss) $ (1,959) $ (1,666) $1,784 $(1,779)
Basic and diluted net
income or(loss) per
common share:
Net loss before
extraordinary gain $ (.16) $ (.13) $ (.10) $ (.14)
Extraordinary gain -- -- .24 --
--------- ---------- ---------- ----------
Net income or (loss) $ (.16) $ (.13) $ .14 $ (.14)
--------- ---------- ---------- ----------
--------- ---------- ---------- ----------
14. Disclosure about Oil and Gas Properties and Producing Activities:
Impairment of Long-lived Assets
In accordance with generally accepted accounting principles, the Company
must record an impairment expense if the Company determines the net book
value of its domestic proved oil and gas properties, on a property by
property basis, exceeds the aggregate future net revenues from such
properties. As of December 31, 1998, the Company's future undiscounted net
revenues from its domestic proved developed properties was $1,015,000 and
its discounted future net revenues (PV-10) of it domestic proved developed
properties was $472,000. The future net revenues at December 31, 1998
were computed using a price of $8.11 per barrel, the average price at
December 31, 1998, the price which the Company also believes it will
likely receive in the foreseeable future.
In view of the Company's increased focus on its Polish exploration and
development opportunities and the probability of continued depressed oil
prices, management believes it is unlikely the Company will incur any
domestic development costs in the foreseeable future. Accordingly, the
Company's proved reserves as of December 31, 1998 include only those
reserves attributable to developed properties.
The Company recorded an impairment expense of $5,885,000 for the year
ended December 31, 1998 which reduced the carrying value of its domestic
proved properties to $463,000, an amount which approximates the fair value
of its domestic proved developed reserves determined on a property by
property basis.
Capitalized Costs
Capitalized costs relating to oil and gas producing activities as of
December 31, 1998 and 1997 are summarized as follows:
United
States Poland Total
--------- ---------- ----------
(In thousands)
December 31, 1998:
Proved properties $1,605 $ -- $1,605
Unproved properties 718 461 1,179
------ ------ ------
Total gross properties 2,323 461 2,784
Less accumulated depreciation,
depletion and amortization (1,142) -- (1,142)
------ ------ ------
Total net properties,
December 31, 1998 $1,181 $ 461 $1,642
------ ------ ------
------ ------ ------
December 31, 1997:
Proved properties $7,359 $ -- $7,359
Unproved properties 710 460 1,170
------ ------ ------
Total gross properties 8,069 460 8,529
Less accumulated depreciation,
depletion and amortization (912) -- (912)
------ ------ ------
Total net properties,
December 31, 1997 $7,157 $ 460 $7,617
------ ------ ------
------ ------ ------
Acquisition, Exploration and Development Activities
Costs incurred in oil property acquisition, exploration and development
activities during the years ended December 31, 1998, 1997 and 1996, whether
capitalized or expensed, are summarized as follows:
United
States Poland Total
--------- ---------- ----------
(In thousands)
December 31, 1998:
Acquisition of properties:
Proved $ -- $ -- $ --
Unproved 15 33 48
Exploration costs 34 2,092 2,126
Development costs 132 -- 132
------ ------ ------
Total $ 181 $2,125 $2,306
------ ------ ------
------ ------ ------
December 31, 1997:
Acquisition of properties:
Proved $ -- $ -- $ --
Unproved 733 66 799
Exploration costs 1,419 3,895 5,314
Development costs 187 -- 187
------ ------ ------
Total $2,339 $3,961 $6,300
------ ------ ------
------ ------ ------
December 31, 1996:
Acquisition of
properties:
Proved $ 10 $ -- $ 10
Unproved 97 274 371
Exploration costs 676 1,750 2,426
Development costs 907 -- 907
------ ------ ------
Total $1,690 $2,024 $3,714
------ ------ ------
------ ------ ------
15. Summary Oil and Gas Reserve Data (Unaudited):
The following quantity and value information is based on prices as of the
end of each respective reporting period. No price escalations were
assumed. Operating costs and production taxes were deducted in determining
the quantity and value information. Such costs were estimated based on
current costs and were not adjusted to anticipate increases due to
inflation or other factors. No amounts were deducted for general overhead,
depreciation, depletion and amortization, interest expense and income
taxes.
