SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

[X]    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2014

 

[_]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ___________ to ___________

 

Commission file number 1-10262

 

HKN, INC.

(Exact name of registrant as specified in its charter)

 

Delaware	95-2841597
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
180 State Street, Suite 200	76092
Southlake, Texas	(Zip Code)
(Address of principal executive offices)

 

Registrant’s telephone number, including area code (817) 424-2424

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:	Name of each exchange on which registered:
Common Stock, Par Value $0.01 Per Share	None

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [_]  No [X]

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes [_]  No [X]

 

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 of 1934 during the preceding 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 checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]  No [_]

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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. [_]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer [_]   Accelerated filer [_]   Non-accelerated filer [_]   Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [_]  No [X]

 

The aggregate market value of the voting common stock, par value $0.01 per share, held by non affiliates of the Registrant as of June 30, 2014 was approximately $8.8 million. For purposes of the determination of the above stated amount only, all directors, executive officers and 5% or more stockholders of the Registrant are presumed to be affiliates.

 

The number of shares of common stock, par value $0.01 per share, outstanding as of February 28, 2015 was 390,916.

 

 

TABLE OF CONTENTS

  

				Page
PART I.
ITEM 1.		Business		4
ITEM 1A.		Risk Factors		11
ITEM 1B.		Unresolved Staff Comments		12
ITEM 2.		Properties		12
ITEM 3.		Legal Proceedings		12
ITEM 4.		Mine Safety Disclosures		14
PART II.
ITEM 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		15
ITEM 6.		Selected Financial Data		16
ITEM 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
ITEM 7A.		Quantitative and Qualitative Disclosures about Market Risk		29
ITEM 8.		Financial Statements and Supplementary Data		30
ITEM 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		60
ITEM 9A.		Controls and Procedures		60
PART III.
ITEM 10.		Directors, Executive Officers and Corporate Governance		62
ITEM 11.		Executive Compensation		64
ITEM 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		67
ITEM 13.		Certain Relationships and Related Transactions and Director Independence		68
ITEM 14.		Principal Accounting Fees and Services		70
PART IV.
ITEM 15.		Exhibits, Financial Statement Schedules		71

 

 The following discussion is intended to assist you in understanding our business and the results of our operations. It should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this report. Certain statements made in our discussion may be forward-looking. Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations. Unless the context requires otherwise, when we refer to “we,” “us” and “our,” we are describing HKN, Inc. and its consolidated subsidiaries on a consolidated basis.

 

PART I

 

ITEM 1. BUSINESS

 

Overview

 

Our business strategy is focused on enhancing value for our shareholders through the development of a well-balanced portfolio of assets in the energy industry. Currently, the majority of the value of our assets is derived from our investment in publicly-traded ordinary shares of Global Energy Development PLC (“Global”) and our wholly-owned subsidiaries, BriteWater International, Inc. (“BWI”), HKN Bakken, Inc. (“HBI”) and HTH, Inc. (“HTH”). We believe these assets could present growth potential for us. We are continuing to seek new investment opportunities in undervalued energy-based assets or companies which could provide future value for our shareholders.

 

We were incorporated in 1973 in the State of California and reincorporated in 1979 in the State of Delaware. Our corporate offices are located at 180 State Street, Suite 200, Southlake, Texas 76092. Our telephone number is (817) 424-2424, and our web site is accessed at www.hkninc.com. We make available, free of charge, on our website, our Code of Business Conduct and Ethics, Code of Ethics for Senior Financial Officers, Audit Committee Charter and Nominating Committee Charter as well as our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as is reasonably practical after such materials are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). You can also access our filings with the SEC at http://www.sec.gov.

 

BriteWater International, Inc.

 

BWI holds patents for oilfield emulsion breaking technology. This is a continuous process technology that can purify oilfield emulsions by breaking and separating the emulsions into oil, water and solids, thereby reducing the environmental impact and disposal costs of these waste materials while recovering valuable oil. This technology has been successfully tested in multiple refineries as well as in a demonstration in Prudhoe Bay, Alaska, all of which confirmed the effectiveness of the emulsion breaking technology to recover valuable hydrocarbons and reduce wastes. BWI has completed the design, construction and installation of standardized modules which can be configured for use in both upstream and downstream applications in the oil and gas industry, including processing oilfield and refinery emulsions to recover valuable oil and remediating oil spills. BWI’s wholly-owned subsidiary, Arctic Star Alaska, Inc. (“Arctic Star”), substantially completed commissioning this set of modules as a mobile waste processing plant which is located on the North Slope of Alaska during the fourth quarter. However, due to the seasonal drilling schedule in Alaska, feedstock needed to perform final test runs was not available as of December 31, 2014. In addition, as a result of the recent steep decline in oil prices, the plant is currently not economic. As a result, management does not expect to operate the Arctic Star plant until oil prices substantially recover.

 

BWI also has an existing purpose-built plant which was designed to break emulsions found in weathered lagoon pits. BWI had previously anticipated to develop a business plan to deploy this plant, or parts of the plant, once the Arctic Star plant was commissioned in the first quarter 2015. However, due to current oil prices and the age of this plant, we have determined that it is not likely that we will be able to deploy and operate this plant for its intended purpose in the near future. As a result, we wrote down the book value of this plant to its estimated salvage value. See Note 2 – “BriteWater International, Inc.” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

 

Domestic Energy Investments – HKN Bakken, Inc. and HTH, Inc.

 

HBI

 

HBI currently holds non-operated oil and gas leases and mineral interests in properties strategically located in the Bakken and Niobrara shale oil plays. Due to the impact of decreased oil prices on the ultimate economics of wells in these plays, we plan to assess each drilling opportunity on a case-by-case basis and participate in wells that we expect to meet our return thresholds based upon our estimates of ultimate recoverable crude oil and natural gas, expertise of the operator and completed well cost from each project, as well as other factors. As a result, we plan to participate on a discretionary basis during 2015 and anticipate we will participate in fewer wells than past years.

 

HKN Texas Holdings

 

We hold rights to acreage in the Permian Basin of Texas related to certain properties which were not conveyed during sales and merger activities of former subsidiaries which were subsequently discontinued or sold. We leased mineral interests for properties in Reeves County, Texas and Pecos County, Texas for development by third parties in October 2013 and March 2014, respectively. We recognized the related lease bonus payments of $121 thousand and $38 thousand, respectively, within interest and other income within our consolidated statements of operations. Both these leases have a three year term and provide for a 25% royalty interest of all production. In October 2014, we created a new entity HTH, Inc. (“HTH”) and assigned any mineral interests held in Texas to HTH. As of December 31, 2014, we held royalty interests in two gross producing wells in Reeves County through these leases.

 

Colombian Energy Investment – Global Energy Development PLC

 

At December 31, 2014 and 2013, we held an investment in Global through our ownership of approximately 35% of Global’s ordinary shares. Global is a petroleum exploration and production company focused on Latin America. Global’s shares are traded on the Alternative Investment Market (“AIM”), a market operated by the London Stock Exchange. In addition to financing opportunities, we continue to monitor our investment in Global in order to identify opportunities for divesting of shares or making additional investments in the company. Although Global’s share price decreased during 2014, we intend to hold our shares of Global until we believe the market price more accurately reflects the value of its operations and asset base.

 

Ordinary Shares - We account for our ownership of Global shares as an available for sale investment. During 2014, we purchased an additional 343 thousand shares of Global for $422 thousand, increasing our ownership from 34.51% to 35.46%. At December 31, 2014 and 2013, our investment in Global was equal to the market value of Global’s ordinary shares as follows (in thousands, except for closing price and exchange rate amounts):

 

		December 31, 2014				December 31, 2013
Shares of Global Stock Held by HKN			12,805				12,462
Closing Price of Global Stock		£	0.50			£	0.94
Foreign Currency Exchange Rate			1.5586				1.6574
Market Value of Investment in Global		$	9,979			$	19,312

 

The foreign currency translation adjustment of approximately $548 thousand, the unrealized loss on investment of $9.2 million for the changes in market value between the two periods, and an other than temporary impairment loss of $937 thousand were recorded to other comprehensive income in stockholders’ equity during the year ended December 31, 2014. Due to the fair market value of our investment in Global being lower than our cost basis as a result of the continued decline in Global's share price and the current industry conditions, we determined that the impairment was other than temporary and recognized an impairment loss of $937 thousand in our consolidated statements of operations at December 31, 2014. See Note 4 – “Investment in Global” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

 

2013 Note Receivable - In March 2013, we entered into a new loan agreement (the “Global 2013 Note”) with Global to refinance the outstanding $5 million Global Note Receivable and the $12 million Global Loan into one $17 million note. The Global 2013 Note extended the maturity date to June 15, 2015 and initially increased the interest rate from 12.5% to 12.75%. During September 2014, pursuant to provisions of the Global 2013 Note agreement, the interest rate charged was increased from 12.75% up to 13.5% per annum due to Global’s nonconformity with performance conditions as of June 30, 2014. This new stated interest rate was to remain in effect until the maturity of the loan agreement. Beginning June 30, 2014, the Global 2013 Note was classified as a current asset because all quarterly payments on the Global 2013 Note had been received in accordance with the stated repayment terms, and we believed the remaining payments would also be made as scheduled.

 

In December 2014, Global announced it had completed the sale of its rights and obligations for its contract areas within the Llanos Basin. Global used a portion of the net sale proceeds to repay the Global 2013 Note. We received $7.5 million in outstanding principal, $225 thousand in prepayment penalty, $200 thousand in accrued interest and recognized the remaining $47 thousand of unamortized origination fees.

 

During the years ended December 31, 2014 and 2013, we received interest payments from Global of approximately $1.2 million and $2 million, respectively and recognized deferred origination fees of $177 thousand and $282 thousand, respectively.

 

Oil and Gas Operations

 

As a result of the 2011 sale of our oil and gas properties as discussed in Note 8 - “Discontinued Operations” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K, any residual Gulf Coast oil and gas and coalbed methane activities are included as discontinued operations on the consolidated balance sheets, consolidated statements of operations and consolidated statements of cash flows for all periods presented.

 

Oil and Gas Development and Production Operations

 

We engage in crude oil and natural gas exploration and production by participating on a non-operated, proportionate basis alongside third-party interests in wells drilled and completed in spacing units that include our acreage.  We depend on drilling partners to propose, permit and initiate the drilling of wells. Prior to commencing drilling, our partners are required to provide all owners of crude oil, natural gas and mineral interests within the designated spacing unit the opportunity to participate in the drilling costs and revenues of the well to the extent of their pro-rata share of such interest within the spacing unit.  We assess each drilling opportunity on a case-by-case basis and participate in wells that we expect to meet our return thresholds based upon our estimates of ultimate recoverable crude oil and natural gas, expertise of the operator and completed well cost from each project, as well as other factors.  At the present time, we plan to participate on a discretionary basis during 2015 and anticipate we will participate in fewer wells than past years due to the current economic environment.

 

As of December 31, 2014 and 2013, all of our non-operated oil and gas development and production operations were located in the United States.

 

During 2014, we realized a net decrease of approximately 24 net acres of working interests as a result of a settlement agreement for the final dissolution of Gerrity Oil, LLC in April 2014, in which HBI sold its interest in 4 gross producing Bakken wells. We purchased no additional acreage during 2014. As of December 31, 2014, our oil and gas assets are comprised of working interests and royalty interests of 204 and 84 net acres, respectively, in the Bakken region and 9 and 3 net acres, respectively, in the Niobrara region. We also held royalty interests through HTH of 6,209 gross acres and 135 net acres, respectively, in the Permian Basin of Texas. We also elected to participate in the completion of 26 producing gross wells during 2014, in which we have a working interest, with a 98% success rate in the Bakken formations since our initial investment. As of December 31, 2014, we owned working interests in 97 gross oil and gas wells that consisted of 74 that were producing, 6 that were in the process of being drilled and completed and 17 that were permitted. We owned royalty interests in 27 gross producing oil and gas wells as of December 31, 2014.

 

Oil and Gas Marketing and Customers

 

We rely on our operating partners to market and sell our production. We understand that our partners generally sell our production to a variety of purchasers at prevailing market prices under separately negotiated short term contracts. The price at which oil production is sold generally is tied to the spot market for crude oil.  Natural gas produced in the Bakken formation has a higher dollar value than other natural gas production areas due to its higher wet gas content. As a result, the average differential based on actual Bakken sales during 2014 was approximately $3.54 per mcf above Henry Hub published pricing.  

 

As of December 31, 2014, our operating partners are comprised of 8 different exploration and development companies, which range from large publicly-traded companies to small, privately owned companies. We do not believe that the loss of any single operator would have a material adverse effect on our company as a whole.

 

Oil and Gas Properties and Locations

 

Production and Revenues – We use the sales method to recognize our oil and gas revenues. Under this method, revenues are recognized based on our interests in the actual volumes of gas and oil sold to purchasers. The following table shows, for the periods indicated, operating information attributable to our oil and gas interests, all of which are located in the United States:

 

		2014				2013
Production:
Oil (Bbls)			10,669				11,114
Natural Gas (Mcf)			17,512				14,283
Barrel of Crude Oil Equivalent (BOE)			13,588				13,494
Revenues:
Oil		$	862,000			$	997,000
Natural Gas			126,000				96,000
Total		$	988,000			$	1,093,000
Unit Prices:
Oil (per Bbl)		$	80.79			$	89.71
Natural Gas (Mcf)		$	7.20			$	6.72
Production costs per BOE		$	9.55			$	7.14

  

Depletion of Oil and Gas Properties – Our depletion expense is driven by many factors including certain exploration costs involved in the development of producing reserves, production levels and estimates of proved reserve quantities and future developmental costs.  The following table presents our depletion expenses during 2014 and 2013:

 

		2014				2013
Depletion of crude oil and natural gas properties		$	411,000			$	479,000
Depletion per BOE		$	33.95			$	35.50

 

All depletion results are from our HBI oil and gas properties as our HTH oil and gas properties are legacy holdings from former subsidiaries that were discontinued or sold and have no remaining capitalized costs allocated to them.

 

Acreage and Wells – At December 31, 2014, we owned working interests in the following oil and gas wells and acreage.

 

	Gross Wells				Net Wells				Developed Acreage				Undeveloped Acreage
Country	Oil		Gas		Oil		Gas		Gross		Net		Gross		Net
United States	96		1		0.46		0.01		5,670		210		120		3
Total	96		1		0.46		0.01		5,670		210		120		3

  

As a non-operator, we are subject to lease expirations if an operator does not commence the development of operations within the agreed terms of our leases, generally not exceeding five years. In addition, our leases typically provide that the lease does not expire at the end of the primary term if drilling operations have been commenced. While we generally expect to establish production from most of our acreage prior to expiration of the applicable lease terms, there can be no such guarantee we can do so. The approximate expiration of our gross and net acres which are not held by production and thus subject to expire between 2015 and 2019 and thereafter, are set forth below:

 

					Acres Expiring
	Year Ended				Gross				Net
	December 31, 2015				—				—
	December 31, 2016				—				—
	December 31, 2017				120				3
	December 31, 2018				—				—
	December 31, 2019 and thereafter				—				—
	Total				120				3

 

We believe that we have satisfactory title to or rights in all of our producing properties. As is customary in the oil and gas industry, minimal investigation of title is made at the time of acquisition of undeveloped properties.

 

Drilling Activity – The following table sets forth the number of gross and net productive and non-productive wells for our drilling and development activity during 2013 and 2014. The following table does not include the 6 gross wells that were in the process of being drilled, awaiting completion or awaiting flowback subsequent to fracture stimulation at December 31, 2014. Subsequent to December 31, 2014, one of these 6 gross wells has reported production to date and no additional wells have been spud. We have classified all wells drilled to date targeting the Bakken formation as developmental wells. As of December 31, 2014, we have had a 98% success rate in our Bakken wells.

 

		Number of Gross Wells
		Exploratory				Developmental				Total
		Productive		Non-productive		Productive		Non-productive		Productive		Non-productive
2013		—		—		22		1		22		1
2014		—		—		26		—		26		—
Total		—		—		48		1		48		1

 

		Number of Net Wells
		Exploratory				Developmental				Total
		Productive		Non-productive		Productive		Non-productive		Productive		Non-productive
2013		—		—		0.15		0.01		0.15		0.01
2014		—		—		0.03		—		0.03		—
Total		—		—		0.18		0.01		0.18		0.01

 

Reserves Information – The process of estimating oil and gas reserves is complex and requires significant judgments. As a result, our reserves report has been prepared by qualified third-party engineers, as defined by the Society of Petroleum Engineers’ standards. We also require that the independent third-party reservoir engineers ensure that the proved reserves estimates are determined in accordance with SEC definitions and guidance. We currently do not have any employees that have professional training or experience in the geological or reserves engineering field. We rely on an independent consultant to provide a final review of our reserves report and the assumptions relied upon in such report. This consultant has a B.S in Geology, 25 years of experience in the oil and gas industry and is a member of the American Society of Petroleum Geologists. He has evaluated and worked on a number of domestic and international unconventional shale oil plays.

 

Our estimates of reserves and related future net revenues at December 31, 2014 and 2013 were based on reports prepared by Moyes and Co., our independent reserve engineers, in compliance with the SEC rules, regulations, definitions and guidance and in accordance with Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers. Moyes and Co. was established in 1983 and performs consulting petroleum engineering services, including the issuance of reserves reports and audits, acquisition and divestiture evaluations, simulation studies, exploration resources assessments, equity determinations, and management and advisory services. Mr. P. Dee Patterson, P.E. is the technical person primarily responsible for preparing the estimates set forth in the reserves reports included as an exhibit to the Annual Reports on Form 10-K. Mr. Patterson has been practicing consulting petroleum engineering at Moyes and Co. since 2000. Mr. Patterson is a Licensed Professional Engineer in the State of Texas (No. 64836) and has over 30 years of experience in the estimation and evaluation of reserves. He graduated from University of Texas at Arlington in 1981 with a Bachelor of Science Degree in Engineering. Mr. Patterson meets or exceeds the education, training, and experience requirements set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers; and he is proficient in judiciously applying industry standard practices to engineering and geoscience evaluations as well as applying SEC and other industry reserves definitions and guidelines.

 

Proved oil and gas reserves are defined as the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Reservoirs are considered proved if economic productibility is supported by either actual production or conclusive formation tests. The area of a reservoir considered proved includes that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. Reserves which can be economically produced through application of improved recovery techniques are included in the “proved” classification when either successful testing by a pilot project or the operation of an installed program in the reservoir provides support for the engineering analysis on which the project or program was based.

 

The reserves set forth in the Moyes and Co. report for the properties were estimated utilizing generally accepted engineering practices. An analysis and interpretation of production history was utilized to make the estimate of recoverable reserves from the captioned leases. In accordance with applicable requirements of the SEC, estimates of our net proved reserves and future net revenues are made using average prices at the beginning of each month in the 12-month period prior to the date of such reserve estimates and are held constant throughout the life of the properties.

 

The reliability of reserves information is considerably affected by several factors. Reserves information is imprecise due to the inherent uncertainties in, and the limited nature of, the data upon which the estimating of reserves information is predicated. Moreover, the methods and data used in estimating reserves information are often necessarily indirect or analogical in character rather than direct or deductive. Furthermore, estimating reserves information by applying generally accepted petroleum engineering and evaluation principles involves numerous judgments based upon the engineer’s educational background, professional training and professional experience. The extent and significance of the judgments to be made are, in themselves, sufficient to render reserve information inherently imprecise.

 

The following table sets forth our estimated proved reserves based on the SEC rules defined in Rule 4.10(a) of Regulation S-X. Immaterial interests were not included in our reserve estimates.

 

	Oil (Barrels)		Gas (Mcf)
	(in thousands)
Proved reserves as of December 31, 2013:
Proved developed reserves	52		73
Proved undeveloped reserves	145		187
Total Proved Reserves as of December 31, 2013	197		260
Proved reserves as of December 31, 2014:
Proved developed reserves	46		72
Proved undeveloped reserves	71		134
Total Proved Reserves as of December 31, 2014	117		206

_____________________

All reserves were held within the United States for the years ended December 31, 2014 and 2013.

 

Despite incurring approximately $330 thousand of capital expenditures for drilling activities during 2014, which resulted in 26 additional gross producing wells during the year, the decrease in our proved developed reserves was mainly a result of reflecting uneconomic results for certain wells in the Bakken play, decreased investment anticipated in new wells and the sale of 4 gross producing wells during 2014. Proved undeveloped reserves decreased by approximately 9 thousand bbls and 20 thousand mcfs as a result of becoming proved developed reserves in the current year. The remaining decrease was a result of reflecting uneconomic results for certain wells in the Bakken play and decreased investment anticipated in new wells as compared to the prior year. We performed an analysis of producing Bakken wells in the counties we hold ownership interests, and developed a type-curve based on the statistical analysis of the estimated recoveries to determine the estimated reserves for proved undeveloped locations. Of our proved oil and gas reserves 93% are concentrated in the Bakken formation in North Dakota.

