UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

For the Quarterly Period Ended September 30, 2015

 

or

 

 

for the transition period from _____ to _____

 

Commission File No. 1-10762

______________________________

 

Harvest Natural Resources, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

(281) 899-5700

(Registrant's Telephone Number, Including Area Code) 

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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  ☒  No   ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  ☒  No   ☐

 

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 the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ☐  No   ☒

At November 2, 2015, the Registrant had 51,415,164 shares of its common stock, par value $0.01 per share, outstanding.

 

 

 

 

 

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HARVEST NATURAL RESOURCES, INC.

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

 

 

 

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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands, except per share data)

 

 

See accompanying notes to consolidated  condensed financial statements.

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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

(Unaudited)

 

See accompanying notes to consolidated condensed financial statements.

 

 

 

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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

 

 

See accompanying notes to consolidated condensed financial statements.

 

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Supplemental Schedule of Noncash Investing and Financing Activities:

 

 

 

See accompanying notes to consolidated condensed  financial statements.

 

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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

Note 1 – Organization

 

Interim Reporting

 

In our opinion, the accompanying unaudited consolidated condensed financial statements contain all adjustments, which are of a normal recurring nature, necessary to present fairly the financial position as of September 30, 2015 and December 31, 2014, results of operations for the three and nine months ended September 30, 2015 and 2014, and the cash flows for nine months ended September 30, 2015 and 2014.  The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.  The unaudited consolidated condensed financial statements are presented in accordance with the requirements of Form 10-Q and do not include all disclosures normally required by accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated condensed financial statements included in this report should be read with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014, which include certain definitions and a summary of significant accounting policies. The results of operations for any interim period are not necessarily indicative of the results of operations for the entire year.

 

Organization

 

Harvest Natural Resources, Inc. (“Harvest” or the “Company”) is a petroleum exploration and production company incorporated under Delaware law in 1988.  We have acquired and developed significant interests in the Bolivarian Republic of Venezuela (“Venezuela”). In addition to our interests in Venezuela, we hold exploration acreage mainly offshore of the Republic of Gabon (“Gabon”) through the Dussafu Marin Permit (“Dussafu PSC”).  See Note 8 – Gabon.

Our Venezuelan interests are owned through our 51 percent ownership interest in Harvest-Vinccler Dutch Holding B.V., a Dutch private company with limited liability (“Harvest Holding”). Our ownership of Harvest Holding is through HNR Energia B.V. (“HNR Energia”), in which we have a direct controlling interest.  The remaining 49 percent ownership interest of Harvest Holding is owned by Oil & Gas Technology Consultants (Netherlands) Cooperatie U.A. (“Vinccler”) (20 percent) and Petroandina Resources Corporation N.V. ("Petroandina") (29 percent); Petroandina is a wholly owned subsidiary of Pluspetrol Resources Corporation B.V. (“Pluspetrol”). Harvest Holding owns 100 percent of HNR Finance B.V. (“HNR Finance”), and HNR Finance owns a 40 percent interest in Petrodelta, S.A. (“Petrodelta”). Petrodelta is the Venezuelan mixed company formed in 2007 for the purpose of owning and operating certain oil and gas interests in Venezuela. The other 60 percent of Petrodelta is owned by CorporacionVenezolana del Petroleo A.S. (“CVP”) and PDVSA Social S.A., both companies owned and controlled by the Government of Venezuela through Petroleos de Venezuela S.A. (“PDVSA”). Thus, we own an indirect 20.4 percent of Petrodelta (51 percent of 40 percent).  In addition to its 40 percent interest in Petrodelta, Harvest Holding also indirectly owns 100 percent of Harvest Vinccler, S.C.A. (“Harvest Vinccler”), which currently assists us in the oversight of our investment in Petrodelta and in negotiations with PDVSA.

Purchase Agreement

On June 19, 2015, the Company and certain of its domestic subsidiaries entered into a securities purchase agreement (the “Purchase Agreement”) with CT Energy Holding SRL (“CT Energy”), a  Venezuelan-Italian consortium organized as a Barbados Society with Restricted Liability, under which CT Energy purchased certain securities of the Company and acquired certain governance rights.  Harvest immediately received gross proceeds of $32.2 million from the sale of the securities, as described below.   

Terms of the transaction include:

While negotiating the purchase agreement, the Company borrowed $1.3 million to fund certain corporate expenses for a note payable to CT Energy bearing an interest rate of 15% per annum, with a maturity date of January 1, 2016.  On June 19, 2015, the Company repaid the note payable. 

Note 2 – Liquidity

Historically, prior to the transaction pursuant to the Purchase Agreement, our primary ongoing source of cash had been dividends from Petrodelta, issuance of debt and the sale of oil and gas properties. Our primary use of cash has been to fund oil and gas exploration projects, principal payments on debt, interest, and general and administrative costs. We require capital principally to fund the exploration and development of new oil and gas properties. As is common in the oil and gas industry, we have various contractual commitments pertaining to exploration, development and production activities.  