The determination of oil and gas reserves is based on estimates and is
highly complex and interpretive. The estimates are subject to continuing
revisions as additional information becomes available or assumptions
change.
Estimated Quantities of Proved Oil Reserves
Following is a reconciliation of the Company's interest in net quantities
of proved oil reserves. All proved oil reserves are located in the United
States. Proved reserves are the estimated quantities of crude oil which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reserves under existing economic and
operating conditions.
Changes in estimated oil reserves of the Company for the years ended
December 31, 1998, 1997 and 1996 are as follows:
For the years ended December 31,
----------------------------------
1998 1997 1996
------ ------ ------
(In thousands bbls of oil)
Total proved reserves:
Beginning of year 4,760 5,443 5,257
Purchase of minerals in- -- -- --
place
Extensions and -- 18 --
discoveries
Revisions of previous (3,110) (575) 316
estimates
Production (115) (126) (130)
------ ------ ------
End of year 1,535 4,760 5,443
------ ------ ------
Proved developed
reserves:
Beginning of year 2,282 2,829 2,683
------ ------ ------
End of year 1,535 2,282 2,829
------ ------ ------
The decrease in 1998 reserves as compared to 1997 was principally due to
the elimination of 2,478,000 bbls of proved undeveloped reserves which
were included as of as of December 31, 1997 and a $5.70 per bbl decrease
in oil prices at year-end 1998 as compared to year-end 1997. The
decrease in 1997 reserves as compared to 1996 was principally due to
a $7.57 decrease in oil prices at year-end 1997 as compared to year-end
1996.
Standardized Measure of Discounted Future Net Cash Flows ("SMOG") and
Changes Therein Relating to Proved Oil Reserves
Estimated discounted future net cash flows and changes therein were
determined in accordance with SFAS No. 69. Certain information concerning
the assumptions used in computing the valuation of proved reserves and
their inherent limitations are discussed below. The Company believes such
information is essential for a proper understanding and assessment of the
data presented.
Future net cash flows were computed by applying the year-end oil prices of
$8.11, $13.81 and $21.38 for the years ended December 31, 1998, 1997 and
1996, respectively, and production costs per bbl of $7.43, $6.86 and $7.53
for 1998, 1997 and 1996, respectively, to the period-end quantities of the
Company's proved reserves.
The assumptions used to compute the proved reserve valuation do not
necessarily reflect the Company's expectations of actual revenues to be
derived from those reserves nor their present worth. Assigning monetary
values to the reserve quantity estimation process does not reduce the
subjective and ever-changing nature of such reserve estimates. Additional
subjectivity occurs when determining present values because the rate of
producing the reserves must be estimated. In addition to errors inherent
in predicting the future, variations from the expected production rates
also could result directly or indirectly from factors outside the Company's
control, such as unintentional delays in development, environmental
concerns and changes in prices or regulatory controls. The reserve
valuation assumes that all reserves will be disposed of by production.
However, if reserves are sold in place, additional economic considerations
also could affect the amount of cash eventually realized. Future
development and production costs are computed by estimating expenditures to
be incurred in developing and producing the proved oil reserves at the end
of the period, based on period-end costs and assuming continuation of
existing economic conditions. A discount rate of 10% per year was used to
reflect the timing of the future net cash flows.
The components of SMOG are detailed below:
As of December 31,
----------------------------------
1998 1997 1996
------ ------ ------
SMOG Components: (In thousands bbls of oil)
Future cash flows $12,518 $ 65,740 $116,405
Future production costs (11,408) (32,658) (40,966)
Future development costs (95) (6,273) (6,117)
------ ------ ------
Future net cash flows 1,015 26,809 69,322
Future income tax expense -- (125) (17,880)
------ ------ ------
Future net cash flows 1,015 26,684 51,442
10% annual discount for
estimated timing of cash flows (543) (13,109) (25,158)
------ ------ ------
Total $ 472 $ 13,575 $ 26,284
------ ------ ------
------ ------ ------
The following are principal sources of changes in SMOG:
Years Ended December 31,
----------------------------------
1998 1997 1996
------ ------ ------
SMOG Sources: (In thousands)
Balance, beginning of year $13,575 $ 26,284 $ 17,661
Sales of oil produced, net of (77) (801) (1,120)
production costs
Net changes in prices and (4,482) (16,707) 11,374
production costs
Purchases of minerals in place -- -- --
Extensions and discoveries, net of -- 108 --
future costs
Changes in estimated future 2,875 (79) (1)
development costs
Development costs incurred during
the year 132 394 1,070
Revisions in previous quantity
estimates (9,076) (1,969) 2,234
Accretion of discount 1,357 2,628 1,766
Net change in income taxes (952) 9,071 (3,015)
Changes in rates of production and
other (2,880) (5,354) (3,685)
------ ------ ------
Balance, end of year $ 472 $ 13,575 $ 26,284
------ ------ ------
------ ------ ------
16. SUBSEQUENT EVENTS:
FX Energy and Apache AMI
On January 29, 1999, the Company and Apache entered into an agreement,
effective January 1, 1999, which creates an AMI for a period of two years
covering the entire country of Poland for oil and gas exploration,
production and acquisition activities with the exception of the Company's
Baltic Project Area. The agreement also provides for joint exploration of
Apache's Warsaw West Project Area, an area covering approximately 2.9
million acres in thirteen exploration blocks located adjacent to the
northwest section of the Company's Lublin Project Area in central Poland.
The Company and Apache will share equally in all of the Warsaw West Project
Area costs, including the cost to acquire a minimum of 1,000 kilometers of
2D seismic and to drill one exploration well during the first three years
of a six year exploration period. In turn, Apache will not be required to
pay any of the Company's share of cost in respect to the Company's
Pomeranian Project Area, in which Apache had previously elected to earn an
interest on December 14, 1998 by agreeing to pay the Company's pro-rata
share of acquiring 600 kilometers of 2D seismic, drilling one exploration
well and other miscellaneous costs and, the Company and Apache will each
retain an equal working interest in all exploratory wells drilled on the
Original 8 Blocks portion of the Lublin Project Area after POGC's
participation election.
Other terms of the agreement include: (1) The Company and Apache must
offer each other a fifty-percent interest in any new exploration,
production, acquisition or other project activities conducted within
Poland; (2) the Company is not required to pay any Polish general and
administrative costs incurred during 1999. Beginning in 2000, Apache may
bill the Company for its pro-rata share of Apache's Polish general and
administrative costs, except for the Lublin and Carpathian project areas,
which may be billed only upon Apache completing their respective earning
requirements in each Project Area; and, (3) Apache will complete its
requirement to drill seven exploratory wells on the Lublin Project Area
during 1999 and will complete its requirement to drill three exploratory
wells in the Carpathian Project Area by the end of the third quarter of
2001.
Initial Results of Lublin Project Area Drilling Program
On February 16, 1999, the Company announced the Czernic 277-2 and the
Poniatowa 317-1, the first two exploratory wells drilled on the Company's
Lublin Project Area, were both determined to be exploratory dry holes.
Under terms of the agreements between the Company and Apache, Apache
covered all of the Company's pro- rata working interest share of costs
for both wells, including 33.33% for the Czernic 277-2 and 47.5% for the
Poniatowa 317-1.
Lachowice Field Development Agreement with Apache and POGC
On February 26, 1999, the Company and Apache entered into an agreement
with POGC whereby the Company and Apache will each earn a one-third
interest in POGC's Lachowice Field, which is located within the Company's
Carpathian Project Area. The Lachowice Field contains three shut-in gas
wells which POGC previously tested at an average production rate of 5.7
MMcf of gas per day per well. Under terms of the agreement, the Company
and Apache will pay all of the following costs in order to earn a
one-third interest each in the project: (1) recomplete up to three
shut-in gas wells; (2) drill three additional wells; and (3) construct
gathering and processing facilities. All costs and net revenues
thereafter, including additional development drilling and lease operating
costs, will be shared one-third each by the Company, Apache and POGC.
Apache will be the operator of the Lachowice Field. The project's
preliminary work schedule is as follows: (1) begin testing and
recompletion of up to three wells during the second quarter of 1999;
(2) commence additional developmental drilling as warranted; and, (3)
construct facilities and pipeline and commence production by mid-2000.