 

2015 Outlook

 

Our objective in 2015 is to continue to build the value of our portfolio of assets through:

 

·

Identifying, developing, operating and marketing applications for the BWI emulsion-breaking technology within an economic environment,

·

Pursuing opportunities to invest in or acquire undervalued assets or companies in the energy industry which we believe present significant near-term growth potential,

·

Providing management expertise and/or additional capital for our assets to enhance their value and accelerate growth and

·

Managing our capital expenditures and selling, general and administrative costs.

 

Employees

 

At December 31, 2014, we had 18 employees, 17 of which were full time employees. We have experienced no work stoppages or strikes as a result of labor disputes and consider relations with our employees to be satisfactory. We maintain group medical, dental, vision, life, long-term disability and long-term care insurance plans for our employees.

 

 

ITEM 1A. RISK FACTORS

 

Not applicable.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

 

ITEM 2. PROPERTIES

 

Our corporate offices are located in Southlake, Texas. We have a lease for approximately 5,826 square feet in Southlake, Texas, which runs through August 2017.

 

In March 2014, our BWI subsidiary entered into a lease of approximately 881 square feet of office space in Southlake, Texas, which runs through March 2015.

 

In December 2014, our Arctic Star subsidiary, part of our BWI operating segment, entered into a lease of approximately 833 square feet of office space in Anchorage, Alaska, which runs through December 2015.

 

See “Liquidity and Capital Structure – Obligations, Contingencies and Commitments – Consolidated Contractual Obligations” contained in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for more information.

 

See Item 1. “Business” for a discussion of our non-operated interests in oil and gas properties.

 

 

ITEM 3. LEGAL PROCEEDINGS

 

XPLOR Energy Litigation – Pursuant to a PSA dated as of November 17, 2011 between our subsidiary XPLOR and TPIC, XPLOR sold to TPIC its oil and gas production assets and related operations at its Main Pass 35 field.  The closing of the transaction occurred on November 17, 2011 but was effective as of October 1, 2011.  On November 21, 2011, TPIC informed XPLOR that they had discovered defects in the salt water disposal system at Main Pass resulting in a salt water spill in the Gulf of Mexico, which had been reported to regulatory authorities. 

 

TPIC has filed a lawsuit against XPLOR in the 236^th Judicial District Court, Tarrant County, Texas. The case is styled: Texas Petroleum Investment Company vs. XPLOR Energy SPV-1, Inc., Richard Cottle, Sarah Gasch, and John Hewitt. In the lawsuit, TPIC has asserted claims of fraud, fraudulent inducement, negligent misrepresentation, and indemnity related to its purchase of a production platform and associated assets from XPLOR. TPIC’s claims focus on alleged salt water system defects, related repairs to the facilities, and purported representations regarding the condition of the platform and associated assets. TPIC is seeking an unstated amount of alleged actual and exemplary damages as well as costs and fees. Although litigation is inherently uncertain, based upon the information known to date, we do not believe TPIC’s civil, contractual and fraud claims have merit. We intend to vigorously defend any assertions related to the above lawsuit. Accordingly, as of December 31, 2014, we did not record a contingency related to TPIC’s allegations. Based upon information known to date, the range of estimated loss if TPIC were to prevail on its claims is currently estimated not to exceed $2.5 million in damages, costs, and fees.

 

Main Pass Environmental Investigations – In January 2013, we were notified by the Louisiana Department of Environmental Quality (“LDEQ”) of an investigation and potential penalty related to the TPIC allegations of improper salt water disposal at the Main Pass 35 field previously owned by our subsidiary XPLOR Energy SPV-1, Inc. and previously operated by our subsidiary, XPLOR Energy Operating Company.  The matter is styled: In the Matter of Xplor Energy Operating Company, Louisiana Division of Administrative Law Docket No. 2014-2388-EQ, Louisiana Department of Environmental Quality (“LDEQ”) Tracking No. WE-CN-12-01101. In October 2014, a telephone status conference was held with the LDEQ and the Administrative Law Judge (“ALJ”) handling this matter, and the Company held a subsequent meeting at the LDEQ offices during November 2014. Following these meetings, the parties agreed to pursue settlement discussions and are currently engaged in this process. At December 31, 2014, we have a $65 thousand contingency within liabilities of discontinued operations in our consolidated balance sheets related to these investigations.

 

In March 2013, we were advised that the U.S. Environmental Protection Agency (“EPA”) was undertaking a criminal investigation of the salt water disposal incident. In June 2014, we began discussions with the U. S. Attorney’s Office in New Orleans, Louisiana with regard to resolving any potential allegations against XPLOR. On September 15, 2014, the U.S. Attorney’s Office filed a Bill of Information with the U.S. District Court for the Eastern District of Louisiana (the “Court”) alleging that XPLOR knowingly violated The Federal Water Pollution Control Act (the “Clean Water Act”) at its Main Pass operations. Subject to the Court’s acceptance and to avoid the risks, uncertainties, costs and other burdens of litigation, we agreed with the U. S. Attorney’s Office to enter into a plea agreement reflecting a payment of $3.1 million in settlement of one felony count of a knowing violation of the Clean Water Act. At a hearing on November 19, 2014, Xplor pled guilty to that felony count pursuant to the plea agreement. The sentencing hearing in this matter is scheduled for March 4, 2015. Accordingly, at December 31, 2014, we have a $3.1 million contingency within liabilities of discontinued operations in our consolidated balance sheets related to these investigations.

 

Point Au Fer Lawsuit – During the second quarter 2013, we learned HKN, Inc. was named in a lawsuit filed in the 32nd Judicial District Court for the Parish of Terrebonne, Louisiana by Point Au Fer, L.L.C., and The Roman Catholic Church of the Archdiocese of New Orleans.  The case is styled: Point Au Fer, L.L.C., and The Roman Catholic Church of the  Archdiocese of New Orleans v. ExxonMobil Oil Corporation, et al, No. 169160. In the lawsuit, the plaintiffs have alleged that real property they own in Terrebonne Parish has been environmentally damaged as a result of oil and gas exploration activities of twenty different defendants.  The plaintiffs seek damages for testing and remediation of the property, property stigma, loss of use of land and lost profits, civil fruits for defendants trespass, land loss and subsidence, punitive or exemplary damages and attorney’s fees. Per Louisiana law, no actual dollar amount of damages has been alleged in the Petition. With specific regard to HKN, Inc., out of over one hundred wells identified in the Petition, HKN, Inc. only drilled one well, the MA Smythe Nelson #1, which was a dry hole. The MA Smythe Nelson #1 was drilled on June 2, 1980 and plugged and abandoned on July 12, 1980.  We have and intend to continue to vigorously defend any assertions related to the above lawsuit. Due to the inherent uncertainties of the lawsuit at this time, we cannot accurately predict the ultimate outcome of the matter. Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

Point a la Hache Lawsuit – During the second quarter 2013, we learned XPLOR Energy Operating Company and XPLOR Energy SPV-1, Inc. were named in a lawsuit filed in the 25^th Judicial District Court for the Parish of Plaquemines, Louisiana. The case is styled: Catherine P. Alford et al. v. BP America Production Company, et al., Docket No. 60-479. In the lawsuit, eight plaintiffs have sued 25 defendants, alleging that they own and/or use a certain 4,480 acres located in the Pointe a la Hache oil and gas field.  Plaintiffs further allege that the property has been contaminated or otherwise damaged by oil and gas exploration and production activities.  Per Louisiana law, no actual dollar amount of damages has been alleged in the Petition. On March 18, 2014, prior to the hearing on defendants’ exceptions, plaintiffs filed a motion to dismiss the lawsuit in its entirety. The court signed the order dismissing all claims against the defendants on March 27, 2014, and the case is now closed. Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

SLFPA-E Litigation – Plaintiffs South Louisiana Flood Protection Authority—East (“SLFPA-E”) filed this lawsuit in Louisiana state court against over 90 oil and gas and pipeline companies.  Generally the lawsuit alleges that activities by defendants—primarily but not exclusively the dredging of canals—have made it more difficult for the SLFPA-E to protect the New Orleans metropolitan area from flooding.  The petition alleges that HKN, Inc. is "by virtue of [one or more of] mergers, acquisitions, name changes, etc., responsible for" the actions of Tejas Power Corporation, which is alleged to have obtained in the 1980s certain dredging permits and rights of way.  HKN, Inc. disputes that it is responsible for any actions of Tejas Power Corporation.  The public record appears to suggest that Tejas Power Corporation may have been a subsidiary of Harken Oil and Gas, Incorporated (a previous name of HKN, Inc.) for a few years in the 1980s and 1990s.  However, there appears to be nothing to indicate that HKN, Inc. would have liability for the actions of Tejas Power Corporation, which continued to exist after HKN, Inc. no longer had any interest in Tejas Power Corporation. Defendants removed the case to federal court and the plaintiff filed a motion to remand the case back to state court.  On June 27, 2014, the Judge issued an Order denying remand to state court. A status conference was held on August 6, 2014, and the Defendants filed a Joint Motion to Dismiss during September 2014.  Oral arguments with respect to this motion were held before the court on November 12, 2014.  On February 13, 2015, the court signed an order ruling in favor of the Defendants and dismissing all claims.  Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Price Range of Common Stock

 

Beginning March 1991 until June 2007, our common stock was listed on the American Stock Exchange and traded under the symbol HEC. In June 2007, the trading symbol of our common stock was changed to the symbol HKN. The American Stock Exchange was acquired by NYSE Euronext during 2008 and renamed NYSE Amex. Our common stock was listed on the NYSE Amex until October 26, 2012 when we voluntarily delisted from the exchange. Our common stock is currently traded on the Over the Counter Bulletin Board and quoted on the OTCQB marketplace under the symbol HKNI. At December 31, 2014, there were 63 holders of record of our common stock.

 

The following table sets forth, for the periods indicated, the reported high and low closing sales prices of our common stock:

 

							Prices
							High				Low
	2013--			First Quarter		$	95.25			$	74.50
				Second Quarter			90.00				78.00
				Third Quarter			79.00				68.00
				Fourth Quarter		$	80.00			$	65.00
	2014--			First Quarter		$	96.00			$	71.50
				Second Quarter			78.50				67.00
				Third Quarter			78.50				40.50
				Fourth Quarter		$	54.75			$	39.00

 

Dividends

 

While we have not paid any cash dividends on common stock since our organization, we may decide to pay dividends in the future subject to our ability to pay dividends and to a determination by management and our Board of Directors that dividends are in our best interests and those of our shareholders.

 

For discussion of dividends paid to holders of our preferred stock, see “Payments of Preferred Stock Dividends and Preferred Stock Repurchases” contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Equity Compensation Plans

 

In April 2012, our wholly-owned subsidiary BWI adopted a 2012 Equity Compensation Plan (the “BWI Plan”), which is administered by the Compensation Committee (the “Committee”) of the HKN Board of Directors.  The Committee has complete and absolute authority to make any and all decisions regarding the administration of the BWI Plan, and all employees of BWI, employees of HKN and its subsidiaries and nonemployee directors of BWI, are eligible to receive awards under the BWI Plan. An aggregate of 100,000 shares of common stock of BWI (10% of BWI’s currently outstanding shares of common stock) have been reserved for potential award issuance under the BWI Plan. See Note 11 – “BWI Stock Compensation” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for further information about our equity compensation plan.

 

Information on Share Repurchases

 

In January 2013, we announced that our Board of Directors authorized the cancellation of our amended September 2005 stock repurchase plan and authorized a new stock repurchase program which allows us to repurchase up to 45 thousand shares of our common stock.

 

We had no additional repurchases of our common stock pursuant to our previously announced share repurchase program during the three months ended December 31, 2014. During the year ended December 31, 2014, we purchased and retired approximately 11 thousand shares of our common stock. As of December 31, 2014 we had approximately 582 shares remaining that may be purchased under this program.

 

In addition, we purchased and retired all 1,000 remaining outstanding shares in each of our Series G1 and G2 preferred stock for $80 thousand.

 

 

ITEM 6. SELECTED FINANCIAL DATA

 

Not applicable.

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion is intended to assist you in understanding our business and the results of our operations. It should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this report. Certain statements made in our discussion may be forward-looking. Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations. Unless the context requires otherwise, when we refer to “we,” “us” and “our,” we are describing HKN, Inc. and its consolidated subsidiaries on a consolidated basis.

 

BUSINESS OVERVIEW

 

Our business strategy is focused on enhancing value for our shareholders through the development of a well-balanced portfolio of assets in the energy industry. Currently, the majority of the value of our assets is derived from our investment in publicly-traded ordinary shares of Global Energy Development PLC (“Global”) and our wholly-owned subsidiaries, BriteWater International, Inc. (“BWI”), HKN Bakken, Inc. (“HBI”) and HTH, Inc. (“HTH”).

 

Management continues to evaluate additional potential projects and opportunities within the energy and related industries.

 

Recent Developments

 

Current Year Investments

 

Throughout 2014, we continued to invest in our emulsions-breaking technology through BWI and the construction of the Arctic Star plant, to participate in the development of the Bakken and Niobrara shale plays through HBI, and to support our investments in Global.

 

Investment in BWI

 

Arctic Star, BWI’s initial project to commercialize its emulsions-breaking technology, leased a site in Deadhorse, Alaska for its plant during the first quarter 2014. Arctic Star currently holds contracts which grant Arctic Star the option to take title to oilfield waste generated in six fields on the North Slope at no cost and sell any recovered crude volumes at market prices. The Company continued negotiations for additional feedstock supply agreements during 2014, one of which was obtained in April 2014 and two of which were obtained in January 2015. Arctic Star also entered into an agreement for the sale of 100% of its recovered hydrocarbons on the North Slope during April 2014.

 

During the year ended December 31, 2014, we invested approximately $7.8 million in the Arctic Star plant. Construction was completed during the first quarter 2014 and the modules were shipped to the North Slope and installed during the second quarter 2014. Commissioning of the plant was substantially complete as of December 31, 2014. However, due to the seasonal drilling schedule in Alaska, feedstock needed to perform final test runs was not available as of December 31, 2014. As a result of this and due to the recent steep decline in oil prices, the plant is currently not economic. As a result, management does not expect to operate the Arctic Star plant until oil prices substantially recover.

 

As a result of the current decline in oil prices at December 31, 2014, we evaluated our BWI assets for recoverability. Using a probability weighted average income approach of different courses of actions available, we determined that the Arctic Star plant would be unable to recover its investment at current pricing and recognized an impairment loss of $10.3 million as a component of operating expenses within our consolidated statements of operations as of December 31, 2014. Furthermore, we determined that as a result of current oil pricing and the age of the plant, we would not likely deploy and operate the BWI weathered lagoon plant for its intended purpose and, as a result, we wrote down the book value of this plant to its estimated salvage value, resulting in an impairment loss of $6.1 million as a component of operating expenses within our consolidated statements of operations as of December 31, 2014. See Note 2 – “BriteWater International, Inc.” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

 

Investment in Global

 

During 2014, we purchased an additional 343 thousand shares of Global for approximately $422 thousand, increasing our ownership from 34.51% to 35.46%.

 

As of December 31, 2014, we had a cumulative unrealized loss position on our investment in Global. Therefore, we assessed the decline in market value to determine whether it was considered a temporary or other than temporary impairment. Although we intend to hold the investment, after reviewing Global’s published operational updates and plans, the severity and duration of the decline and analyzing the historical price volatility and decreases in share price subsequent to this reporting date, we determined the impairment to be other than temporary as of December 31, 2014. As a result, we recognized an impairment loss of $937 thousand in our consolidated statements of operations. See Note 4 – “Investment in Global” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

 

Investment in Domestic Energy

 

HBI

 

We continued to strategically invest in HBI, on a non-operated basis, in all phases of the oil and gas business, including participation in the drilling, completion, operation and maintenance of oil and gas wells. During the year ended December 31, 2014, we invested approximately $276 thousand in drilling and completion costs related to our interests in 73 gross wells in the Bakken. As of December 31, 2014, we held both mineral and working interests in 88 gross producing Bakken wells and 11 gross producing Niobrara wells.

 

Due to decreased oil prices, which resulted in uneconomic conditions for certain wells in the Bakken play and anticipated decreased investments in new wells, we recognized impairment losses of $1.4 million and $314 thousand on proved and unproved Bakken properties, respectively, as a component of operating expenses within our consolidated statements of operations as of December 31, 2014. See Note 3 – “HKN Bakken, Inc.” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

 

HTH

 

We hold rights to acreage in the Permian Basin of Texas related to certain properties which were not conveyed during sales and merger activities of former subsidiaries which were subsequently discontinued or sold. We leased mineral interests for properties in Reeves County, Texas and Pecos County, Texas for development by third parties in October 2013 and March 2014, respectively. We recognized the related lease bonus payments of $121 thousand and $38 thousand, respectively, within interest and other income within our consolidated statements of operations. Both these leases have a three year term and provide for a 25% royalty interest of all production. In October 2014, we created a newly formed entity HTH, Inc. (“HTH”) and assigned any mineral interests held in Texas to HTH. As of December 31, 2014, we held royalty interests in two gross producing wells in Reeves County through these leases.

 

Other Matters

 

Share Repurchases

 

During 2014, we purchased and retired 11,029 shares of our common stock for approximately $847 thousand. In addition, we purchased and retired all 1,000 remaining outstanding shares in each of our Series G1 and G2 preferred stock for $80 thousand.

 

Discontinued Operations

 

As a result of the sales of our Gulf Coast oil and gas properties and the abandonment of our coalbed methane projects during 2011, all related activities are included as discontinued operations on the consolidated balance sheets and consolidated statements of operations for all periods presented.

 

CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

 

Our consolidated financial statements have been prepared in accordance with U.S. GAAP which requires us to use estimates and make assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Our estimates and assumptions are based on historical experience, industry conditions and various other factors which we believe are appropriate. Actual results could vary significantly from our estimates and assumptions as additional information becomes known. We have identified the following accounting estimates and assumptions critical to our financial statements:

 

Investment in Global – We do not account for our investment in Global as an equity method investment in spite of our 35% ownership. We are unable to obtain U.S. GAAP financial statements quarterly to perform equity method accounting due to the semi-annual reporting requirements Global follows under the AIM exchange rules. As a result, we account for Global as an available for sale investment.

 

We review our investment in Global at least semi-annually and more often if any indicators of impairment become known. We continuously monitor macroeconomic indicators and track Global’s stock price volatility for any downward trends in the market. We also review public financial information including Global’s issued financial statements, investor presentations, as well as financial analysts’ reviews and recommendations for any indicators of an other than temporary impairment in our carrying value. In addition to these external indicators, we also assess internally our ability and intent to hold our investment in Global should the fair value drop below our cost. Any resulting other than temporary impairment is immediately recognized in earnings. At December 31, 2014, we recognized an other than temporary impairment loss of $937 thousand in our consolidated statements of operations. No such impairments were recognized during 2013. See Note 4 – “Investment in Global” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

 

Amortizing Intangible and Long-Lived Asset Impairment Analysis – We review our amortizing intangible assets, currently consisting of patents acquired in connection with our investment in BWI, and our long-lived assets, consisting of BWI’s Arctic Star plant and the weathered lagoon plant, on an annual basis as well as when events or changes in circumstances indicate the carrying amount of the assets may not be fully recoverable. Recoverability is measured by a comparison of the carrying value of the asset to its undiscounted future cash flows over the life of the related asset. If it is determined that an asset is not recoverable, an estimated fair value of the asset is determined. Any excess of the carrying value of the asset over its fair value is recognized as an impairment loss. Considerable management judgment is necessary to evaluate the impact of operating changes and to estimate asset useful lives and future cash flows. The actual results may vary significantly from these estimates over the lives of these assets. If actual results are not consistent with our estimates and assumptions used to calculate estimated future cash flows, we may be exposed to impairment losses that could be material.

 

Proved and unproved crude oil and natural gas properties are reviewed for impairment on a reservoir basis annually, or when events and circumstances indicate a possible decline in the recoverability of the carrying value of such reservoir. The estimated future cash flows expected in connection with the reservoir are compared to the carrying amount of the reservoir to determine if the carrying amount is recoverable. If the carrying amount of the reservoir exceeds its estimated undiscounted future cash flows, the carrying amount of the field is reduced to its estimated fair value.