The Company plans to either further develop, farm down, or sell (or a combination of these options) the Dussafu Project, while weighing the liquidity requirements necessary to maintain ongoing Company operations.  The development of, or a transaction regarding, the Dussafu project and the success of negotiations between PDVSA, CT Energy, and HNR Finance for the management of Petrodelta will directly impact our future earnings, cash flows, and balance sheet.  Without these transactions or additional financings or other sources of cash, we may not have sufficient liquidity for operations or capital requirements.  There can be no guarantee of realizing the value of our exploration and exploitation acreage or suspended wells in the Dussafu project or our investment in Petrodelta or that we can obtain further financings or sources of cash.  See Note 12 – Commitments and Contingencies.

On September 15, 2015, the 9.0%  Note and associated accrued interest was converted into 8,667,597 shares of Harvest common stock.  See Note 1 – Organization.  

Note 3 – Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated condensed financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. Third-party interests in our majority-owned subsidiaries are presented as noncontrolling interests.

 

Investment in Affiliate

 

Through December 31, 2014, we included the results of Petrodelta in our financial statements under the equity method of accounting.  Effective December 31, 2014, we determined that we no longer had significant influence within our investment in Petrodelta and in accordance with Accounting Standards Codification “ASC 323 – Investments – Equity Method” and as such, we account for our investment in Petrodelta under the cost method (“ASC 325 – Investments – Other”).  Under the cost method we will not recognize any equity in earnings from our investment in Petrodelta in our results of operations, but will recognize any cash dividends in the period they are received.   We also performed an impairment analysis of the carrying value of our investment at December 31, 2014.  Based on this assessment we recorded a one-time pre-tax impairment charge of $355.7 million against the carrying value of our investment in the fourth quarter of 2014.  We continue to monitor the carrying value of our investment and may record additional impairments if we believe that any future decrease in the estimated fair value of the investment is other than temporary. 

Use of Estimates

The preparation of financial statements in conformity with 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 reporting period. Actual results could differ from those estimates.

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Oil and Gas Properties

The major components of property and equipment are as follows:

 

 

 

 

Other Administrative Property

Furniture, fixtures and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are recorded at cost and amortized using the straight-line method over the life of the applicable lease. For the three and nine months ended September 30, 2015, depreciation expense was $0.0 million and $0.1 million, respectively.  For the three and nine months ended September 30, 2014, depreciation expense was $0.0 million and $0.2 million, respectively.

Other Assets

Other assets at September 30, 2015 and December 31, 2014 include deposits, prepaid expenses expected to be realized in the next 12 to 24 months and deferred financing costs. Deferred financing costs relate to specific financings and are amortized over the life of the financings to which the costs relate using the interest rate method.  Other assets at September 30, 2015 and December 31, 2014 also consisted of a blocked payment related to our drilling operations in Gabon in accordance with the United States (“U.S.”) sanctions against Libya as set forth in Executive Order 13566 of February 25, 2011, and administered by the United States Treasury Department’s Office of Foreign Assets Control (“OFAC”).  During the nine months ended September 30, 2015, we amortized $0.3 million in deferred financing costs.   During the nine months ended September 30, 2015, we recorded a $0.6 million allowance for doubtful accounts to general and administrative costs associated with the blocked payment. See Note 12 – Commitments and Contingencies. 

 

 

Capitalized Interest

We capitalize interest costs for qualifying oil and gas properties. The capitalization period begins when expenditures are incurred on qualified properties, activities begin which are necessary to prepare the property for production and interest costs have been incurred. The capitalization period continues as long as these events occur.  The average additions for the period are used in the interest capitalization calculation. During the three and nine months ended September 30, 2015, we did not capitalize interest costs due to insufficient on-going activity related to our oil and gas activities. During the three and nine months ended September 30, 2014, we capitalized interest costs for qualifying oil and gas property additions related to our Dussafu project in Gabon of $0.0 million and $0.2 million, respectively.

Fair Value Measurements

We measure and disclose our fair values in accordance with the provisions of ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 defines fair value 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 (exit price) and establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of the hierarchy are defined as follows:

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Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, accounts receivable, stock appreciation rights, restricted stock units, debt, embedded derivatives and warrant derivative liabilities. We maintain cash and cash equivalents in bank deposit accounts with commercial banks with high credit ratings, which, at times may exceed the federally insured limits. We have not experienced any losses from such investments. Concentrations of credit risk with respect to accounts receivable are limited due to the nature of our receivables. In the normal course of business, collateral is not required for financial instruments with credit risk.  The estimated fair value of cash and cash equivalents and accounts receivable approximates their carrying value due to their short-term nature (Level 1).  The following tables set forth by level within the fair value hierarchy our financial liabilities that were accounted for at fair value as of September 30, 2015 and December 31, 2014.

 

 

 

As of September 30, 2015, the fair value of our liability awards included $0.7 million for our stock appreciation rights (“SARs”) and $0.6 million for the restricted stock units (“RSUs”) which were recorded in accrued expenses and other long-term liabilities, respectively.  As of December 31, 2014, the fair value of our liability awards included $0.4 million for our SARs and $0.4 million for our RSUs which were recorded in accrued expenses.  Our remaining $0.2 million for the RSUs liability was recorded in other long-term liabilities.