 

Impairment losses on long-lived assets used in our operations totaling $18.1 million were recognized during the year ended December 31, 2014. Of this, $10.3 million was related to impairment on the Arctic Star plant, $6.1 million was related to the write down of the BWI weathered lagoon plant to its salvage value and $1.7 million was related to our oil and gas properties held by HBI. See Note 2 – “BriteWater International, Inc.”, Note 3 – “HKN Bakken, Inc.” and Note 7 – “Fair Value Measurements” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information. No such impairments were recognized during 2013.

 

Oil and Gas Properties – We use the successful efforts method of accounting for our HKN Bakken, Inc. oil and gas activities. The significant principles for this method are:

 

• Geological and geophysical evaluation costs are expensed as incurred;
• Costs incurred to drill and equip all successful wells are capitalized;
• Dry holes for exploratory wells are expensed;
• Dry holes for development wells are capitalized;
• Capitalized costs related to proved oil and gas property leasehold costs are depleted over total proved oil and gas reserves; and
• Capitalized costs related to wells and related equipment and facilities costs are depreciated over proved developed reserves.

Estimates of proved oil and gas reserves directly impact financial accounting estimates including depreciation, depletion and amortization expense, evaluation of impairment of properties and the calculation of plugging and abandonment liabilities. Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods and government regulations. The process of estimating quantities of proved reserves is very complex, requiring significant subjective decisions in the evaluation of all geological, engineering and economic data for each reservoir. The data for any reservoir may change substantially over time due to results from operational activity.

 

Capital amounts attributable to proved oil and gas properties are depleted by the unit-of-production method over proved reserves using the unit conversion ratio for gas of six Mcf of gas to one barrel of oil equivalent (“BOE”), and one barrel of NGLs to one BOE for each geological formation (Bakken and Niobrara).

 

Our HTH oil and gas activities have no remaining capitalized costs allocated to these properties since these properties are legacy holdings from former subsidiaries that were discontinued or sold.

 

Loss Contingencies – Management continuously reviews with legal counsel the status of regulatory matters and pending or threatened litigation. With respect to all significant litigation matters, we consider the likelihood of a negative outcome. If we determine the likelihood of a negative outcome is probable and the amount of the loss can be reasonably estimated as of the date of the financial statements, we record an estimated loss for the expected outcome of the litigation. If the likelihood of a negative outcome is reasonably possible and we are able to determine an estimate of the possible loss or range of loss, we disclose that fact together with the estimate of the possible loss or range of loss. However, it is often difficult to predict the outcome or estimate a possible loss or range of loss because litigation is subject to inherent uncertainties, particularly when plaintiffs allege substantial or indeterminate damages. Such is also the case when the litigation is in its early stages or when the litigation is highly complex or broad in scope. In these cases, we disclose that we are unable to predict the outcome or estimate a possible loss or range of loss. We expense legal costs related to such loss contingencies as they are incurred.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

Recently Issued Accounting Pronouncements – In April 2014, FASB issued the Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This standard revises the definition of a discontinued operation to limit the circumstances under which a disposal or classification as held for sale qualifies for presentation as a discontinued operation. Amendments in this standard require expanded disclosures concerning a discontinued operation and the disposal of an individually-material component of an entity not qualifying as a discontinued operation. The standard is effective for annual and interim periods beginning on or after December 15, 2014 and should be applied prospectively, with early adoption permitted. We currently do not expect this standard to have any impact on our consolidated financial statements.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 on revenue from contracts with customers. Under this new standard, revenue is recognized at the time a good or service is transferred to a customer for the amount of consideration received for that specific good or service. The standard is effective for interim and annual periods beginning after December 16, 2016, and early adoption is not permitted. Adoption is allowed by either the full retrospective or modified retrospective approach. We are currently evaluating which approach we will apply and the impact, if any, that this standard will have on our consolidated financial statements.

 

In January 2015, FASB issued the Accounting Standards Update No. 2015-1, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Item. This standard eliminates from GAAP the concept of extraordinary items. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We currently do not expect this standard to have any impact on our consolidated financial statements.

 

RESULTS OF OPERATIONS

 

The following is our discussion and analysis of significant components of our operations which have affected our operating results and balance sheets during the years ended December 31, 2014 and 2013 included in the accompanying consolidated financial statements.

 

Results of Continuing Operations for the Year Ended December 31, 2014 Compared to December 31, 2013

 

Our loss from continuing operations increased approximately $20 million from $1 million in 2013 to $21 million in 2014. The increase was primarily due to impairment losses of $19 million, decreased interest income from our related party notes receivable and increased general and administrative costs.

 

Oil and Gas Revenues and Expenses

 

Oil and gas revenues decreased by $105 thousand from $1.1 million in 2013 to $1 million in 2014. The decrease was due to lower oil volumes and decreased oil prices, partially offset by increased gas volumes and higher gas prices. Assuming current levels or continued declines in oil pricing and the resulting anticipated reduction in drilling activity, future revenues from HBI and HTH are expected to decrease as less production from new wells is added to offset the decline rates of existing wells.

 

Oil revenues decreased $135 thousand to $862 thousand and comprised 87% of our total revenues for the year ended December 31, 2014. We realized a 10% decrease in oil prices received, decreasing from an average of $89.71 per barrel in 2013 to $80.79 per barrel in 2014. Oil production for 2014 decreased slightly from 2013 to approximately 11 thousand barrels. Production decreases in the Bakken area resulted from the sale of four producing Bakken wells in April, natural decline and significant downtime on one of our top producing wells, which were nearly offset by additional production from 30 new Bakken wells and from mineral interests in 2 wells held by HTH. Our non-operated Bakken properties represented 84% of our oil production for 2014.

 

Gas revenues increased $30 thousand to $126 thousand and comprised 13% of our total revenues for the year ended December 31, 2014. We realized a 7% increase in gas prices received, increasing from an average of $6.72 per mcf in 2013 period to $7.20 per mcf in 2014. This increased average price over published Henry Hub pricing is mainly a result of natural gas produced in the Bakken formation having a higher dollar value than other natural gas production areas due to its higher wet gas content. Increased gas production resulted from 30 newly producing Bakken wells and from mineral interests in 2 wells held by HTH partially offset by the sale of four producing Bakken wells in April and natural declines. Our non-operated properties located in the Bakken represented approximately 62% of our gas production for 2014.

 

Oil and gas operating expenses increased $9 thousand to $218 thousand for the year ended December 31, 2014, as a result of expenses related to well repairs, as well as an increase of 32 gross producing wells compared to 2013. Oil and gas operating expenses are expected to remain flat or increase only slightly with the anticipated reduction in the drilling of new wells.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased approximately 10% from $3.5 million for 2013 to $3.9 million for 2014 primarily due to increased personnel and related costs and management and administrative activities related to establishing operations at the Arctic Star plant, offset by a decrease in consulting and legal costs related to our HBI oil and gas properties. We anticipate that our selling, general and administrative expenses may decrease in future periods as we continue to monitor and minimize our controllable costs.

 

Depreciation, Depletion and Amortization Expense

 

Depreciation, depletion and amortization expense increased approximately 9% from $743 thousand for 2013 to $807 thousand for 2014. This increase is primarily due to beginning depreciation of the tank farm at the Arctic Star plant upon its final commissioning in October and increased depreciation on other property and equipment due to asset additions, partially offset by a lower depletion rate on oil and gas properties as a result of property sales in April 2014. Depreciation, depletion and amortization expenses are anticipated to significantly increase when the Arctic Star plant is placed into service.

 

Impairment Losses

 

We recognized impairment losses of approximately $18.1 million in 2014. Of this, $10.3 million was related to impairment of the Arctic Star plant using the discounted cash flows of a probability weighted average income approach, $6.1 million was related to the write down of the BWI weathered lagoon plant to salvage value and $1.7 million was related to our oil and gas properties held by HBI using the discounted cash flow method. These impairments were primarily a result of the current pricing conditions in the energy industry. No impairment losses related to these assets were recognized during 2013.

 

Gain on Contingency

 

BWI had a contingent liability of $800 thousand at December 31, 2013 which would have been payable upon the conclusion of certain performance events related to its weathered lagoon plant. As of December 31, 2014, this contingency was reversed and a gain on contingency was recognized. The reversal was recorded due to the expectation that the plant will not be placed into service in its current state, as well as the determination that the statute of limitations on any contractual obligation had expired.

 

Interest and Other Income

 

Interest and other income decreased approximately 30% from $2.4 million in 2013 to $1.7 million in 2014, primarily as a result of lower principal balances outstanding on the Global notes during the period, offset by a $225 thousand prepayment penalty and the recognition of $47 thousand in unamortized origination fees due to the early payoff of the Global 2013 Note in December 2014.

 

Impairment Loss on Investment in Global

 

Due to the fair market value of our investment in Global being lower than our cost basis as a result of the continued decline in Global's share price, we determined that the impairment was other than temporary and recognized an impairment loss of $937 thousand at December 31, 2014. No impairment related to this investment was recognized during 2013.

 

Gain on Disposal of Discontinued Operations

 

We recognized an additional gain on the 2011 disposal of our Gulf Coast oil and gas properties of $41 thousand in 2014 primarily as a result of an unanticipated refund of a drilling prepayment related to retained plugging and abandonment costs. No gain or losses were recognized on this disposal in 2013.

 

Loss from Discontinued Operations

 

Our loss from discontinued operations increased from $471 thousand in 2013 to $3.4 million in 2014. This is primarily a result of the $3.1 million contingency recorded during the third quarter 2014 and the $65 thousand contingency recorded in the fourth quarter 2014 related to the Main Pass Environmental Investigations. In addition, we continued to incur additional legal costs for litigation and regulatory matters during 2014 and 2013 related to the oil and gas properties we sold in 2011.

 

Accrual of Dividends Related to Preferred Stock

 

All of our preferred stock issues contain dividend provisions. Dividends related to all of our preferred stock are cumulative and may be paid in cash or common stock at our option, depending on the respective preferred agreement. We accrue the dividends at their cash liquidation value and reflect the accrual of dividends as an increase to net loss to arrive at net loss attributed to common stock. Accrual of dividends related to preferred stock for each of the two years ended December 31, are as follows:

  

				2014				2013
	Series G1			$	7,422			$	8,000
	Series G2				7,422				8,000
	Total			$	14,844			$	16,000

 

Payments of Preferred Stock Dividends and Preferred Stock Repurchases

 

At December 31, 2014 and 2013 the following shares of our Preferred Stock issuances were outstanding:

  

				2014				2013
	Series G1				—				1,000
	Series G2				—				1,000
	Total				—				2,000

 

Payment of Preferred Stock Dividends -- During 2014, we paid the accrued dividends related to the Series G1 and Series G2 preferred stock with 2 shares of our common stock and approximately $7 thousand in cash for the accrued, unpaid dividends included in the repurchase of the preferred stock in December 2014. During 2013, we paid the accrued dividends related to the Series G1 and Series G2 preferred stock with shares of our common stock and issued 4 shares of our common stock as payment for the accrued dividends. The difference between the fair value of the shares of our common stock and the carrying value of the dividend liability, net of withholding taxes paid on behalf of the preferred shareholders, is considered a debt extinguishment gain of $15 thousand and $16 thousand in 2014 and 2013, respectively, and is reflected as a gain on payments of dividends of preferred stock as a decrease to net loss to arrive at net loss attributed to common stock. The net effect of these payments of preferred stock dividends for the two years ended December 31, is as follows:

 

				2014				2013
	Series G1			$	7,352			$	8,000
	Series G2				7,352				8,000
	Total			$	14,704			$	16,000

 

Preferred Stock Repurchases -- In December 2014, we repurchased all outstanding shares of our Series G1 and Series G2 preferred stock for $80 thousand. This transaction resulted in a net loss of $78 thousand and is reflected as a loss on payments of dividends of preferred stock as an increase to net loss to arrive at net loss attributed to common stock.

 

 

LIQUIDITY AND CAPITAL STRUCTURE

 

Financial Condition

 

		December 31,
(Thousands of dollars)		2014				2013
Current ratio			3.17 to 1				5.76 to 1
Working capital (1)		$	10,214			$	12,275
Total debt (2)		$	63			$	—
Total cash less debt		$	14,439			$	14,302
Total stockholders' equity		$	30,086			$	63,577
Total liabilities to equity			0.16 to 1				0.05 to 1

(1)

Working capital is the difference between current assets and current liabilities.

(2)

Excludes capital lease obligations.

 

Cash on hand was primarily generated from proceeds from our oil and gas property divestitures and the rights offering to our stockholders, both of which occurred during 2011. These proceeds have been used to develop our BWI and HBI assets as well as to support our Global investment. The decrease in our working capital as of December 31, 2014 as compared to December 31, 2013 is primarily due to an increase in current liabilities as a result of recognizing $3.2 million in environmental contingencies related to our discontinued operations in 2014, the addition of $441 thousand in short term capital lease obligations and $48 thousand in short term note payable obligations in 2014, offset by a $1.4 million reduction in accounts payable and accrued liabilities, a $88 thousand decrease in accrued liabilities related to our discontinued operations and a $74 thousand increase in prepaid and other current assets in 2014.

 

We used approximately $7.6 million for capital expenditures during 2014 for Arctic Star plant construction, installation and commissioning. We anticipate it will cost a total of approximately $16 million to complete the construction and commissioning of the Arctic Star plant, of which approximately $15.6 million has been spent through December 31, 2014.

 

We anticipate our cash balance on hand will adequately fund our 2015 operating cash flow. We also anticipate that we will have access to other capital resources, if needed, to fund our planned capital expenditures and other investing activities.

 

We may continue to deploy cash to acquire or invest in other energy-related businesses, to acquire securities, or for discretionary capital expenditures. We may also decide to pay dividends to our common shareholders, subject to our ability to pay dividends and to a determination by management and our Board of Directors that dividends are in our best interests and those of our shareholders.

 

We may also seek to raise financing through the issuance of equity, debt and convertible debt instruments, if needed, for utilization of acquisition, development or investment opportunities as they arise. Additionally, we may reduce our ownership interests in any of our investments through strategic sales under certain conditions.

 

Significant Ownership of our Stock

 

As of December 31, 2014, Everest Hill Group, Inc. (“Everest Hill”) beneficially owned approximately 68% of the combined voting power of our outstanding common stock. This entity is beneficially owned by Wayne Quasha through the AQ, JQ and WQ Trusts. Mr. Alan Quasha, Chairman of the Board of Directors of HKN, is the brother of Wayne Quasha, who is deemed the beneficial owner of Everest Hill, but Mr. Alan Quasha disclaims any beneficial ownership of these shares. Everest Hill is in a position to exercise significant influence over the election of our Board of Directors and other matters.

 

Cash Flows

 

Net cash used in operating activities during the year ended December 31, 2014 was $2.4 million, as compared to $622 thousand in 2013. Net cash used in continuing operations increased from $529 thousand to $2.4 million. This increase was primarily a result of a $805 thousand increase in cash adjusted losses and an approximate $1.1 million increase in cash used for operating capital. Cash used by discontinued operations decreased from $93 thousand in 2013 to $41 thousand in 2014.

 

Net cash provided by investing activities during the year ended December 31, 2014 was $3.8 million, as compared to cash used of $1.4 million in 2013. Cash provided by investing activities in 2014 is primarily comprised of $12 million in repayments on the Global 2013 Note and proceeds of $271 thousand from properties sold pursuant to the final dissolution of Gerrity Oil, partially offset by $7.6 million in capital expenditures for BWI, $330 thousand in capital expenditures for HBI and $422 thousand for the purchase of shares of Global. Cash used in investing activities in 2013 was primarily the result of $5.9 million in capital expenditures for BWI and $598 thousand for HBI, partially offset by $5 million in repayments and the $340 thousand origination fee on the Global 2013 Note.

 

Net cash used in financing activities during the year ended December 31, 2014 was $1.2 million, as compared to $3 million in 2013. Cash used in financing activities in 2014 was primarily related to $847 thousand to repurchase and retire approximately 11 thousand of our outstanding common shares, $80 thousand to repurchase all outstanding Series G1 and G2 preferred shares and $245 thousand in principal payments on our notes payable and capital leases held by our Arctic Star subsidiary. We used cash for financing activities in 2013 to repurchase and retire approximately 33 thousand of our outstanding common shares.

 

Obligations, Contingencies and Commitments

 

XPLOR Energy Litigation – Pursuant to a PSA dated as of November 17, 2011 between our subsidiary XPLOR and TPIC, XPLOR sold to TPIC its oil and gas production assets and related operations at its Main Pass 35 field.  The closing of the transaction occurred on November 17, 2011 but was effective as of October 1, 2011.  On November 21, 2011, TPIC informed XPLOR that they had discovered defects in the salt water disposal system at Main Pass resulting in a salt water spill in the Gulf of Mexico, which had been reported to regulatory authorities. 

 

TPIC has filed a lawsuit against XPLOR in the 236^th Judicial District Court, Tarrant County, Texas. The case is styled: Texas Petroleum Investment Company vs. XPLOR Energy SPV-1, Inc., Richard Cottle, Sarah Gasch, and John Hewitt. In the lawsuit, TPIC has asserted claims of fraud, fraudulent inducement, negligent misrepresentation, and indemnity related to its purchase of a production platform and associated assets from XPLOR. TPIC’s claims focus on alleged salt water system defects, related repairs to the facilities, and purported representations regarding the condition of the platform and associated assets. TPIC is seeking an unstated amount of alleged actual and exemplary damages as well as costs and fees. Although litigation is inherently uncertain, based upon the information known to date, we do not believe TPIC’s civil, contractual and fraud claims have merit. We intend to vigorously defend any assertions related to the above lawsuit. Accordingly, as of December 31, 2014, we did not record a contingency related to TPIC’s allegations. Based upon information known to date, the range of estimated loss if TPIC were to prevail on its claims is currently estimated not to exceed $2.5 million in damages, costs, and fees.

 

Main Pass Environmental Investigations – In January 2013, we were notified by the Louisiana Department of Environmental Quality (“LDEQ”) of an investigation and potential penalty related to the TPIC allegations of improper salt water disposal at the Main Pass 35 field previously owned by our subsidiary XPLOR Energy SPV-1, Inc. and previously operated by our subsidiary, XPLOR Energy Operating Company.  The matter is styled: In the Matter of Xplor Energy Operating Company, Louisiana Division of Administrative Law Docket No. 2014-2388-EQ, Louisiana Department of Environmental Quality (“LDEQ”) Tracking No. WE-CN-12-01101. In October 2014, a telephone status conference was held with the LDEQ and the Administrative Law Judge (“ALJ”) handling this matter, and the Company held a subsequent meeting at the LDEQ offices during November 2014. Following these meetings, the parties agreed to pursue settlement discussions and are currently engaged in this process. At December 31, 2014, we have a $65 thousand contingency within liabilities of discontinued operations in our consolidated balance sheets related to these investigations.

 

In March 2013, we were advised that the U.S. Environmental Protection Agency (“EPA”) was undertaking a criminal investigation of the salt water disposal incident. In June 2014, we began discussions with the U. S. Attorney’s Office in New Orleans, Louisiana with regard to resolving any potential allegations against XPLOR. On September 15, 2014, the U.S. Attorney’s Office filed a Bill of Information with the U.S. District Court for the Eastern District of Louisiana (the “Court”) alleging that XPLOR knowingly violated The Federal Water Pollution Control Act (the “Clean Water Act”) at its Main Pass operations. Subject to the Court’s acceptance and to avoid the risks, uncertainties, costs and other burdens of litigation, we agreed with the U. S. Attorney’s Office to enter into a plea agreement reflecting a payment of $3.1 million in settlement of one felony count of a knowing violation of the Clean Water Act. At a hearing on November 19, 2014, Xplor pled guilty to that felony count pursuant to the plea agreement. The sentencing hearing in this matter is scheduled for March 4, 2015. Accordingly, at December 31, 2014, we have a $3.1 million contingency within liabilities of discontinued operations in our consolidated balance sheets related to these investigations.

 

Point Au Fer Lawsuit – During the second quarter 2013, we learned HKN, Inc. was named in a lawsuit filed in the 32nd Judicial District Court for the Parish of Terrebonne, Louisiana by Point Au Fer, L.L.C., and The Roman Catholic Church of the Archdiocese of New Orleans.  The case is styled: Point Au Fer, L.L.C., and The Roman Catholic Church of the  Archdiocese of New Orleans v. ExxonMobil Oil Corporation, et al, No. 169160. In the lawsuit, the plaintiffs have alleged that real property they own in Terrebonne Parish has been environmentally damaged as a result of oil and gas exploration activities of twenty different defendants.  The plaintiffs seek damages for testing and remediation of the property, property stigma, loss of use of land and lost profits, civil fruits for defendants trespass, land loss and subsidence, punitive or exemplary damages and attorney’s fees. Per Louisiana law, no actual dollar amount of damages has been alleged in the Petition. With specific regard to HKN, Inc., out of over one hundred wells identified in the Petition, HKN, Inc. only drilled one well, the MA Smythe Nelson #1, which was a dry hole. The MA Smythe Nelson #1 was drilled on June 2, 1980 and plugged and abandoned on July 12, 1980.  We have and intend to continue to vigorously defend any assertions related to the above lawsuit. Due to the inherent uncertainties of the lawsuit at this time, we cannot accurately predict the ultimate outcome of the matter. Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

Point a la Hache Lawsuit – During the second quarter 2013, we learned XPLOR Energy Operating Company and XPLOR Energy SPV-1, Inc. were named in a lawsuit filed in the 25^th Judicial District Court for the Parish of Plaquemines, Louisiana. The case is styled: Catherine P. Alford et al. v. BP America Production Company, et al., Docket No. 60-479. In the lawsuit, eight plaintiffs have sued 25 defendants, alleging that they own and/or use a certain 4,480 acres located in the Pointe a la Hache oil and gas field.  Plaintiffs further allege that the property has been contaminated or otherwise damaged by oil and gas exploration and production activities.  Per Louisiana law, no actual dollar amount of damages has been alleged in the Petition. On March 18, 2014, prior to the hearing on defendants’ exceptions, plaintiffs filed a motion to dismiss the lawsuit in its entirety. The court signed the order dismissing all claims against the defendants on March 27, 2014, and the case is now closed. Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

SLFPA-E Litigation – Plaintiffs South Louisiana Flood Protection Authority—East (“SLFPA-E”) filed this lawsuit in Louisiana state court against over 90 oil and gas and pipeline companies.  Generally the lawsuit alleges that activities by defendants—primarily but not exclusively the dredging of canals—have made it more difficult for the SLFPA-E to protect the New Orleans metropolitan area from flooding.  The petition alleges that HKN, Inc. is "by virtue of [one or more of] mergers, acquisitions, name changes, etc., responsible for" the actions of Tejas Power Corporation, which is alleged to have obtained in the 1980s certain dredging permits and rights of way.  HKN, Inc. disputes that it is responsible for any actions of Tejas Power Corporation.  The public record appears to suggest that Tejas Power Corporation may have been a subsidiary of Harken Oil and Gas, Incorporated (a previous name of HKN, Inc.) for a few years in the 1980s and 1990s.  However, there appears to be nothing to indicate that HKN, Inc. would have liability for the actions of Tejas Power Corporation, which continued to exist after HKN, Inc. no longer had any interest in Tejas Power Corporation. Defendants removed the case to federal court and the plaintiff filed a motion to remand the case back to state court.  On June 27, 2014, the Judge issued an Order denying remand to state court. A status conference was held on August 6, 2014, and the Defendants filed a Joint Motion to Dismiss during September 2014.  Oral arguments with respect to this motion were held before the court on November 12, 2014.  On February 13, 2015, the court signed an order ruling in favor of the Defendants and dismissing all claims.  Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

Louisiana Limited Scope Audit – In April 2012, we received notice from the State of Louisiana’s Department of Revenue that our discontinued oil and gas subsidiary, XPLOR Energy Operating Company, was the subject of a limited scope sales tax audit focused on the company’s on-site use and consumption of lease gas in connection with its lease, gathering and pipeline operations from January 1, 2006 through June 30, 2009. The Louisiana Department of Revenue issued a preliminary assessment, or “Notice of Proposed Tax Due,” preliminarily assessing sales tax of $194 thousand and related penalties and interest of $157 thousand, resulting in a total assessment of $351 thousand. In July 2012, we filed an audit protest with the Louisiana Department of Revenue challenging the preliminary assessment, as we do not agree with the legal basis of the assessment or the methodology in which the taxes were calculated and plan to vigorously defend our position. Due to the inherent uncertainties of the audit protest and preliminary assessment, we cannot accurately predict the ultimate outcome of the matter. Accordingly, at December 31, 2014, we did not record a contingency related to this matter. In the event of a negative outcome, the potential loss related to the audit and preliminary assessment is currently estimated not to exceed $351 thousand.

 

BWI Contingency – BWI had a contingent liability of $800 thousand at December 31, 2013 which would have been payable upon the conclusion of certain performance events related to its weathered lagoon plant. As of December 31, 2014, this contingency was reversed and a gain on contingency was recognized. The reversal was recorded due to the expectation that the plant will not be placed into service in its current state, as well as the determination that the statute of limitations on the contractual obligation had expired.

 

Consolidated Contractual Obligations – The following table presents a summary of our consolidated contractual obligations and commercial commitments as of December 31, 2014 (in thousands):

 

		Payments Due by Period
Contractual Obligations (1)		2015				2016				2017				2018				Thereafter				Total
Operating Lease Obligations (2)		$	326			$	295			$	139			$	—			$	—			$	760
Capital Lease Obligations (3)			572				173				—				—				—				745
Total Contractual Cash Obligations		$	898			$	468			$	139			$	—			$	—			$	1,505

_____________________

(1)

As of December 31, 2014, we had no material purchase obligations.

(2)

Consists of our corporate office lease, subsidiary office leases and a site lease for the Arctic Star project.

(3)

Consists of two equipment leases related to the Arctic Star project.

 

Off-Balance Sheet Arrangements - As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2014, we were not involved in any unconsolidated SPE transactions and we have no off-balance sheet arrangements.

 

Treasury Stock – At December 31, 2014 and 2013, we held no shares of treasury stock. In January 2013, we announced that our Board of Directors authorized the cancellation of our September 2005 stock repurchase plan and authorized a new stock repurchase program which allows us to buy back up to 45 thousand shares of our common stock. During 2014, we purchased and retired approximately 11 thousand shares of our common stock for approximately $847 thousand. As of December 31, 2014, approximately 582 shares remained available for repurchase under our repurchase program.

 

Adequacy of Capital Sources and Liquidity

 

We believe that we will have the ability to provide for our operational needs, our planned capital expenditures, estimated contingencies and possible investments through projected operating cash flow and cash on hand. Our operating cash flow has been adversely affected by cost increases and delays in the construction and commissioning of the Arctic Star plant for BWI and lower than anticipated return on our HBI oil and gas assets. To address this challenge, we continue to minimize our controllable costs until BWI begins revenue generation. We also continue to seek operating assets which will generate cash from operations. Should projected operating cash flow not materialize, we may reduce HBI capital expenditures and future investments and/or consider the issuance of debt, equity and convertible debt instruments, if needed, for utilization in planned capital expenditures and new energy-based investment opportunities. All of our HBI and BWI capital expenditures, purchases of Global stock and treasury stock repurchases are purely discretionary and may be curtailed or delayed at any time. We may also reduce our ownership interest in any of our investments through strategic sales.

 

Our debt outstanding at December 31, 2014 consists of two capital lease obligations for a total of $604 thousand and notes payable of $63 thousand. Both of the capital leases carry a minimum two year lease period and include options to renew and/or purchase the leased property. If we seek to raise other equity or debt financing to fund capital expenditures or other acquisition and development opportunities, those transactions may be affected by the market value of our common stock. If the price of our common stock declines, our ability to utilize our stock either directly or indirectly through convertible instruments for raising capital could be negatively affected. Further, raising additional funds by issuing common stock or other types of equity securities could dilute our existing stockholders, and dilution could be substantial if the price of our common stock decreases. Any securities we issue may have rights, preferences and privileges that are senior to our existing equity securities. Borrowing money may also involve pledging some or all of our assets.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The following financial statements appear on pages 31 through 60 in this Annual Report.

		Page
Report of Independent Registered Public Accounting Firm		31
Consolidated Balance Sheets -- December 31, 2014 and 2013		32
Consolidated Statements of Operations --
Years ended December 31, 2014 and 2013		33
Consolidated Statements of Comprehensive Loss --
Years ended December 31, 2014 and 2013		34
Consolidated Statements of Stockholders’ Equity --
Years ended December 31, 2014 and 2013		35
Consolidated Statements of Cash Flows --
Years ended December 31, 2014 and 2013		36
Notes to Consolidated Financial Statements		37

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Board of Directors and Stockholders

HKN, Inc.

 

We have audited the accompanying consolidated balance sheets of HKN, Inc. and subsidiaries (collectively, the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HKN, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the then ended, in conformity with U.S. generally accepted accounting principles.

 

 

 

/s/ Hein & Associates LLP

Dallas, Texas

March 3, 2015

 

 HKN, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except for share and per share amounts)

          

		December 31,				December 31,
		2014				2013
Assets
Current Assets:
Cash and cash equivalents		$	14,502			$	14,302
Accounts receivable			138				334
Assets of discontinued operations, net of allowance of $158 thousand at
December 31, 2014 and 2013			—				6
Prepaid expenses and other current assets			288				214
Total Current Assets			14,928				14,856
Oil and gas property, using the successful efforts method of accounting			2,774				4,450
Arctic Star plant			611				—
Construction in progress - Arctic Star plant			5,736				8,833
Weathered lagoon plant			79				6,236
Office equipment and other			356				305
Accumulated depreciation and depletion			(1,304	)			(781	)
Total Property and Equipment, net			8,252				19,043
Intangible assets, net			1,462				1,667
Long term note receivable - related party, net of deferred transaction fees
of $177 thousand at December 31, 2013			—				11,823
Investment in Global			9,979				19,312
Other assets			359				259
Total Assets		$	34,980			$	66,960
Liabilities and Stockholders' Equity
Current Liabilities:
Trade payables		$	329			$	838
Liabilities of discontinued operations			3,237				160
Notes payable - short term			48				—
Capital lease obligation - short term			441				—
Accrued liabilities and other			659				1,583
Total Current Liabilities			4,714				2,581
Asset retirement obligation			2				2
Notes payable - long term			15				—
Capital lease obligation - long term			163				—
BWI contingency			—				800
Total Liabilities			4,894				3,383
Contingencies (Note 2 and 15)
Stockholders’ Equity:
Series G1 convertible preferred stock, $1.00 par value; $100,000 liquidation value;
700,000 shares authorized; no shares outstanding at December 31, 2014			—				1
and 1,000 shares outstanding at December 31, 2013
Series G2 convertible preferred stock, $1.00 par value; $100,000 liquidation value;
100,000 shares authorized; no shares outstanding at December 31, 2014			—				1
and 1,000 shares outstanding at December 31, 2013
Common stock, $0.01 par value; 2,000,000 shares authorized;
390,916 and 401,943 shares issued and outstanding, respectively			4				4
Additional paid-in capital			449,762				450,394
Accumulated deficit			(419,680	)			(395,643	)
Accumulated other comprehensive income			—				8,820
Total Stockholders' Equity			30,086				63,577
Total Liabilities and Stockholders' Equity		$	34,980			$	66,960

 

The accompanying Notes to Consolidated Financial Statements are

an integral part of these Statements.

 

HKN, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for share and per share amounts)

          

		Year Ended December 31,
		2014				2013
Revenues:
Oil and gas operations		$	988			$	1,093
Total revenues			988				1,093
Operating costs and expenses:
Oil and gas operating			218				209
Selling, general and administrative			3,862				3,520
Depreciation, depletion and amortization			807				743
Impairment losses			18,129				—
Gain on BWI contingency			(800	)			—
Total operating costs and expenses			22,216				4,472
Loss from operations			(21,228	)			(3,379	)
Other income and expenses:
Interest and other expenses			(166	)			(36	)
Interest and other income - related party			1,608				2,250
Interest and other income			80				163
Impairment loss on investment in Global			(937	)			—
Total other income			585				2,377
Loss from continuing operations			(20,643	)			(1,002	)
Gain on disposal of discontinued operations			41				—
Loss from discontinued operations			(3,357	)			(471	)
Net loss			(23,959	)			(1,473	)
Accrual of dividends related to preferred stock			(15	)			(16	)
Payment of preferred stock dividends and repurchase of preferred stock			(63	)			16
Net loss attributed to common stock		$	(24,037	)		$	(1,473	)
Loss per common share from continuing operations		$	(52.66	)		$	(2.46	)
Loss per common share from discontinued operations			(8.43	)			(1.15	)
Net loss per common share, basic and diluted		$	(61.09	)		$	(3.61	)
Weighted average common shares outstanding:
Basic and diluted			393,497				408,166

 

The accompanying Notes to Consolidated Financial Statements are

an integral part of these Statements.  

HKN, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

              

		Year Ended December 31,
		2014				2013
Net loss		$	(23,959	)		$	(1,473	)
Foreign currency translation adjustments			(548	)			160
Unrealized loss on investments			(9,209	)			(4,626	)
Impairment loss recognized on investment in Global			937				—
Other comprehensive loss			(8,820	)			(4,466	)
Comprehensive loss		$	(32,779	)		$	(5,939	)

 

The accompanying Notes to Consolidated Financial Statements

are an integral part of these Statements.

 

HKN, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)

                                

																										Accumulated
														Additional												Other
			Preferred Stock								Common				Paid-In				Treasury				Accumulated				Comprehensive
			G1				G2				Stock				Capital				Stock				Deficit				Income				Total
Balance, December 31, 2012		$	1			$	1			$	4			$	453,300			$	—			$	(394,170	)		$	13,286			$	72,422
Stock-based compensation expense			—				—				—				60				—				—				—				60
Accrual of preferred stock dividends			—				—				—				—				—				(16	)			—				(16	)
Issuance of preferred stock dividends			—				—				—				—				—				16				—				16
Treasury stock repurchase			—				—				—				—				(2,966	)			—				—				(2,966	)
Treasury stock retirements			—				—				—				(2,966	)			2,966				—				—				—
Comprehensive loss:
Net loss																							(1,473	)
Unrealized loss on available for sale investments																											(4,626	)
Unrealized foreign currency gain																											160
Total comprehensive loss																															(5,939	)
Balance, December 31, 2013		$	1			$	1			$	4			$	450,394			$	—			$	(395,643	)		$	8,820			$	63,577
Stock-based compensation expense			—				—				—				212				—				—				—				212
Accrual of preferred stock dividends			—				—				—				—				—				(15	)			—				(15	)
Issuance of preferred stock dividends			—				—				—				—				—				15				—				15
Preferred stock repurchase			(1	)			(1	)			—				—				—				(78	)			—				(80	)
Treasury stock repurchase			—				—				—				—				(847	)			—				—				(847	)
Treasury stock retirements			—				—				—				(847	)			847				—				—				—
Other			—				—				—				3				—				—				—				3
Comprehensive loss:
Net loss																							(23,959	)
Unrealized loss on available for sale investments																											(9,209	)
Unrealized foreign currency loss																											(548	)
Impairment loss recognized on investment in Global																											937
Total comprehensive loss																															(32,779	)
Balance, December 31, 2014		$	—			$	—			$	4			$	449,762			$	—			$	(419,680	)		$	—			$	30,086

 

The accompanying Notes to the Consolidated Financial Statements

are an integral part of these Statements.

 

HKN, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

            

		Year Ended December 31,
		2014				2013
Cash flows from operating activities:
Net loss		$	(23,959	)		$	(1,473	)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation, depletion and amortization			807				743
Stock-based compensation expense			212				60
Gain on disposal of discontinued operations			(41	)			—
Loss contingency on discontinued operations			3,165				—
Gain on sale of assets			(30	)			(25	)
Amortization of note receivable - related party transaction fee			(177	)			(282	)
Impairment losses			19,066				—
Gain on BWI contingency			(800	)			—
Other			—				(5	)
Change in operating assets and liabilities:
Accounts receivable and accounts receivable - related party			158				(141	)
Prepaid assets and other			(37	)			(97	)
Trade payables and other			(753	)			691
Net cash used in operating activities - continuing operations			(2,389	)			(529	)
Net cash used in operating activities - discontinued operations			(41	)			(93	)
Net cash used in operating activities			(2,430	)			(622	)
Cash flows from investing activities:
Capital expenditures			(7,997	)			(6,618	)
Purchase of Global shares			(422	)			(171	)
Net proceeds from sales of assets			271				53
Origination fee from note receivable - related party restructuring			—				340
Repayment of note receivable - related party			12,000				5,000
Change in restricted cash			(50	)			—
Net cash provided by (used in) investing activities			3,802				(1,396	)
Cash flows from financing activities:
Principal payments on note payable obligations			(17	)			—
Principal payments on capital lease obligations			(228	)			—
Preferred stock repurchased			(80	)			—
Purchase of treasury stock			(847	)			(2,966	)
Net cash used in financing activities			(1,172	)			(2,966	)
Net increase (decrease) in cash and cash equivalents			200				(4,984	)
Cash and cash equivalents at beginning of period			14,302				19,286
Cash and cash equivalents at end of period		$	14,502			$	14,302
Supplemental cash disclosures:
Cash paid for interest		$	150			$	—
Noncash financing activities:
Equipment acquired through capital lease obligations		$	844			$	—

 

The accompanying Notes to Consolidated Financial Statements

are an integral part of these Statements.

 

HKN, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Our business strategy is focused on enhancing value for our shareholders through the development of a well-balanced portfolio of assets in the energy industry. Currently, the majority of the value of our assets is derived from our investment in publicly-traded ordinary shares of Global Energy Development PLC (“Global”) and our wholly-owned subsidiaries, BriteWater International, Inc. (“BWI”), HKN Bakken, Inc. (“HBI”) and HTH, Inc. (“HTH”).

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates and such differences could be material. Certain prior year amounts have been reclassified to conform with the 2014 presentation.

 

Principles of Consolidation – The consolidated financial statements include the accounts of all companies that we, through our direct or indirect ownership or shareholding, were provided the ability to control their operating policies and procedures. All significant intercompany balances and transactions have been eliminated.

 

As a result of the sales of our Gulf Coast oil and gas properties and the abandonment of our coalbed methane projects during 2011, any remaining Gulf Coast oil and gas and coalbed methane activities are included as discontinued operations on the consolidated balance sheets, consolidated statements of operations and consolidated statements of cash flows for all periods presented.

 

Statement of Cash Flows - For purposes of the consolidated statements of cash flows, we consider all highly liquid investments and treasury bills purchased with an original maturity of three months or less to be cash equivalents. Cash paid for interest during 2014 was $150 thousand and no interest was paid for 2013. No income taxes were paid for the years ended December 31, 2014 and 2013.

 

Concentrations of Credit Risk - Although our cash and cash equivalents and accounts receivable are exposed to potential credit loss, we do not believe such risk to be significant. Cash and cash equivalents include investments in money markets placed with highly rated financial institutions.

 

Accounts Receivable and Allowance for Doubtful Accounts – Trade accounts receivable are customer obligations due under normal trade terms. We had $131 thousand and $285 thousand in trade receivables related to oil and gas production at December 31, 2014 and 2013, respectively. We had other accounts receivable of $7 thousand and $49 thousand at December 31, 2014 and 2013, respectively.

 

Senior management reviews accounts receivable to determine if any receivables will potentially be uncollectible. We include provisions for any accounts receivable balances that are determined to be uncollectible in the allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. However, actual write-offs could exceed the recorded allowance. We recorded an allowance within our Assets of Discontinued Operations of $2 thousand for a potentially uncollectible account related to our discontinued operations during the year ended December 31, 2013. No allowance has been recognized on our accounts receivable as of December 31, 2014.

 

 Accumulated Other Comprehensive Income – Comprehensive income includes changes in stockholders’ equity during the periods that do not result from transactions with stockholders. Changes in our accumulated other comprehensive income during the period are as follows (in thousands): 

 

		Accumulated Other Comprehensive Income as of December 31, 2013				Current Period Unrealized Loss				Impairment (Gain) Loss Recognized on Investment in Global				Accumulated Other Comprehensive Income as of December 31, 2014
Investment in Global		$	7,605			$	(9,209	)		$	1,604			$	—
Foreign Currency Translation Adjustments			1,215				(548	)			(667	)			—
		$	8,820			$	(9,757	)		$	937			$	—

 

Fair Value of Financial Instruments – Financial instruments are stated at fair value as determined in good faith by management. Factors considered in valuing individual investments include, without limitation, available market prices, reported net asset values, marketability, restrictions on disposition, current financial position and operating results, and other pertinent information. See Note 7 – “Fair Value Measurements” for more information.

 

We carry our financial instruments, which include cash, restricted cash and our common stock investment in Global at their estimated fair values. Our investment in ordinary shares of Global has been designated as available for sale rather than a trading security. The associated unrealized gains and losses on our available for sale investment are recorded to other comprehensive income until realized and reclassified into earnings using specific identification. The fair value of our investment in the ordinary shares of Global is based on prices quoted in an active market. Our investment in Global is classified as a non-current asset in our accompanying consolidated balance sheets.

 

Translation of Non-U.S. Currency Amounts – Our investment in Global is subject to foreign currency exchange rate risk as Global’s ordinary shares are denominated in British pounds sterling. Translation adjustments are recorded to other comprehensive income until realized through sale or impairment and reclassified into earnings.

 

BWI Property and Equipment – Project costs that are clearly associated with the acquisition, development and construction of a plant are capitalized as costs of that project. In addition, indirect project costs that are identified with a specific project, including selling, general and administrative expenses, are capitalized and allocated to the project to which the costs relate. Overhead costs and costs incurred after the project is ready for its intended use are charged to expense as incurred.

 

The BWI weathered lagoon plant within property and equipment on our consolidated balance sheets has not been depreciated as of December 31, 2014, as it has not been placed in service as of the date of these financial statements. We determined that as a result of current oil pricing and the age of the plant, we would not likely deploy and operate the BWI weathered lagoon plant for its intended purpose. As a result, we wrote down the book value of this plant to its estimated salvage value, resulting in an impairment loss of $6.1 million as a component of operating expenses within our consolidated statements of operations as of December 31, 2014. After impairment, the new cost basis of the BWI weathered lagoon plant was $79 thousand. See Note 2 – “BriteWater International, Inc.” for more information.

 

In addition, Construction in Progress related to the BWI Arctic Star plant under development within property and equipment on our consolidated balance sheets is not subject to depreciation until commissioning is completed and it is placed into service. Due to current oil prices, the undiscounted cash flows of the Arctic Star plant were less than its carrying value. As a result, we determined that the Arctic Star plant would be unable to recover its investment at current pricing and recognized an impairment loss of $10.3 million as a component of operating expenses within our consolidated statements of operations as of December 31, 2014. After impairment, the new cost basis of Construction in Progress is $5.7 million. See Note 2 – “BriteWater International, Inc.” for more information. Once the Arctic Star plant is fully commissioned and placed into service, assets in Construction in Progress will be subject to depreciation.

 

During October 2014, the Arctic Star plant fully commissioned and placed in service capital leased tanks and related modifications and were thus subject to depreciation. These assets will be depreciated over the remaining term of the capital lease. We recorded depreciation expense of $108 thousand related to these capital leased assets and their modifications for the year ended December 31, 2014. Of this depreciation expense, $87 thousand was related to capital lease assets for the year ended December 31, 2014.

 

Capital Leases – During the second quarter 2014, we leased equipment for the Arctic Star plant under two separate capital leases which each have two year minimum lease terms. These leases include options to renew and/or purchase the leased property. At December 31, 2014, total assets acquired under capital leases were $844 thousand. Of this amount, $354 thousand was included in Construction in Progress and $490 thousand, net of accumulated amortization of $87 thousand, was included in the Arctic Star plant in our consolidated balance sheets.

 

At December 31, 2014, the total capital lease obligation was $604 thousand, of which $441 thousand was classified as a short-term liability and $163 thousand was classified as a long-term liability in our consolidated balance sheets. Capital lease interest expense was $165 thousand for the year ended December 31, 2014. The following is a schedule of remaining future minimum lease payments under capital leases (in thousands):

 

Year Ending December 31,
2015		$	572
2016			173
Total minimum lease payments			745
Less: Amount representing interest (1)			(141	)
Present value of minimum lease payments		$	604

__________________________

(1) Amount to reduce minimum lease payments to fair value as calculated by the imputed interest rate at lease inception since the present value of the minimum lease payments as calculated by the incremental borrowing rate exceeded fair value at inception of the leases.

 

Oil and Gas Properties – We use the successful efforts method of accounting for our HBI oil and gas activities. The significant principles for this method are:

 

• Geological and geophysical evaluation costs are expensed as incurred;
• Costs incurred to drill and equip all successful wells are capitalized;
• Dry holes for exploratory wells are expensed;
• Dry holes for development wells are capitalized;
• Capitalized costs related to proved oil and gas property leasehold costs are depleted over total proved oil and gas reserves; and
• Capitalized costs related to wells and related equipment and facilities costs are depreciated over proved developed reserves.

 

Estimates of proved oil and gas reserves directly impact financial accounting estimates including depreciation, depletion and amortization expense, evaluation of impairment of properties and the calculation of plugging and abandonment liabilities. Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods and government regulations. The process of estimating quantities of proved reserves is very complex, requiring significant subjective decisions in the evaluation of all geological, engineering and economic data for each reservoir. The data for any reservoir may change substantially over time due to results from operational activity.

 

Our liability for asset retirement obligations is determined using significant assumptions, including current estimates of plugging and abandonment costs, annual inflation of these costs, the productive lives of wells and our risk-adjusted interest rate. Changes in any of these assumptions can result in significant revisions to the estimated asset retirement obligation.

 

Capital amounts attributable to developed oil and gas properties are depleted by the unit-of-production method over proved reserves using the unit conversion ratio for gas of six Mcf of gas to one barrel of oil equivalent (“BOE”), and one barrel of NGLs to one BOE. Unproved properties are excluded from this calculation. Due to decreased oil prices, resulting in uneconomic conditions for certain wells in the Bakken play, and decreased investments anticipated in new wells, we recognized impairment losses of $1.4 million and $314 thousand on proved and unproved Bakken properties, respectively, in our consolidated statements of operations at December 31, 2014. After impairment, the new gross cost basis of the oil and gas properties is $2.8 million. Depreciation, depletion and amortization expense for oil and gas producing properties and related equipment was $411 thousand and $479 thousand for the years ended December 31, 2014 and 2013, respectively.

 

We use the sales method to recognize our oil and gas revenues. Under this method, revenues are recognized based on our interests in the actual volumes of gas and oil sold to purchasers.

 

Other Property and Equipment – Other property and equipment, which includes computer equipment, computer hardware and software, furniture and fixtures, leasehold improvements and automobiles, is recorded at cost and is depreciated on a straight-line basis over the estimated useful lives of the assets, ranging from 3 to 5 years. We recorded depreciation expense related to other property and equipment of $83 thousand and $59 thousand for the years ended December 31, 2014 and 2013, respectively.

 

Intangible Assets – Our intangible assets consist of patents acquired in connection with our investment in BWI. Our patents were valued at $2.6 million on their acquisition date and are amortized on a straight-line basis over a period of 6-21 years, based on their respective contractual lives. Accumulated amortization in the amount of $1.1 million has been recorded on these patents to date. We have recorded amortization expense related to these patents of $205 thousand for both the years ended December 31, 2014 and 2013, respectively. Patent annuity fees and legal fees related to the renewal of our existing patents are expensed as incurred and recorded within selling, general and administrative expenses in our consolidated statements of operations. The estimated future annual amortization of our patents over the next five years is as follows (in thousands):

 

Year				Amount
	2015			$	191
	2016				183
	2017				170
	2018				75
	2019				75
	Thereafter				768
	Total			$	1,462

 

Investment in Global – We do not account for our investment in Global as an equity method investment in spite of our 35% ownership. We are unable to obtain U.S. GAAP financial statements quarterly to perform equity method accounting due to the semi-annual reporting requirements Global follows under the AIM exchange rules. As a result, we account for Global as an available for sale investment.

 

Our policy is to review our investment in Global semi-annually or more often if any indicators of impairment become known. We continuously monitor macroeconomic indicators and track Global’s stock price volatility for any downward trends in the market. We also review public financial information including Global’s issued financial statements and investor presentations, as well as financial analysts’ reviews and recommendations for any indicators of an other than temporary impairment in our carrying value. We also assess internally our ability and intent to hold our investment in Global should the fair value drop below our cost. Any resulting other than temporary impairment would be immediately recognized in earnings. We recognized an other than temporary impairment of $937 thousand in our consolidated statements of operations at December 31, 2014. No such impairments were recognized during 2013.

 

Other Assets – At December 31, 2014, other assets included $289 thousand in prepaid drilling costs related to the drilling and completion of wells held by HBI, $20 thousand in deposits related to the Arctic Star site lease and facility and restricted cash of $50 thousand for a Letter of Credit required for the Arctic Star plant site lease.

 

Notes Receivable – Our notes receivable are stated at their outstanding principal balance, less any allowance for doubtful accounts and deferred transaction fees. Interest income is recognized as earned at the stated interest rate over the life of the loan. Transaction fees related to the notes are deferred and amortized using the effective interest method over the life of the loan and are recognized in interest income from related parties within our consolidated statements of operations. As of December 31, 2014 we had no notes receivable outstanding.

 

Stock-Based Compensation – We measure all stock-based compensation awards using a fair value method on the date of grant and recognize such expense in our consolidated financial statements over the requisite service period on a straight-line basis. We use the Black-Scholes formula to determine the fair value of stock-based compensation awards on the date of grant. The Black-Scholes formula requires management to make assumptions regarding the option lives, expected volatility, and risk free interest rates. Please see Note 11 – “BWI Stock Compensation” for additional information on our stock-based compensation plan.

 

Provisions for Asset Impairments - Assets that are used in our operations and not held for sale, are carried at cost, less accumulated depreciation and amortization. We review our long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When evidence indicates that operations will not produce sufficient cash flows to cover the carrying amount of the related asset, and when the carrying amount of the related asset cannot be realized through sale, a permanent impairment is recorded and the asset is written down to fair value.

 

Proved crude oil and natural gas properties are reviewed for impairment on a reservoir basis annually, or when events and circumstances indicate a possible decline in the recoverability of the carrying value of such reservoir. The estimated future cash flows expected in connection with the reservoir are compared to the carrying amount of the reservoir to determine if the carrying amount is recoverable. If the carrying amount of the reservoir exceeds its estimated undiscounted future cash flows, the carrying amount of the field is reduced to its estimated fair value.

 

Impairment losses totaling $18.1 million were recognized on long-lived assets used in our operations during the year ended December 31, 2014. Of this, $10.3 million was related to impairment of the Arctic Star plant, $6.1 million was related to the write down of the BWI weathered lagoon plant to its salvage value and $1.7 million was related to our oil and gas properties held by HBI. Please see Note 7 – “Fair Value Measurements” for more information on these impairments and related assumptions. No such impairments were recognized during 2013.

 

Accrued Liabilities and Other – At December 31, 2014, accrued liabilities and other included approximately $414 thousand in accrued capital costs related to the construction, installation and commissioning of the Arctic Star plant and approximately $121 thousand in accrued capital costs related to the drilling and completion of HBI wells under development.

 

Notes Payable – We had notes payable of $63 thousand at December 31, 2014 as a result of the purchase of a generator and insurance premiums for the Arctic Star plant, both of which were financed. The note payable for the generator has a two year term at zero percent interest. The note payable related to the insurance premiums has a ten month term and bears interest at approximately 2.4% of the initial note amount. Interest expense on the insurance premiums note was negligible for the year ended December 31, 2014.

 

Income Taxes – We account for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. We measure and record income tax contingency accruals in accordance with guidance related to uncertain tax positions.

 

We recognize liabilities for uncertain income tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as we must determine the probability of various possible outcomes. We reevaluate these uncertain tax positions on a quarterly basis or when new information becomes available to management. These reevaluations are based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, successfully settled issues under audit, expirations due to statutes, and new audit activity. Such a change in recognition or measurement could result in the recognition of a tax benefit or an increase to the tax accrual.

 

We classify interest related to income tax liabilities as income tax expense, and if applicable, penalties are recognized as a component of income tax expense. The income tax liabilities and accrued interest and penalties that are anticipated to be due within one year of the balance sheet date are presented as current liabilities in our consolidated balance sheets.

 

Loss Contingencies – Management continuously reviews with legal counsel the status of regulatory matters and pending or threatened litigation. With respect to all significant litigation matters, we consider the likelihood of a negative outcome. If we determine the likelihood of a negative outcome is probable and the amount of the loss can be reasonably estimated as of the date of the financial statements, we record an estimated loss for the expected outcome of the litigation. If the likelihood of a negative outcome is reasonably possible and we are able to determine an estimate of the possible loss or range of loss, we disclose that fact together with the estimate of the possible loss or range of loss. However, it is often difficult to predict the outcome or estimate a possible loss or range of loss because litigation is subject to inherent uncertainties, particularly when plaintiffs allege substantial or indeterminate damages. Such is also the case when the litigation is in its early stages or when the litigation is highly complex or broad in scope. In these cases, we disclose that we are unable to predict the outcome or estimate a possible loss or range of loss. We expense legal costs related to such loss contingencies as they are incurred.

 

Recent Accounting Pronouncements – In April 2014, FASB issued the Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This standard revises the definition of a discontinued operation to limit the circumstances under which a disposal or classification as held for sale qualifies for presentation as a discontinued operation. Amendments in this standard require expanded disclosures concerning a discontinued operation and the disposal of an individually-material component of an entity not qualifying as a discontinued operation. The standard is effective for annual and interim periods beginning on or after December 15, 2014 and should be applied prospectively, with early adoption permitted. We currently do not expect this standard to have any impact on our consolidated financial statements.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 on revenue from contracts with customers. Under this new standard, revenue is recognized at the time a good or service is transferred to a customer for the amount of consideration received for that specific good or service. The standard is effective for interim and annual periods beginning after December 16, 2016, and early adoption is not permitted. Adoption is allowed by either the full retrospective or modified retrospective approach. We are currently evaluating which approach we will apply and the impact, if any, that this standard will have on our consolidated financial statements.

 

In January 2015, FASB issued the Accounting Standards Update No. 2015-1, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Item. This standard eliminates from GAAP the concept of extraordinary items. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We currently do not expect this standard to have any impact on our consolidated financial statements.

 

(2) BRITEWATER INTERNATIONAL, INC.

 

BWI holds patents for oilfield emulsion breaking technology. This is a continuous process technology that can purify oilfield emulsions by breaking and separating the emulsions into oil, water and solids, thereby reducing the environmental impact and disposal costs of these waste materials while recovering valuable oil. This technology has been successfully tested in multiple refineries as well as in a demonstration in Prudhoe Bay, Alaska, all of which confirmed the effectiveness of the emulsion breaking technology to recover valuable hydrocarbons and reduce wastes. BWI has completed the design, construction and installation of standardized modules which can be configured for use in both upstream and downstream applications in the oil and gas industry, including processing oilfield and refinery emulsions to recover valuable oil and remediating oil spills.

 

BWI’s wholly-owned subsidiary, Arctic Star Alaska, Inc. (“Arctic Star”), BWI’s initial project to commercialize its emulsions-breaking technology, leased a site in Deadhorse, Alaska for its plant during the first quarter 2014. Arctic Star currently holds contracts which grant Arctic Star the option to take title to oilfield waste generated in six fields on the North Slope at no cost and sell any recovered crude volumes at market prices. The Company continued negotiations for additional feedstock supply agreements during 2014, one of which was obtained in April 2014 and two of which were obtained in January 2015. Arctic Star also entered into an agreement for the sale of 100% of its recovered hydrocarbons on the North Slope during April 2014. Construction was completed during the first quarter 2014 and the modules were shipped to the North Slope and installed during the second quarter 2014. Commissioning of the plant was substantially complete as of December 31, 2014. However, due to the seasonal drilling schedule in Alaska, feedstock needed to perform final test runs was not available as of December 31, 2014. As a result of this and due to the recent steep decline in oil prices, the plant is currently not economic. As a result, management does not expect to operate the Arctic Star plant until oil prices substantially recover.

 

As a result of the current decline in oil prices at December 31, 2014, we evaluated our BWI assets for recoverability. Using a probability weighted average income approach of different courses of actions available, we determined that the Arctic Star plant would be unable to recover its investment at current pricing and recognized an impairment loss of $10.3 million as a component of operating expenses within the BWI operating segment of our consolidated statements of operations as of December 31, 2014. No impairment was recognized on the Arctic Star plant during 2013. Please see Note 7 – “Fair Value Measurements” for more information on the method used to determine the fair value of this asset.

 

BWI also has a completed purpose-built plant which was designed to break emulsions found in weathered lagoon pits. We determined that as a result of current oil pricing and the age of the plant, we would not likely deploy and operate the BWI weathered lagoon plant for its intended purpose in the near future and, as a result, we wrote down the book value of this plant to its estimated salvage value, resulting in an impairment loss of $6.1 million as a component of operating expenses within the BWI operating segment of our consolidated statements of operations as of December 31, 2014. No impairment was recognized on the weathered lagoon plant during 2013. Please see Note 7 – “Fair Value Measurements” for more information on the method used to determine the fair value of this asset.

 

BWI Contingency – BWI had a contingent liability of $800 thousand at December 31, 2013 which would have been payable upon the conclusion of certain performance events related to its weathered lagoon plant. As of December 31, 2014, this contingency was reversed and a gain on contingency was recognized. The reversal was recorded due to the expectation that the plant will not be placed into service in its current state, as well as the determination that the statute of limitations on the contractual obligation had expired.

 

(3) HKN BAKKEN, INC.

 

HBI holds non-operated working and royalty interests in properties strategically located in the Bakken and Niobrara shale oil plays. We invested in these assets because we believe they may present near-term growth potential and align well with our long term investment goals. We continued to invest in HBI on a non-operated basis, in all phases of the oil and gas business, including participation in the drilling, completion, operation and maintenance of oil and gas wells. During the year ended December 31, 2014, we invested approximately $276 thousand in drilling and completion costs. Due to decreased oil prices and the current drilling and completion costs of wells in these plays, we plan to assess each drilling opportunity on a case-by-case basis and participate in wells that we expect to meet our return thresholds based upon our estimates of ultimate recoverable crude oil and natural gas, expertise of the operator and completed well costs from each project, as well as other factors, and participate on a discretionary basis during 2015.

 

Due to decreased oil prices, which resulted in uneconomic conditions for certain wells in the Bakken play and anticipated decreased investments in new wells, we recognized impairment losses of $1.4 million and $314 thousand on proved and unproved Bakken properties as a component of operating expenses within the HKN operating segment of our consolidated statements of operations for the year ended December 31, 2014. No impairment was recognized on these properties during 2013. Please see Note 7 – “Fair Value Measurements” for more information on the method used to determine the fair value of these assets.

 

During April 2014, we executed and closed on an agreement for the final dissolution of Gerrity Oil, LLC. In conjunction with this agreement, HBI sold its interest in four Bakken wells and a six acre parcel of land in Colorado for proceeds of approximately $271 thousand and recognized a gain on this sale of $47 thousand within interest and other income in our consolidated statements of operations.

 

(4) INVESTMENT IN GLOBAL

 

Our non-current available-for-sale investment consists of our ownership of approximately 35% of Global’s outstanding ordinary shares at December 31, 2014.

 

During 2014, we purchased an additional 343 thousand shares of Global for $422 thousand, increasing our ownership from 34.51% to 35.46%. During 2013, we purchased an additional 105 thousand shares of Global for $171 thousand. At December 31, 2014 and 2013, our investment in Global was equal to the market value of Global’s ordinary shares as follows (in thousands, except share amounts):

 

		December 31, 2014				December 31, 2013
Shares of Global Stock Held by HKN			12,805				12,462
Closing Price of Global Stock		£	0.50			£	0.94
Foreign Currency Exchange Rate			1.5586				1.6574
Market Value of Investment in Global		$	9,979			$	19,312

 

The foreign currency translation adjustment of approximately $548 thousand, the unrealized loss on investment of $9.2 million for the changes in market value between the two periods, and an other than temporary impairment loss of $937 thousand were recorded to other comprehensive income in stockholders’ equity during the year ended December 31, 2014.

 

The decrease in Global’s market value below our costs was previously determined to be temporary as of September 30, 2014 due to the recent nature of the decline and the increase in share price subsequent to the reporting date. However, as of December 31, 2014, we continued to have a cumulative unrealized loss position on our investment in Global. Therefore, we assessed the decline in market value again to determine whether it was considered a temporary or other than temporary impairment. Although we intend to hold the investment, after reviewing Global’s published operational updates and plans, the severity and duration of the decline and analyzing the historical price volatility and decreases in share price subsequent to this reporting date, we determined the impairment to be other than temporary as of December 31, 2014. As a result, we recognized an impairment loss of $937 thousand within the HKN operating segment of our consolidated statements of operations. No unrealized loss position existed at December 31, 2013 and no impairment was recognized on the investment in Global during 2013.

 

(5) NOTES RECEIVABLE – RELATED PARTY

 

In March 2013, we entered into a new loan agreement (the “Global 2013 Note”) with Global to refinance the outstanding $5 million Global Note Receivable and the $12 million Global Loan into one $17 million note. The Global 2013 Note extended the maturity date to June 15, 2015 and initially increased the interest rate from 12.5% to 12.75%. During September 2014, pursuant to provisions of the Global 2013 Note agreement, the interest rate charged was increased from 12.75% up to 13.5% due to Global’s nonconformity with performance conditions as of June 30, 2014. This new stated interest rate was to remain in effect until the maturity of the loan agreement. Beginning June 30, 2014, the Global 2013 Note was classified as a current asset because all quarterly payments on the Global 2013 Note had been received in accordance with the stated repayment terms, and we believed the remaining payments would also be made as scheduled.

 

In December 2014, Global announced it had completed the sale of its rights and obligations for its contract areas within the Llanos Basin. Global used a portion of the net sale proceeds to repay the Global 2013 Note. We received $7.5 million in outstanding principal, $225 thousand in prepayment penalty, $200 thousand in accrued interest and recognized the remaining $47 thousand of unamortized origination fees.

 

During the years ended December 31, 2014 and 2013, we received interest payments from Global of approximately $1.2 million and $2 million, respectively and recognized deferred origination fees of $177 thousand and $282 thousand, respectively.

 

(6) ASSET RETIREMENT OBLIGATION

 

We recognize the present value of asset retirement obligations beginning in the period in which they are incurred if a reasonable estimate of a fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. A summary of our asset retirement obligations as of December 31, 2014 is as follows (in thousands):

 

		Asset Retirement
Asset Category		Obligation				Estimated Life
Oil and gas producing properties		$	2	(1)		27.5 years

_______________

(1) This is a recurring Level 3 fair value measurement.

 

The following table describes all changes to our asset retirement obligation liability during the years ended December 31, 2014 and 2013 (in thousands):

 

		2014				2013
Asset retirement obligation at beginning of period		$	2			$	4
Additions during the period			—				1
Revisions of estimates			—				(3	)
Accretion expense			—				—
Asset retirement obligation at end of period		$	2			$	2

 

(7) FAIR VALUE MEASUREMENTS

 

We account for certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The accounting guidance establishes a framework for measuring fair value and a valuation hierarchy based upon the transparency of inputs used in the valuation of an asset or liability. Classification within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The valuation hierarchy contains three levels:

 

• Level 1 – Valuation inputs are unadjusted quoted market prices for identical assets or liabilities in active markets.

• Level 2 – Valuation inputs are quoted prices for identical assets or liabilities in markets that are not active, quoted market prices for similar assets and liabilities in active markets and other observable inputs directly or indirectly related to the asset or liability being measured.

• Level 3 – Valuation inputs are unobservable and significant to the fair value measurement.

Fair Values: Recurring – The following tables present recurring financial assets which are carried at fair value as of December 31, 2014 and 2013 (in thousands):

 

		December 31, 2014
		Level 1				Level 2				Level 3
Investment in Global (1)		$	9,979			$	—			$	—

 

		December 31, 2013
		Level 1				Level 2				Level 3
Investment in Global (1)		$	19,312			$	—			$	—

____________________________________________________

(1)

Global’s ordinary shares are publicly traded on the Alternative Investment Market (“AIM”), a market operated by the London Stock Exchange, with quoted prices in active markets. Accordingly, the fair value measurements of these securities have been classified as Level 1.

 

Fair Values: Nonrecurring – The following table shows the fair values and non-cash impairments of long-lived assets, by major category, measured on a nonrecurring basis as of December 31, 2014 and 2013 (in thousands). These impairment losses are recognized as a component of operating expenses within our consolidated statements of operations.

 

		December 31, 2014								December 31, 2013
		Fair Value				Impairment				Fair Value				Impairment
Construction in progress- Arctic Star plant		$	5,736			$	10,290			$	8,833			$	—
Weathered lagoon plant		$	79			$	6,151			$	6,236			$	—
Oil and gas property -proved		$	1,633			$	1,375			$	3,369			$	—
Oil and gas property -unproved		$	77			$	314			$	391			$	—

 

The fair value of the Arctic Star plant was determined using a probability weighted average income approach of different courses of actions available as estimated by management using significant unobservable inputs such as estimated commodity pricing using futures price strips, anticipated feedstock available and timing of the plant start up and consistent operations. Accordingly, the fair value measurements of these assets have been classified as Level 3. As a result of this fair value determination, we recognized an impairment loss of $10.3 million as a component of operating expenses within the BWI operating segment of our consolidated statements of operations for the year ended December 31, 2014.

 

The fair value of the weathered lagoon plant was determined using an estimated salvage value determined by management using significant unobservable inputs such as vendor quotes for comparable used products and parts. Accordingly, the fair value measurements of these assets have been classified as Level 3. As a result of this fair value determination, we recognized an impairment loss of $6.1 million as a component of operating expenses within the BWI operating segment of our consolidated statements of operations for the year ended December 31, 2014.

 

The fair value of the oil and gas properties was determined using the discounted cash flow method using significant unobservable inputs to determine future cash flows, which were based on management’s estimates using reserve and production estimates made by our reservoir engineers, estimated commodity prices using futures price strips as of the reporting date adjusted for quality and location differentials, and forecasted operating expenses and timing of investments for the remaining estimated life of the reservoir. Accordingly, the fair value measurements of these assets have been classified as Level 3. As a result of this fair value determination, we recognized impairment losses of $1.4 million and $314 thousand on proved and unproved Bakken properties as a component of operating expenses within the HKN operating segment of our consolidated statements of operations for the year ended December 31, 2014.

 

(8) DISCONTINUED OPERATIONS

 

As a result of the sales of our Gulf Coast oil and gas properties and the abandonment of our coalbed methane projects during 2011, all related activities are included as discontinued operations on the consolidated balance sheets and consolidated statements of operations for all periods presented.

 

The carrying amounts of the major classes of assets and liabilities for our discontinued oil and gas operations are summarized below (in thousands):

 

		December 31,				December 31,
		2014				2013
Current Assets:
Accounts receivable, net		$	—			$	6
Total Current Assets			—				6
Total Assets of Discontinued Operations		$	—			$	6
Current Liabilities:
Trade payables		$	3			$	29
Revenues and royalties payable			18				18
Accrued contingencies			3,165				—
Accrued liabilities and other			51				113
Total Current Liabilities			3,237				160
Total Liabilities of Discontinued Operations		$	3,237			$	160

 

Accrued Contingencies at December 31, 2014, consist of a $3.1 million contingency and a $65 thousand contingency related to the Main Pass Environmental Investigations. Our Accrued Liabilities and Other at December 31, 2014 consist of legal fees related to the XPLOR Energy Litigation and Main Pass Environmental Investigations. See Note 15 – “Commitments and Contingencies” for additional information.

 

Cash used by discontinued operations during the year ended December 31, 2014 is mainly related to legal costs resulting from the sale of the oil and gas properties net of any related insurance recoveries. Upon resolution of the XPLOR Energy litigation and regulatory matters, no significant activities are expected related to these discontinued operations.

 

The revenues and net loss before income tax associated with our discontinued oil and gas operations are as follows (in thousands):

 

		Years Ended December 31,
		2014				2013
Revenues and other:
Oil and gas operations		$	—			$	—
Oil and gas processing and handling income			—				—
Total revenues from discontinued operations		$	—			$	—
Loss from discontinued operations before taxes		$	(3,357	)		$	(471	)

 

We recognized a gain of $41 thousand on the 2011 disposal of our Gulf Coast oil and gas properties during the year ended December 31, 2014 due to an unanticipated refund of a drilling prepayment related to retained plugging and abandonment costs. No losses were recognized on this disposal in 2013.

 

The loss from discontinued operations for the year ended December 31, 2014 is primarily due to approximately $3.2 million in contingencies related to the Main Pass Environmental Investigations. See Note 15 – “Commitments and Contingencies” for additional information.

 

(9) INCOME TAXES

 

We did not generate any current or deferred tax benefit during the years ended December 31, 2014 or 2013. The following is a reconciliation of the reported amount of income tax benefit for the years ended December 31, 2014 and 2013 to the amount of income tax expense that would result from applying domestic federal statutory tax rates to pretax income:

 

		Years Ended December 31,
		2014				2013
		(in thousands)
Statutory tax benefit		$	(7,019	)		$	(340	)
Increase (decrease) in valuation allowance
Change in valuation allowance			5,940				337
Effect of permanent differences			1,076				—
Other			3				3
Total tax benefit		$	—			$	—

 

At December 31, 2014, we had available for U.S. federal income tax reporting purposes, a net operating loss (NOL) carryforward for regular tax purposes of approximately $102 million which expires in varying amounts during the tax years 2018 through 2034, an alternative minimum tax NOL carryforward of approximately $88 million which expires in varying amounts during the tax years 2018 through 2034, and a statutory depletion carryforward of approximately $9 million which can be carried forward indefinitely to offset our future taxable income, subject to certain limitations imposed by the Internal Revenue Code. Additionally, at December 31, 2014, we have a capital loss carryforward of approximately $2 million which will expire in 2015. Current federal income tax law allows corporations to deduct capital losses only if they offset capital gains. In 2003, we underwent a change in ownership, within the meaning of Internal Revenue Code Section 382, which significantly restricts our ability to utilize our domestic NOLs and capital losses.

 

The components of our federal deferred income taxes were as follows for the years ended December 31, 2014 and 2013:

 

		2014				2013
		(in thousands)
Deferred tax assets:
Net operating losses (NOL) carryover		$	34,657			$	33,973
Depletion carryover			3,020				3,020
Share based compensation			120				48
Deferred book liabilities			1				1
Debt and lease obligations			205				—
Loan origination fees			—				60
Book vs. tax basis in investments			24,000				20,683
Capital loss carryover			763				2,688
Property and equipment			5,024				—
Total gross deferred tax assets			67,790				60,473
Deferred tax liabilities:
Property and equipment			—				(824	)
Net deferred tax assets			67,790				59,649
Less valuation allowances			(67,790	)			(59,649	)
Deferred tax liabilities, net of valuation allowance		$	—			$	—

 

Our policy is to recognize potential interest and penalties accrued related to unrecognized tax benefits within income tax expense. The tax years 2011-2014 remain open to examination for federal income tax purposes and by the other major taxing jurisdictions to which we are subject.  The tax years 2010-2014 also remain open for examination purposes for the Texas Franchise tax.

 

In May 2006, the Governor of Texas signed into law a Texas margin tax (H.B. No. 3) which restructured the state business tax by replacing the taxable capital and earned surplus components of the current franchise tax with a new “taxable margin” component.  Specifically, we became subject to an entity level tax on the portion of our total revenue (as that term is defined in the legislation) that is generated in Texas beginning in our tax year ending December 31, 2007. The Texas margin tax is imposed at a maximum effective rate of 0.7% of our total revenue that is apportioned to Texas.

 

(10) STOCKHOLDERS’ EQUITY

 

Common Stock - We have authorized 2 million shares of $.01 par value common stock. At December 31, 2014 and 2013, we had 390,916 and 401,943 shares, respectively, issued and outstanding.

 

Treasury Stock – At December 31, 2014 and December 31, 2013, we held no shares of treasury stock. In January 2013, we announced that our Board of Directors authorized the cancellation of our amended September 2005 stock repurchase plan and authorized a new stock repurchase program which allows us to buy back up to 45 thousand shares of our common stock. During the year ended December 31, 2014, we purchased and retired 11,029 shares of our common stock for approximately $847 thousand. As of December 31, 2014, 582 shares remained available for repurchase under our repurchase program.

 

Series G1 Convertible Preferred Stock - Our Series G1 convertible preferred stock (“Series G1 preferred”), which was issued in 2000, has a liquidation value of $100 per share, is non-voting, and is convertible at the holder’s option into our common stock at a conversion price of $11,200 per share. In December 2014, we repurchased all remaining 1,000 outstanding shares of our Series G1 preferred stock and any accrued, unpaid dividends for $40 thousand. This transaction resulted in a net loss of $39 thousand and is reflected as a loss on payments of dividends of preferred stock as an increase to net loss to arrive at net loss attributed to common stock. At December 31, 2013 there were 1,000 shares of Series G1 preferred issued and outstanding.

 Series G2 Convertible Preferred Stock - Our Series G2 convertible preferred stock (“Series G2 preferred”), which was issued in 2000, has a liquidation value of $100 per share, is non-voting, and is convertible at the holder’s option into our common stock at a conversion price of $2,688 per share. The Series G2 preferred is also convertible by us into shares of our common stock if for any period of twenty consecutive calendar days the average of the closing prices of our common stock during such period shall have equaled or exceeded $3,360 per share. In December 2014, we repurchased all remaining 1,000 outstanding shares of our Series G2 preferred stock and any accrued, unpaid dividends for $40 thousand. This transaction resulted in a net loss of $39 thousand and is reflected as a loss on payments of dividends of preferred stock as an increase to net loss to arrive at net loss attributed to common stock. At December 31, 2013 there were 1,000 shares of Series G2 preferred issued and outstanding.

 

Changes in our common, preferred and treasury shares during 2014 and 2013 are as follows:

 

		Number of Shares
Description			Preferred G1				Preferred G2				Common				Treasury
Balance as of December 31, 2012			1				1				435,328				—
Shares issued for preferred stock dividends			—				—				4				—
Treasury stock repurchase			—				—				—				33,389
Treasury stock retirements			—				—				(33,389	)			(33,389	)
Balance as of December 31, 2013			1				1				401,943				—
Shares issued for preferred stock dividends			—				—				2				—
Treasury stock repurchase			—				—				—				11,029
Treasury stock retirements			—				—				(11,029	)			(11,029	)
Preferred stock repurchased			(1	)			(1	)			—				—
Balance as of December 31, 2014			—				—				390,916				—

 

(11) BWI STOCK COMPENSATION

 

In April 2012, our wholly-owned subsidiary, BWI, adopted a 2012 Equity Compensation Plan (the “BWI Plan”), which is administered by the Compensation Committee (the “Committee”) of the HKN Board of Directors.  The Committee has complete and absolute authority to make any and all decisions regarding the administration of the BWI Plan, and all employees of BWI, HKN and its subsidiaries are eligible to receive awards under the BWI Plan. An aggregate of 100,000 shares of common stock of BWI (10% of BWI’s currently outstanding shares of common stock) have been reserved for potential award issuance under the BWI Plan. 

 

Awards under the BWI Plan are granted in the form of nonqualified stock options.  The Committee also has complete and absolute authority to set the terms, conditions and provisions of each award, including the size of the award, the exercise or base price, the vesting and exercisability schedule (including provisions regarding acceleration of vesting and exercisability) and termination, cancellation and forfeiture provisions, subject to limitations on the exercise price and term under the BWI Plan.  In particular, the exercise price for a stock option granted under the BWI Plan may not be less than 100% of the fair market value of the stock on the award date, and no stock option granted under the BWI Plan may expire more than ten years after the award date.

 

In April 2012, 40 thousand options were granted to BWI officers and directors with an exercise price of $14.50 per share of BWI common stock and a vesting period of three years, with one third of the options vesting on the first, second and third anniversaries of the grant date. As of December 31, 2014, 14 thousand of these options were forfeited and approximately 17 thousand options were exercisable. The grant date fair value of the stock of $14.50 per share was based on an independent third-party valuation. This valuation used the income approach method based on a discounted forecasted cash flow analysis.

 

In December 2013, 24.5 thousand options were granted to BWI directors, officers and employees with an exercise price of $31.60 per share of BWI common stock and a vesting period of three years, with one third of the options vesting on the first, second and third anniversaries of the grant date. As of December 31, 2014, approximately 8 thousand options were exercisable. The grant date fair value of the stock of $31.60 per share was based on an independent third-party valuation. This valuation used the income approach method based on a discounted forecasted cash flow analysis.

 

Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period, using the straight-line method. The weighted average grant date fair value of each stock option granted in April 2012 and December 2013 was $8.56 and $16.89, respectively. The fair value of each option at the grant date was estimated by using the Black-Scholes option-pricing model using the following weighted average assumptions:

 

	Grant Date
	December		April
	2013		2012
Expected dividend yield	0.00%		0.00%
Expected volatility	56.00%		65.00%
Expected life (in years)	6.00		6.00
Risk free interest rate	1.86%		1.29%

 

We estimate the expected dividend yield to be zero because we do not anticipate paying dividends out of BWI.  Because BWI is not publicly traded, the expected volatility is based on an average historical and implied volatility for comparable public reporting companies over a period similar to the expected life of the options.  Expected life is based on the simplified method of computing an average of the vesting periods and the contractual term, and the risk-free interest rate represents the published interest rate for a comparable term US Treasury Bond on the grant date.

 

We are also required to estimate forfeitures at the time of grant, and to revise those estimates in subsequent periods if actual forfeitures differ from our estimates as a cumulative adjustment in the period of revision. Stock compensation is recorded only for those awards that are expected to vest. No forfeiture rate was applied during the years ended December 31, 2014 or 2013, as no forfeitures were expected. However, in the fourth quarter of 2012 and the first quarter of 2013, a total of 14 thousand shares were forfeited and an immaterial amount of stock compensation expense was reversed. No additional forfeiture rate was applied during the year ended December 31, 2013, as no further forfeitures were expected.

 

The following table summarizes stock option activity during the year ended December 31, 2014:

 

		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (in years)				Aggregate Intrinsic Value (in thousands)
Outstanding at January 1, 2014			50,500			$	22.80
Granted			—				—
Exercised			—				—
Forfeited or Expired			—				—
Outstanding at December 31, 2014			50,500			$	22.80				8.08			$	—
Exercisable at December 31, 2014			25,500			$	19.98				7.80			$	—

 

The following table summarizes nonvested option activity during the year ended December 31, 2014:

 

				Shares				Weighted Average Grant Date Fair Value
	Nonvested at January 1, 2014				41,833			$	13.44
	Granted				—				—
	Vested				(16,833	)			12.60
	Forfeited				—				—
	Nonvested at December 31, 2014				25,000			$	14.00

 

 

At December 31, 2014, there was approximately $283 thousand of total unrecognized stock compensation expense. This compensation expense is expected to be recognized over the weighted-average vesting term remaining of 1.82 years.

 

Total stock-based compensation recognized within selling, general and administrative expenses in the Company’s consolidated statements of operations for the years ended December 31, 2014 and 2013 was $212 thousand and $60 thousand, respectively.

  

(12) RELATED PARTY TRANSACTIONS

 

Our related party transactions at December 31, 2014 include purchases of shares of Global. Our CEO, Mikel Faulkner, serves as Chairman of Global. See Note 4 – “Investment in Global” for additional information on our purchases of Global stock.

 

(13) SEGMENT INFORMATION

 

We currently have one reportable segment consisting of our investment in BWI which is managed separately. Our BWI operating segment owns a patented oilfield emulsion breaking technology. This is a continuous process technology that can purify oilfield emulsions by breaking and separating the emulsions into oil, water and solids, thereby reducing the environmental impact and disposal costs of these waste materials while recovering valuable oil. See Note 2 – “BriteWater International, Inc.” for further discussion.

 

We have included activity of our parent company, HKN, in our disclosure to reconcile to our consolidated operating loss and total assets. HKN includes our investment in Global, our non-operated working interests in properties held by HBI, mineral interests leased in Texas, performance of general corporate activities such as corporate reporting and governance, financing, management and growth of current operations and the evaluation of new investment opportunities. Our accounting policies for each of our operating segments are the same as those for our consolidated financial statements. Intersegment interest income and intersegment expenses between our parent company and BWI have been eliminated in consolidation. There were no material intersegment sales or transfers for the periods presented.

 

Our financial information, expressed in thousands, for each of our operating segments for the years ended December 31, 2014 and 2013 is as follows:

 

		Year Ended December 31, 2014
			HKN				BWI				Eliminations				Consolidated
Oil and gas revenues		$	988			$	—			$	—			$	988
Oil and gas expenses			(218	)			—				—				(218	)
Selling, general and administrative expenses			(2,894	)			(968	)			—				(3,862	)
Depreciation, depletion and amortization			(470	)			(337	)			—				(807	)
Impairment losses			(1,688	)			(16,441	)							(18,129	)
Gain on BWI contingency			—				800								800
Interest and other expenses			—				(437	)			271				(166	)
Interest and other income - related parties			1,879				—				(271	)			1,608
Interest and other income			80				—				—				80
Impairment loss on investment in Global			(937	)			—				—				(937	)
Segment loss from continuing operations		$	(3,260	)		$	(17,383	)		$	—			$	(20,643	)
Capital Expenditures		$	386			$	7,611			$	—			$	7,997
Total Assets		$	37,582			$	8,088			$	(10,690	)		$	34,980

  

		Year Ended December 31, 2013
			HKN				BWI				Eliminations				Consolidated
Oil and gas revenues		$	1,093			$	—			$	—			$	1,093
Oil and gas expenses			(209	)			—				—				(209	)
Selling, general and administrative expenses			(2,767	)			(753	)			—				(3,520	)
Depreciation, depletion and amortization			(523	)			(220	)			—				(743	)
Interest and other expenses			(36	)			(651	)			651				(36	)
Interest and other income - related parties			2,901				—				(651	)			2,250
Interest and other income			163				—				—				163
Segment income (loss) from continuing operations		$	622			$	(1,624	)		$	—			$	(1,002	)
Capital Expenditures		$	694			$	5,924			$	—			$	6,618
Total Assets		$	62,149			$	17,014			$	(12,203	)		$	66,960

 

(14) EARNINGS (LOSS) PER SHARE

 

Basic earnings (loss) per share includes no dilution and is computed by dividing income or loss attributed to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if security interests were exercised or converted into common stock.

 

The following table sets forth the computation of basic and diluted loss per share for the years ended December 31, 2014 and 2013 (in thousands, except per share data):

 

		Year Ended December 31, 2014												Year Ended December 31, 2013
		Net Loss Attributed to Common Stock				Weighted- Average Shares				Per Share Loss				Net Loss Attributed to Common Stock				Weighted- Average Shares				Per Share Loss
Basic EPS:
Loss from continuing operations (1)		$	(20,721	)						$	(52.66	)		$	(1,002	)						$	(2.46	)
Loss from discontinued operations			(3,316	)							(8.43	)			(471	)							(1.15	)
Net loss attributed to common stock		$	(24,037	)			393			$	(61.09	)		$	(1,473	)			408			$	(3.61	)
Effect of dilutive securities
Preferred stock (2)			—				—				—				—				—				—
Diluted loss per share		$	(24,037	)			393			$	(61.09	)		$	(1,473	)			408			$	(3.61	)

__________________________

 

(1)

Includes accrual of dividends, net of the payment of preferred stock dividends and repurchase of preferred stock, related to preferred stock for the years ended December 31, 2014 and 2013.

(2)

Includes 46 shares of our common stock related to our Series G1 preferred and Series G2 preferred stock for the year ended December 31, 2013. These shares were issuable upon their conversion in the period presented and were excluded from the calculation of diluted earnings per share as their effect would have been antidilutive. In December 2014, we repurchased all outstanding shares of our Series G1 and Series G2 preferred stock. As a result, there is no dilutive effect for the year ended December 31, 2014.

 

(15) COMMITMENTS AND CONTINGENCIES

 

Leases - We lease our corporate and other office space. Total office operating lease payments during 2014 and 2013 totaled $215 thousand and $209 thousand, respectively. Total site lease payments for our Arctic Star project were $92 thousand. In addition, we have two capital equipment leases related to our Arctic Star project which began in 2014. Total capital lease payments during 2014 totaled $378 thousand. Future minimum rental payments required under all leases that have initial or remaining non-cancellable lease terms in excess of one year as of December 31, 2014 are as follows (in thousands):

 

Year				Operating Leases				Capital Leases
	2015			$	326			$	572
	2016				295				173
	2017				139				—
	2018				—				—
	Thereafter				—				—
	Total			$	760			$	745

 

BWI Contingencies – As of December 31, 2014, we recognized a $800 thousand gain on contingency for the reversal of the BWI contingent liability which may have been payable upon the conclusion of certain performance events related to its weathered lagoon plant. Please See Note 2 – “BriteWater International, Inc.” for further discussion on BWI contingencies.

 

XPLOR Energy Litigation – Pursuant to a PSA dated as of November 17, 2011 between our subsidiary XPLOR and TPIC, XPLOR sold to TPIC its oil and gas production assets and related operations at its Main Pass 35 field.  The closing of the transaction occurred on November 17, 2011 but was effective as of October 1, 2011.  On November 21, 2011, TPIC informed XPLOR that they had discovered defects in the salt water disposal system at Main Pass resulting in a salt water spill in the Gulf of Mexico, which had been reported to regulatory authorities. 

 

TPIC has filed a lawsuit against XPLOR in the 236^th Judicial District Court, Tarrant County, Texas. The case is styled: Texas Petroleum Investment Company vs. XPLOR Energy SPV-1, Inc., Richard Cottle, Sarah Gasch, and John Hewitt. In the lawsuit, TPIC has asserted claims of fraud, fraudulent inducement, negligent misrepresentation, and indemnity related to its purchase of a production platform and associated assets from XPLOR. TPIC’s claims focus on alleged salt water system defects, related repairs to the facilities, and purported representations regarding the condition of the platform and associated assets. TPIC is seeking an unstated amount of alleged actual and exemplary damages as well as costs and fees. Although litigation is inherently uncertain, based upon the information known to date, we do not believe TPIC’s civil, contractual and fraud claims have merit. We intend to vigorously defend any assertions related to the above lawsuit. Accordingly, as of December 31, 2014, we did not record a contingency related to TPIC’s allegations. Based upon information known to date, the range of estimated loss if TPIC were to prevail on its claims is currently estimated not to exceed $2.5 million in damages, costs, and fees.

 

 Main Pass Environmental Investigations – In January 2013, we were notified by the Louisiana Department of Environmental Quality (“LDEQ”) of an investigation and potential penalty related to the TPIC allegations of improper salt water disposal at the Main Pass 35 field previously owned by our subsidiary XPLOR Energy SPV-1, Inc. and previously operated by our subsidiary, XPLOR Energy Operating Company.  The matter is styled: In the Matter of Xplor Energy Operating Company, Louisiana Division of Administrative Law Docket No. 2014-2388-EQ, Louisiana Department of Environmental Quality (“LDEQ”) Tracking No. WE-CN-12-01101. In October 2014, a telephone status conference was held with the LDEQ and the Administrative Law Judge (“ALJ”) handling this matter, and the Company held a subsequent meeting at the LDEQ offices during November 2014. Following these meetings, the parties agreed to pursue settlement discussions and are currently engaged in this process. At December 31, 2014, we have a $65 thousand contingency within liabilities of discontinued operations in our consolidated balance sheets related to these investigations.

 

In March 2013, we were advised that the U.S. Environmental Protection Agency (“EPA”) was undertaking a criminal investigation of the salt water disposal incident. In June 2014, we began discussions with the U. S. Attorney’s Office in New Orleans, Louisiana with regard to resolving any potential allegations against XPLOR. On September 15, 2014, the U.S. Attorney’s Office filed a Bill of Information with the U.S. District Court for the Eastern District of Louisiana (the “Court”) alleging that XPLOR knowingly violated The Federal Water Pollution Control Act (the “Clean Water Act”) at its Main Pass operations. Subject to the Court’s acceptance and to avoid the risks, uncertainties, costs and other burdens of litigation, we agreed with the U. S. Attorney’s Office to enter into a plea agreement reflecting a payment of $3.1 million in settlement of one felony count of a knowing violation of the Clean Water Act. At a hearing on November 19, 2014, Xplor pled guilty to that felony count pursuant to the plea agreement. The sentencing hearing in this matter is scheduled for March 4, 2015. Accordingly, at December 31, 2014, we have a $3.1 million contingency within liabilities of discontinued operations in our consolidated balance sheets related to these investigations.

 

Point Au Fer Lawsuit – During the second quarter 2013, we learned HKN, Inc. was named in a lawsuit filed in the 32nd Judicial District Court for the Parish of Terrebonne, Louisiana by Point Au Fer, L.L.C., and The Roman Catholic Church of the Archdiocese of New Orleans.  The case is styled: Point Au Fer, L.L.C., and The Roman Catholic Church of the  Archdiocese of New Orleans v. ExxonMobil Oil Corporation, et al, No. 169160. In the lawsuit, the plaintiffs have alleged that real property they own in Terrebonne Parish has been environmentally damaged as a result of oil and gas exploration activities of twenty different defendants.  The plaintiffs seek damages for testing and remediation of the property, property stigma, loss of use of land and lost profits, civil fruits for defendants trespass, land loss and subsidence, punitive or exemplary damages and attorney’s fees. Per Louisiana law, no actual dollar amount of damages has been alleged in the Petition. With specific regard to HKN, Inc., out of over one hundred wells identified in the Petition, HKN, Inc. only drilled one well, the MA Smythe Nelson #1, which was a dry hole. The MA Smythe Nelson #1 was drilled on June 2, 1980 and plugged and abandoned on July 12, 1980.  We have and intend to continue to vigorously defend any assertions related to the above lawsuit. Due to the inherent uncertainties of the lawsuit at this time, we cannot accurately predict the ultimate outcome of the matter. Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

Point a la Hache Lawsuit – During the second quarter 2013, we learned XPLOR Energy Operating Company and XPLOR Energy SPV-1, Inc. were named in a lawsuit filed in the 25^th Judicial District Court for the Parish of Plaquemines, Louisiana. The case is styled: Catherine P. Alford et al. v. BP America Production Company, et al., Docket No. 60-479. In the lawsuit, eight plaintiffs have sued 25 defendants, alleging that they own and/or use a certain 4,480 acres located in the Pointe a la Hache oil and gas field.  Plaintiffs further allege that the property has been contaminated or otherwise damaged by oil and gas exploration and production activities.  Per Louisiana law, no actual dollar amount of damages has been alleged in the Petition. On March 18, 2014, prior to the hearing on defendants’ exceptions, plaintiffs filed a motion to dismiss the lawsuit in its entirety. The court signed the order dismissing all claims against the defendants on March 27, 2014, and the case is now closed. Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

SLFPA-E Litigation – Plaintiffs South Louisiana Flood Protection Authority—East (“SLFPA-E”) filed this lawsuit in Louisiana state court against over 90 oil and gas and pipeline companies.  Generally the lawsuit alleges that activities by defendants—primarily but not exclusively the dredging of canals—have made it more difficult for the SLFPA-E to protect the New Orleans metropolitan area from flooding.  The petition alleges that HKN, Inc. is "by virtue of [one or more of] mergers, acquisitions, name changes, etc., responsible for" the actions of Tejas Power Corporation, which is alleged to have obtained in the 1980s certain dredging permits and rights of way.  HKN, Inc. disputes that it is responsible for any actions of Tejas Power Corporation.  The public record appears to suggest that Tejas Power Corporation may have been a subsidiary of Harken Oil and Gas, Incorporated (a previous name of HKN, Inc.) for a few years in the 1980s and 1990s.  However, there appears to be nothing to indicate that HKN, Inc. would have liability for the actions of Tejas Power Corporation, which continued to exist after HKN, Inc. no longer had any interest in Tejas Power Corporation. Defendants removed the case to federal court and the plaintiff filed a motion to remand the case back to state court.  On June 27, 2014, the Judge issued an Order denying remand to state court. A status conference was held on August 6, 2014, and the Defendants filed a Joint Motion to Dismiss during September 2014.  Oral arguments with respect to this motion were held before the court on November 12, 2014.  On February 13, 2015, the court signed an order ruling in favor of the Defendants and dismissing all claims.  Accordingly, at December 31, 2014, we did not record a contingency related to this matter.

 

Louisiana Limited Scope Audit – In April 2012, we received notice from the State of Louisiana’s Department of Revenue that our discontinued oil and gas subsidiary, XPLOR Energy Operating Company, was the subject of a limited scope sales tax audit focused on the company’s on-site use and consumption of lease gas in connection with its lease, gathering and pipeline operations from January 1, 2006 through June 30, 2009. The Louisiana Department of Revenue issued a preliminary assessment, or “Notice of Proposed Tax Due,” preliminarily assessing sales tax of $194 thousand and related penalties and interest of $157 thousand, resulting in a total assessment of $351 thousand. In July 2012, we filed an audit protest with the Louisiana Department of Revenue challenging the preliminary assessment, as we do not agree with the legal basis of the assessment or the methodology in which the taxes were calculated and plan to vigorously defend our position. Due to the inherent uncertainties of the audit protest and preliminary assessment, we cannot accurately predict the ultimate outcome of the matter. Accordingly, at December 31, 2014, we did not record a contingency related to this matter. In the event of a negative outcome, the potential loss related to the audit and preliminary assessment is currently estimated not to exceed $351 thousand.

 

(16) OIL AND GAS DISCLOSURES (unaudited)

 

The following information is presented with regard to our proved oil and gas reserves.

 

Costs incurred in property acquisition, exploration and development activities (in thousands):

 

		Years Ended December 31,
		2014				2013
Domestic costs incurred:
Acquisition of properties
Proved		$	—			$	4
Unproved			—				—
Exploration			—				—
Development			276				1,359
Total domestic costs incurred		$	276			$	1,363

  

 

Capitalized Costs Relating to Oil and Gas Producing Activities (in thousands):

 

		Years Ended December 31,
		2014				2013
Capitalized costs:
Proved properties		$	4,071			$	4,124
Unproved properties			391				326
Total capitalized costs			4,462				4,450
Less accumulated depreciation and amortization			(1,064	)			(691	)
Less impairment provision			(1,688	)			—
Net capitalized costs		$	1,710			$	3,759

  

Included in the capitalized costs of proved properties of $4.1 million are approximately $3.4 million in costs related to producing wells and related equipment and approximately $674 thousand in costs related to mineral interests in properties.

 

Results of Operations from Oil and Natural Gas Producing Activities

 

		Years Ended December 31,
		2014				2013
		(in thousands)
Oil and gas revenues		$	988			$	1,093
Less:
Oil and gas operating costs			218				209
Depreciation, amortization and accretion			411				479
Property impairments			1,688				—
Total oil and gas expenses			2,317				688
Results of operations from oil and gas producing activities		$	(1,329	)		$	405

  

Oil and Gas Reserve Data - (Unaudited) - The following information is presented with regard to our proved oil and gas reserves. The reserve values and cash flow amounts reflected in the following reserve disclosures are based on a simple average of the first day of the month price for the period of January 1, 2014 to December 1, 2014, in accordance with ASC 932, Oil and Gas Reserve Estimation and Disclosure and the Securities and Exchange Commission’s Final Rule, Modernization of the Oil and Gas Reporting Requirements.

 

The following table presents our independent petroleum consultants’ estimates of our proved crude oil and natural gas reserves.

 

	(Unaudited)
	Total (1)
	Oil (Mbbls)		Gas (Mmcf)
Proved reserves:
As of December 31, 2012	17		29
Extensions and discoveries	187		247
Revisions	4		(2)
Production	(11)		(14)
As of December 31, 2013	197		260
Extensions and discoveries	9		14
Revisions	(65)		(20)
Production	(11)		(18)
Sales of reserves in place	(13)		(30)
As of December 31, 2014	117		206
Proved developed reserves at:
December 31, 2014	46		72
Proved undeveloped reserves at:
December 31, 2014	71		134

________________________________________________

(1)

All reserves were held within the United States for the years ended December 31, 2014 and 2013.

 

“Standardized measure” relates to the estimated discounted future net cash flows, as adjusted for our asset retirement obligations, and major components of that calculation relating to proved reserves at the end of the year in the aggregate and by geographic area, based on average prices, costs, and statutory tax rates and using a 10% annual discount rate. Prices at December 31, 2014 were based on a simple average of the first day of the month price for the period of January 1, 2014 to December 1, 2014 of $91.48 per barrel and $4.35 per mmbtu, as adjusted by basin for quality, transportation and regional price differentials.

 

Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves:

 

		Years Ended December 31,
		2014				2013
		(Unaudited, in thousands)
Future cash inflows		$	11,341			$	19,778
Future production costs			(2,874	)			(5,181	)
Future development costs			(1,902	)			(5,205	)
Future income tax expense			—				—
Future net cash flows			6,565				9,392
10% annual discount for estimated
timing of cash flows			(2,869	)			(5,142	)
Standardized measure of discounted future
net cash flows related to proved reserves (1)		$	3,696			$	4,250

__________________________________________________

(1)

Cash flows associated with asset retirement obligations are included in the Standardized Measure of Discounted Future Net Cash Flows.

  

 

		Years Ended December 31,
		2014				2013
		(Unaudited, in thousands)
Standardized measure - beginning of year		$	4,250			$	835
Sales of oil and gas, net			(770	)			(884	)
Net change in prices and production costs			(435	)			(64	)
Net change in future development costs			2,509				—
Extensions and discoveries			353				3,925
Revisions of previous quantity estimates			(2,155	)			93
Previously estimated development costs incurred			269				—
Accretion of discount			425				83
Sale of reserves			(561	)			—
Other			(189	)			262
Standardized measure - end of year		$	3,696			$	4,250

 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its filings with the SEC are recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including its Chief Executive and Chief Financial Officers, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As of the end of the period covered by this report, and under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of these disclosure controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this annual report.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in the Company’s internal control over financial reporting that occurred during the period ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Management’s Report on Internal Control Over Financial Reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed, under the supervision of the Company’s Chief Executive and Chief Financial Officers, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

The Company conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2014. This evaluation was based on the framework in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP.

 

Based on the Company’s evaluation under the framework in Internal Control – Integrated Framework, our Chief Executive Officer and Chief Financial Officer concluded that internal control over financial reporting was effective as of December 31, 2014.

 

 PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Set forth below is information concerning our directors and executive officers:

 

Name		Age		Position Held with HKN
Michael M. Ameen, Jr.		90		Director (1)
Dr. J. William Petty		72		Director (1)
Alan G. Quasha		65		Chairman of the Board (1)
H. A. Smith		77		Director (1)
Mikel D. Faulkner		65		Director (1), Chief Executive Officer and President
Sarah B. Gasch		40		Executive Vice President and Chief Operating Officer
Kristina M. Humphries		32		Vice President and Chief Financial Officer
Christopher L. DeBerry		33		Vice President Business Development

_____________________________

(1) Each Director serves a term of one year and until his successor is duly elected and qualified.

 

Michael M. Ameen, Jr., Director since 1994 and Independent Consultant on Middle East Affairs since 1991. From 1989 to 1999, Mr. Ameen served as a part time consultant to HKN with regard to Middle Eastern exploration projects. Mr. Ameen has previously served as director of American Near East Refugee Aid; past director of Amideast; past director of Middle East Institute; past director of International College in Beirut, Lebanon; past vice president of government relations and director of Washington office of Aramco; past president of Mobil Middle East Development Corporation; and Member, Energy Intelligence Group International Advisory Board.

Dr. J. William Petty, Director since 2000 and Professor of Finance and the W.W. Caruth Chairholder of Entrepreneurship at Baylor University since 1990.  From December 1979 to 1990, Dr. Petty served as dean of the Business School at Abilene Christian University.  Dr. Petty also serves as the Academic Director of the Baylor Angel Network.  The Angel Network consists of high net worth alumni and friends of Baylor University who actively invest in early-stage high potential companies.

Alan G. Quasha, Director since 2003 and President of Quadrant Management, Inc. (“Quadrant”), an investment management company, since 1988.  Mr. Quasha has served as Chairman of the Board of HKN since March 2003 and previously served as Chairman of the Board of HKN from June 1983 to February 1991.  Mr. Quasha has served as a director of Compagnie Financiére Richemont SA, a Swiss luxury goods company, since its formation in 1988, and American Express Funds, the mutual fund arm of American Express Company, from May 2002 to April 2004.  From April 1994 to April 1997 Mr. Quasha served as a governor of the American Stock Exchange.

H. A. Smith, Director since 1997 and Consultant to Schlumberger Inc., an oil field service company, since June 1991. Previously, Mr. Smith served as Vice President-Customer Relations for Smith International, Inc. Mr. Smith served as a director of Brigham Exploration Company, an independent oil and gas exploration and production company from 2002 to 2011, where he also served as a member of their Compensation Committee. Mr. Smith also serves as a director of Stallion Oilfield Services Ltd. and is currently a member of their Compensation Committee.

 

Mikel D. Faulkner, Chief Executive Officer of HKN since 1982 and President of HKN since March 2003.  From 1991 to March 2003, Mr. Faulkner served as Chairman of the Board of HKN and, from 1982 to February 1993, Mr. Faulkner served as President of HKN.  Mr. Faulkner currently serves as Chairman of the Board of Directors of Global Energy Development PLC (“Global”), a position he has held since April 2002; HKN holds an approximate 35% interest in Global. From August 2007 to July 2008, Mr. Faulkner served on the board of directors and as a member of the compensation committee of Spitfire Energy, Ltd., a Canadian public company. Since October 2009, Mr. Faulkner has served as a director of First Cash Financial Services and is currently a member of their Compensation and Audit Committees.

Sarah B. Gasch, Executive Vice President and Chief Operating Officer of HKN since October 1, 2014. Ms. Gasch served as Executive Vice President and Chief Financial Officer of HKN from February 2011 through September 2014. Prior to that, Ms. Gasch served as Controller and Corporate Secretary of HKN since 2009 and also served as HKN’s Chief Accounting Officer in 2006. Prior to joining HKN, Ms. Gasch served as Vice President and Chief Accounting Officer of GreenHunter Energy, Inc.

Kristina M. Humphries, a Certified Public Accountant and Vice President and Chief Financial Officer of HKN since October 1, 2014. Ms. Humphries previously served as Vice President and Chief Accounting Officer beginning June 2013 and as Corporate Secretary beginning in May 2013. Prior to that, Ms. Humphries served as the Treasurer and Assistant Secretary, beginning in 2012, as Controller and Technical Accounting Manager beginning in 2010 and Financial Reporting Analyst upon joining HKN in 2008. Prior to joining HKN, Ms. Humphries served as Senior Financial Accounting Analyst at Sabre Holdings, Inc.

Christopher L. DeBerry, Vice President Business Development of HKN since October 1, 2014.  Mr. DeBerry has served in roles of increasing responsibility with our wholly-owned BWI subsidiary since 2009, including his most recent position of President where he was responsible for overseeing the design, construction and commissioning of BWI’s first commercial facility.  Prior to joining BWI in 2009, Mr. DeBerry was an Operations Manager at Nabors Industries Ltd.

 

Audit Committee Financial Expert

 

The Audit Committee of our Board (the “Audit Committee”) is composed entirely of independent directors. Although our securities are no longer listed on the NYSE-MKT, we continue to determine the independence of directors under the NYSE-MKT listing standards. Our directors meet the independence, experience and other qualification requirements of the NYSE-MKT, the Securities and Exchange Act of 1934 and the rules and regulations of the SEC. During 2014, Dr. J. William Petty and Messrs. Ameen and Smith were members of HKN’s Audit Committee. The Chairman of the Audit Committee, Dr. J. William Petty, has been determined by our Board of Directors to be an “audit committee financial expert” as defined by the NYSE MKT rules and the SEC rules and regulations and “financially sophisticated” as required by the NYSE MKT listing standards.

 

Our Audit Committee’s responsibilities are specified in the Audit Committee Charter (the “Charter”) which is available on our website at www.hkninc.com. As set forth in the Charter, the Audit Committee’s responsibilities include appointing, compensating, retaining and overseeing the work of the independent auditors for the Company (the “Auditors”), for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attestation services for the Company. Our management retains the primary responsibility for the Company’s financial reporting process, principles and internal controls as well as preparation of its financial statements. Our Audit Committee has implemented procedures to ensure that during the course of each fiscal year they devote the attention that they deem necessary or appropriate to each of the matters assigned to the Audit Committee under its Charter.

 

The Audit Committee is responsible for oversight of the Company’s risks related to accounting matters, financial reporting, and legal and regulatory compliance. To satisfy these overall responsibilities, the Committee separately meets regularly with the Company’s management and our independent auditors. The Audit Committee also reviews the Company’s financial statements and proposed audit adjustments.

 

Code of Ethics

 

HKN has adopted a code of ethics that applies to all members of the Board of Directors and employees of HKN, including the principal executive officer, principal financial officer, principal accounting officer, controller, or persons performing similar functions. HKN has posted a copy of the code on HKN’s website at the internet address: http://www.hkninc.com/corpgov.html. Copies of the code of ethics may be obtained free of charge from HKN’s website at the above internet address.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires HKN’s directors and executive officers, and any persons who own more than ten percent of a registered class of HKN’s equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of HKN. Directors, executive officers and greater than ten percent stockholders are required by SEC regulations to furnish HKN with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms and written representations from certain reporting persons, HKN believes that all filing requirements applicable to its directors and executive officers have been complied with during 2014.

 

 

ITEM 11. EXECUTIVE COMPENSATION

 

EXECUTIVE COMPENSATION

 

The 2014 Summary Compensation Table below sets forth certain information regarding NEO compensation during fiscal years 2014 and 2013. Tables for deferred compensation payments are not presented because HKN does not provide for such forms of compensation.

 

2014 Summary Compensation Table

 

Name and Principal Position		Year				Salary				Bonus (1)				Option Awards (2)				All Other Compensation				Total
Mikel D. Faulkner			2014			$	325,000			$	85,500			$	—			$	35,882	(3)		$	446,382
President and Chief Executive Officer			2013			$	325,000			$	16,000			$	36,117			$	35,859	(3)		$	412,976
Sarah B. Gasch			2014			$	291,000			$	75,500			$	—			$	29,871	(4)		$	396,371
Executive Vice President and Chief Operating Officer			2013			$	270,000			$	13,000			$	18,058			$	29,821	(4)		$	330,879
Kristina M. Humphries			2014			$	172,500			$	36,000			$	—			$	20,871	(5)		$	229,371
Vice President and Chief Financial Officer			2013			$	153,750			$	9,000			$	—			$	17,571	(5)		$	180,321
Christopher L. DeBerry			2014			$	240,000			$	500			$	—			$	11,171	(6)		$	251,671
Vice President of Business Development

 

(1)

The bonus amounts for 2014 include bonus awards for fiscal year 2013 (which were paid in 2014) as well as bonus awards of $500 paid to each officer. The bonus amounts for 2013 include additional bonus awards for fiscal year 2012 (which were paid in 2013) as well as bonus awards of $1,000 paid to each officer.

(2)

Represents the aggregate grant date fair value in accordance with Accounting Standards Codification 718, “Stock Compensation”. For a discussion of the assumptions made in the valuation of option awards, please refer to Note 11 – “BWI Stock Compensation” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for more information.

(3)

All other compensation for 2014 for Mikel D. Faulkner includes the values of personal use of a company car, club dues, life insurance premiums paid by HKN, HKN’s employer contributions for employee’s 401(k) and a Health Savings Account contribution.

All other compensation for 2013 for Mikel D. Faulkner includes the values of personal use of a company car, club dues, life insurance premiums paid by HKN, HKN’s employer contributions for employee’s 401(k) and a Health Savings Account contribution.

 

 

(4)

All other compensation for 2014 for Sarah B. Gasch includes the values of a car allowance, life insurance premiums paid by HKN, HKN’s employer contributions to employee’s 401(k), and a Health Savings Account contribution.

All other compensation for 2013 for Sarah B. Gasch includes the values of a car allowance, life insurance premiums paid by HKN, HKN’s employer contributions to employee’s 401(k), and a Health Savings Account contribution.

(5)

All other compensation for 2014 for Kristina M. Humphries includes the values of life insurance premiums paid by HKN, HKN’s employer contributions to employee’s 401(k), and a Health Savings Account contribution.

All other compensation for 2013 for Kristina M. Humphries includes the values of life insurance premiums paid by HKN and HKN’s employer contributions to employee’s 401(k).

(6)

All other compensation for 2014 for Christopher L. DeBerry includes the values of travel compensation, life insurance premiums paid by HKN, and a Health Savings Account contribution.

 

 The following table sets forth the detail of all outstanding equity awards under the BWI Stock Option Plan by named executive officer.

 

Outstanding Equity Awards at Fiscal Year-End
Named Executive Officer	Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options  (#)	Option Exercise Price ($)	Option Expiration Date
Mikel D. Faulkner	12,000	$14.50	2022
	4,000	$31.60	2023
Sarah B. Gasch	6,000	$14.50	2022
	2,000	$31.60	2023
Kristina M. Humphries	0	N/A	N/A
Christopher L. DeBerry	8,000	$14.50	2022
	4,000	$31.60	2023

 

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

 

During 2014, Dr. J. William Petty and Messrs. Ameen and Smith were members of HKN’s Compensation Committee and participated in all deliberations concerning executive compensation. No executive officer of HKN served as a member of the Compensation Committee during 2014. None of the named Executive Officers serves or has served as a member of the board of directors or compensation committee of any other entity which has one or more executive officers serving on HKN’s Board of Directors or Compensation Committee.

 

DIRECTOR COMPENSATION

 

Name		Fees Earned or Paid in Cash ($)				Stock Awards ($)			Option Awards ($)			Non-Equity Incentive Plan Compensation ($)			Nonqualified Deferred Compensation Earnings ($)			All Other Compensation ($)		Total ($)
Dr. J. William Petty		$	75,000			—			—			—			—			—		$	75,000
Michael M. Ameen, Jr.		$	75,000			—			—			—			—			—		$	75,000
H. A. Smith		$	75,000			—			—			—			—			—		$	75,000
Alan G. Quasha			—			—			—			—			—			—			—
Mikel D. Faulkner (See 2014 Summary Compensation Table)			—			—			—			—			—			—			—

 

Board members are paid an annual fixed per director fee of $75 thousand, with no per meeting fee and no additional fee for a committee chairman.

 

Director performance is a key influence factor in organizational performance. Just as alignment of HKN’s strategic objectives for management compensation are critical, so too is directors’ compensation. To this end, directors’ compensation is assessed annually to monitor and adjust it, as appropriate, in order to ensure alignment with HKN’s strategic objectives.

 

The analysis and review of directors’ compensation is the responsibility of our Compensation Committee and our Board of Directors. We currently do not have a Compensation Committee Charter but in undertaking this responsibility, our Compensation Committee may review compensation surveys of our industry, and may also engage consultants who provide supplemental data considered in establishing the directors’ compensation. No third party compensation consultants were used during the fiscal year 2014. The Compensation Committee also takes into consideration HKN’s financial results for the previous fiscal year, as compared with internal objectives and targets, the business climate during the year and our industry in general. After our Compensation Committee has reviewed the data, it formulates a recommendation for review by our Board of Directors.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

OWNERSHIP OF COMMON STOCK

 

Security Ownership of Certain Beneficial Owners

 

As of February 28, 2015, HKN had 390,916 shares of common stock outstanding. As of that date, the only persons known by HKN to beneficially own five percent (5%) or more of the outstanding shares of common stock were:

 

Title of class		Name and address of beneficial owner		Amount and nature of beneficial ownership				Percent of class
Common Stock		Everest Hill Group, Inc. Tropic Isle Building P.O. Box 3331 Road Town, Tortola British Virgin Islands, VG 1110			264,325				67.62	%
Common Stock		First Eagle Investment Management, LLC 1345 Avenue of the Americas New York, NY 10105			24,806				6.35	%

 

 

Security Ownership of Directors and Management

 

The following table sets forth information, as of February 28, 2015, regarding the number of shares of Common Stock beneficially owned by directors and executive officers that are named in the 2014 Summary Compensation Table, and all of HKN’s directors and named executive officers as a group. Each director and executive officer has sole voting and investment power with respect to the shares beneficially owned by him/her.

 

Name			Number of Shares Beneficially Owned				Percent of Class
Michael M. Ameen, Jr.				65				*
Mikel D. Faulkner				75				*
Dr. J. William Petty				81				*
Alan G. Quasha				0	(1)			*
H. A. Smith				33				*
Sarah B. Gasch				0				*
Kristina M. Humphries				0				*
Christopher L. DeBerry				0				*
All directors and named  executive officers as a group (8 persons)				254				*

*

Less than 1%

(1)

Does not include 264,325 shares beneficially owned by Everest Hill Group, Inc. (“Everest Hill”). Mr. Alan Quasha is the brother of Wayne Quasha, who is deemed to be the beneficial owner of Everest Hill through the AQ, JQ and WQ Trusts but Mr. Alan Quasha disclaims any beneficial ownership of these shares.

 

 The following table sets forth the securities authorized for issuance under the BWI Stock Option Plan.

 

Equity Compensation Plan Information
Plan Category	Number of Securities to be Issued Upon Exercise of Outstanding Options (#)	Weighted-Average Exercise Price of Outstanding Options ($)	Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (#)
Equity compensation plans approved by security holders	50,500	$22.80	49,500
Equity compensation plans not approved by security holders	0	N/A	0
Total	50,500	$22.80	49,500

 

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

DIRECTOR INDEPENDENCE

 

Our common stock is currently traded on the Over the Counter Bulletin Board and quoted on the OTCQB marketplace, which does not have director independence requirements. Although our securities are no longer listed on the NYSE- MKT, we continue to determine the independence of directors under the NYSE - MKT listing standards. As such, Dr. J. William Petty, Michael M. Ameen, Jr. and H. A. Smith have been determined by our Board of Directors to meet the requirements for independence under the listing standards of the NYSE-MKT and SEC Rules, and “financially literate or sophisticated” as required by and in compliance with the listing standards of the NYSE-MKT and the regulations of the SEC. Our Board of Directors based its conclusions regarding the independence of these directors on (i) the fact that none of such persons is an executive officer or employee of the Company; and (ii) its opinion that none of such persons has a relationship which will interfere with the exercise of independent judgment in carrying out the responsibilities of such director. Our Board of Directors intends to analyze the independence issue annually to promote arms-length oversight.

 

As of February 28, 2015, our largest shareholder, Everest Hill, beneficially owned 67.62% of the combined voting power of our Common Stock. Everest Hill is in a position to exercise significant influence over the election of our Board of Directors and other matters.

 

RELATED PARTY TRANSACTIONS

 

There are currently no proposed transactions with related parties.

 

HKN owns approximately 35% of the outstanding ordinary shares of Global Energy Development PLC (“Global”). Our CEO, Mr. Mikel Faulkner, serves as Chairman of Global. In March 2013, we entered into a new loan agreement (the “Global 2013 Note”) with Global to refinance the outstanding $5 million Global Note Receivable and the $12 million Global Loan into one $17 million note. The Global 2013 Note extended the maturity date to June 15, 2015 and initially increased the interest rate from 12.5% to 12.75%. During September 2014, pursuant to provisions of the Global 2013 Note agreement, the interest rate charged was increased from 12.75% up to 13.5% due to Global’s nonconformity with performance conditions as of June 30, 2014. The new stated interest rate was to remain in effect until the maturity of the loan agreement. Beginning June 30, 2014, the Global 2013 Note was classified as a current asset because all quarterly payments on the Global 2013 Note had been received in accordance with the stated repayment terms, and we believed the remaining payments would also be made as scheduled.

 

In December 2014, Global announced it had completed the sale of its rights and obligations for its contract areas within the Llanos Basin. Global used a portion of the net sale proceeds to repay the Global 2013 Note. We received $7.5 million in outstanding principal, $225 thousand in prepayment penalty and $200 thousand in accrued interest. Additionally, we recognized $47 thousand of unamortized origination fees.

 

During the years ended December 31, 2014 and 2013, we received interest payments from Global of approximately $1.2 million and $2 million, respectively.

 

During 2013, we purchased an additional 105 thousand shares of Global for $171 thousand, increasing our ownership from 34.22% to 34.51%. During 2014, we purchased an additional 343 thousand shares of Global for approximately $422 thousand, increasing our ownership from 34.51% to 35.46%.

 

The Audit Committee Charter authorizes our Audit Committee to review and approve all related party transactions in the absence of a separate committee being established by our Board for that purpose. The Audit Committee and a Special Committee composed of Messrs. Ameen, Smith and Petty both reviewed and approved the Global loans and related amendment. Other than as addressed in the Audit Committee Charter, we do not employ specific written procedures for the review, approval or ratification of related party transactions involving our directors, officers and employees or their family members, but we consider such transactions on a case-by-case basis.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

 

INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS

 

Hein & Associates LLP (“Hein”) served as HKN’s independent registered public accounting firm for the years ended December 31, 2014 and 2013.

 

The following table sets forth information concerning the fees billed by HKN’s independent registered public accountants during the last two fiscal years.

 

		2014				2013
Audit Fees		$	103,321			$	126,629
Audit Related Fees			0				0
Tax Fees			0				0
All Other Fees			0				0

 

Audit Fees include fees billed for the audit of the consolidated financial statements and quarterly reviews of unaudited financial statements.

 

The Audit Committee, or a designated member thereof, pre-approves audit and non-audit services rendered by its independent registered public accounting firm to HKN and its subsidiaries. If pre-approval authority is delegated, the delegate must report back to the Audit Committee at the first Audit Committee meeting following any approval. For the fiscal year 2014, 100% of all audit and non-audit services were pre-approved by the Audit Committee, which concluded that the provision of such services by HKN’s independent registered public accounting firm was compatible with the maintenance of that firm’s independence in the conduct of its auditing functions. All persons involved in the services performed by Hein during 2014 were permanent, full-time employees of Hein.

 

 

PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

(a)	The following documents are filed as a part of this Annual Report:
	(1)	Financial Statements included in Part II of this Annual Report:
				Page
		HKN, Inc. and Subsidiaries
		-- Report of Independent Registered Public Accounting Firm		31
		-- Consolidated Balance Sheets -- December 31, 2014 and 2013		32
		-- Consolidated Statements of Operations for the two years ended December 31, 2014		33
		-- Consolidated Statements of Comprehensive Loss for the two years ended December 31, 2014		34
		-- Consolidated Statements of Stockholders’ Equity for the two years ended December 31, 2014		35
		-- Consolidated Statements of Cash Flows for the two years ended December 31, 2014		36
		-- Notes to Consolidated Financial Statements		37
	(2)	The information required by Schedule I is either provided in the related financial statements or in a note thereto, or is not applicable to HKN, Inc. The information required by all other Schedules is not applicable to HKN, Inc.
	(3)	Exhibits

 

		3.1	Restated Certificate of Incorporation of Harken Energy Corporation (filed as Exhibit 3.1 to HKN's Form 10-K dated February 28, 2006, File No. 1-10262, and incorporated herein by reference).
		3.2	Certificate of Amendment of Restated Certificate of Incorporation of Harken Energy Corporation dated June 4, 2007 (filed as Exhibit 3.2 to HKN's Form 10-Q dated August 7, 2007, File No. 1-10262, and incorporated by reference herein).
		3.3	Certificate of Amendment to Restated Certificate of Incorporation of HKN, Inc. dated October 29, 2012 and effective October 30, 2012 (filed as Exhibit 99.2 to HKN’s current report on Form 8-K, dated October 31, 2012, File No. 1-10262, and incorporated by reference herein).
		3.4	Amended and Restated Bylaws of HKN, Inc. (filed as Exhibit 3.1 to HKN’s current report on Form 8-K, dated May 1, 2013, File No. 1-10262, and incorporated by reference herein).
		4.1	Form of certificate representing shares of HKN, Inc. common stock, par value $.01 per share (filed as Exhibit 4.1 to HKN’s Form 10-Q dated August 7, 2007, File No. 1-10262, and incorporated by reference herein).
		*21	Subsidiaries of HKN, Inc.
		*23.1	Consent of Moyes and Co. (Independent Reserve Engineers)
		*24	Power of Attorney

 

 

		*31.1	Certificate of the Chief Executive Officer of HKN, Inc. pursuant to section 302 of the Sarbanes-Oxley Act of 2002 (“S.O. Act”)
		*31.2	Certificate of the Chief Financial Officer of HKN, Inc. pursuant to section 302 of the S.O. Act
		*32.1	Certificate of the Chief Executive Officer of HKN, Inc. pursuant to section 906 of the S.O. Act
		*32.2	Certificate of the Chief Financial Officer of HKN, Inc. pursuant to section 906 of the S.O. Act
		*99.1	Moyes & Co. Reserve report summary
		*101.INS**	XBRL Instance
		*101.SCH**	XBRL Taxonomy Extension Schema
		*101.CAL**	XBRL Taxonomy Extension Calculation
		*101.DEF**	XBRL Taxonomy Extension Definition
		*101.LAB**	XBRL Taxonomy Extension Labels
		*101.PRE**	XBRL Taxonomy Extension Presentation

 

* Filed herewith

** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

SIGNATURES

 

Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 3, 2015.

 

	HKN, INC.
	/s/ Kristina M. Humphries
	By: Kristina M. Humphries, Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

   

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities on March 3, 2015.

 

 

Signature		Title
/s/ Kristina M. Humphries		Vice President and Chief Financial Officer
Kristina M. Humphries		(Principal Financial Officer and Principal Accounting Officer)
/s/ Mikel D. Faulkner		Director, Chief Executive Officer and President
Mikel D. Faulkner		(Principal Executive Officer)
/s/ Michael M. Ameen, Jr. *		Director
Michael M. Ameen, Jr.
		Director
Alan G. Quasha
/s/ Dr. J. William Petty *		Director
Dr. J. William Petty
/s/ H. A. Smith *		Director
H. A. Smith
/s/ Kristina M. Humphries
* By: Kristina M. Humphries, Attorney in-fact

 

 

 

73