Derivative Financial Instruments

 

As required by ASC 820, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value liabilities and their placement within the fair value hierarchy levels. See Note 11 – Warrant Derivative Liabilities for a description and discussion of our warrant derivative liability as well as a description of the valuation models and inputs used to calculate the fair value.  See Note 10 – Debt and Financing for a description and discussion of our embedded derivatives related to our 9.0% Note and 15.0% Note as well as a description of the valuation models and inputs used to calculate the fair value.  All of our embedded derivatives and warrants are classified as Level 3 within the fair value hierarchy. 

 

During the three and nine months ended September 30, 2015, there was a change in the fair value of the CT Warrant liability of $10.0 million and $12.4 million, respectively, as reflected in our consolidated condensed statement of operations and comprehensive income (loss) as change in fair value of warrant liabilities.  As of September 30, 2015, the fair value of the 15.0% Note was $10.4 million.  During the three and nine months ended September 30, 2015, there was a change in the fair value of embedded derivative liability of $1.9 million and $2.3 million, respectively, and a change in the fair value of the embedded derivative assets of $0.8 million and $1.0 million, respectively, recorded as change in fair value of derivative assets and liabilities as reflected in our consolidated condensed statement of operations and comprehensive income (loss).

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Changes in Level 3 Instruments Measured at Fair Value on a Recurring Basis

The following table provides a reconciliation of financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

 

 

 

 

 

 

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During three and nine months ended September 30, 2015 and 2014 no transfers were made between Level 1, Level 2 and Level 3 liabilities or investments. 

Share-Based Compensation

We use a fair value based method of accounting for stock-based compensation. We generally utilize the Black-Scholes option pricing model to measure the fair value of stock options and SARs. Restricted stock and RSUs are measured at their fair values.  On September 9, 2015, Harvest’s stockholders approved an amendment to our 2010 Long-Term Incentive Plan to increase the number of shares of our common stock available for issuance and the number of shares that may be granted in the form of full value awards. The Company accounts for the SARs and RSUs that are granted as liability awards as these awards are cash settled.

On July 22, 2015, we issued stock based compensation awards to certain employees as follows:  847,000 stock options to purchase common shares at an exercise price of $1.13 per share, vesting ratably over three years from the date of grant; 5,062,000 SARs at an exercise price of $1.13 per share, vesting ratably over three years from the date of grant; and 1,571,000 restricted stock units vesting at three years from the date of grant.  Subject to the above vesting requirements, the options, SARs and RSUs awarded will not become exercisable until the first day on which the volume weighted average price of the common stock over any 30-day period, commencing on or after the award date, equals or exceeds $2.50 per share, as reported by the NYSE.  The dual vesting requirements necessitated that all of these awards be valued using a Monte Carlo simulation model.  The SARs and RSUs are classified as liability awards at September 30, 2015.

The assumptions summarized in the following table were used to calculate the fair value of the stock appreciation rights granted on July 22, 2015 that were outstanding as of the balance sheet date presented on our consolidated condensed balance sheet:

 

On September 9, 2015, we issued 320,004 restricted stock units vesting one year from the date of grant to our directors.  These awards are classified as liability awards.  There awards were measured at their fair values using the intrinsic value model.

The assumptions summarized in the following table were used to calculate the fair value of the restricted stock units granted on July 22, 2015 that were outstanding as of the balance sheet date presented on our consolidated condensed balance sheet:

 

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During the three and nine months ended September 30, 2015, the Company recognized share based compensation of $0.7 million and $2.2 million, respectively. 

Income Taxes

Deferred income taxes reflect the net tax effects, calculated at currently enacted rates, of (a) future deductible/taxable amounts attributable to events that have been recognized on a cumulative basis in the financial statements or income tax returns, and (b) operating loss and tax credit carryforwards. A valuation allowance for deferred tax assets is recorded when it is more likely than not that the benefit from the deferred tax asset will not be realized.

We classify interest related to income tax liabilities and penalties as applicable, as interest expense.

Since December of 2013 we have provided deferred income taxes on a portion of the undistributed earnings of our foreign subsidiaries as we are unable to assert that those earnings would be permanently reinvested, nor otherwise could be repatriated in a tax free manner, as part of our ongoing business.

As the conversion feature of the 9.0% Note was reasonably expected to be exercised at the time of the note’s issuance due to the conversion price being in-the-money, the interest on the 9.0% Note paid upon the conversion is non-deductible to the Company under Internal Revenue Code (“IRC”) Section 163(l).  The 15.0% Note was issued, for income tax purposes, with original issue discount (“OID”).  OID generally is deductible for income tax purposes.  However, if the debt instrument constitutes an “applicable high-yield discount obligation” (“AHYDO”) within the meaning of IRC Section 163(i)(1), then a portion of the OID likely would be non-deductible pursuant to IRC Section 163(e)(5).  Our analysis of on the 15.0% Note is that the note may be an AHYDO; consequently, a portion of the OID likely may be non-deductible for income tax purposes.

 

Noncontrolling Interests

 

Changes in noncontrolling interests were as follows: