Item 1A. Risk Factors
Risks Related To Our Company
Our growth depends on our ability to obtain additional capital and we may not be able to obtain sufficient additional capital to grow our business.
Effectuation of our business strategy will require substantial capital expenditures. In order to fund our future growth, we will need to obtain additional capital. The amount and timing of our future capital requirements will depend upon a number of factors, including:
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drilling results and costs;
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transportation costs;
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equipment costs and availability;
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marketing expenses;
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oil and natural gas prices;
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requirements and commitments under existing permits;
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staffing levels and competitive conditions; and
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any purchases or dispositions of assets.
Our ability to raise additional capital will depend on the results of our operations and the status of various capital and industry markets at the time we seek such capital. Our failure or inability to obtain any required additional financing on favorable terms could materially and adversely affect our growth, cash flow and earnings, including our ability to meet our capital expenditures budgets.
On December 28, 2006, we entered a loan and guarantee agreement with International Finance Corporation for our operations in Turkey and Romania. The loan and guarantee agreement provides for two separate facilities, the first of which is the $10 million facility which is unsecured and the second of which is the $25 million facility which is a secured revolving facility. The $25 million facility has a current maximum facility amount of $25 million which maximum facility amount will increase to $40 million when the total borrowing base amount exceeds $50 million.
We also have outstanding $86.25 million of Convertible Senior Notes due October 1, 2025.
At December 31, 2007 our debt to equity ratio was .71 to 1, and this ratio and our increased leverage may make it difficult for us to obtain additional funding, especially additional debt.
No assurance can be given that we will have the needed additional capital to fund our future growth under these facilities or from existing operations.
In addition, to the extent that we are not able to obtain additional capital by the incurrence of additional debt, we may need to issue additional equity. Any such issuance of equity could be materially dilutive to our outstanding equity and equity holders.
The terms of our indebtedness may restrict our ability to grow.
As noted above, our debt to equity ratio may limit our ability to obtain additional indebtedness. Additionally, our loan and guarantee agreement with the International Finance Corporation restricts our ability to incur additional indebtedness because of financial ratios that we must meet.
Thus, we may not be able to obtain sufficient capital to grow our business, effectuate our business strategy and may lose opportunities to acquire interests in oil and natural gas properties or related businesses because of our inability to fund such growth.
Our ability to comply with the restrictions and covenants of our indebtedness in the future is uncertain and is affected by the levels of cash flow from our operations and events or circumstances beyond our control. Our failure to comply with any of the restrictions and covenants could result in a default, which could permit the lender to accelerate repayments and foreclose on the collateral securing the indebtedness.
Any additional future indebtedness may limit our financial and operating flexibility in a manner similar to and potentially more restrictive than the facility discussed above.
Acquisition prospects may be difficult to assess and may pose additional risks to our operations.
On a consistent basis, we evaluate and, where appropriate, pursue acquisition opportunities on terms we consider favorable. In particular, we pursue acquisitions of businesses or interests that will complement and allow us to expand our exploration activities; however, currently, we have no binding commitments related to any acquisitions. The successful acquisition of interests in oil and natural gas properties requires an assessment of:
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recoverable reserves;
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exploration potential;
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future oil and natural gas prices;
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operating costs;
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potential environmental and other liabilities and other factors; and
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permitting and other environmental authorizations required for our operations.
In connection with such an assessment, we would expect to perform a review of the subject properties that we believe to be generally consistent with industry practices. Nonetheless, the resulting conclusions are necessarily inexact and their accuracy inherently uncertain, and such an assessment may not reveal all existing or potential problems, nor will it necessarily permit us to become sufficiently familiar with the properties to fully assess their merits and deficiencies. Inspections may not always be performed on every platform or well, and structural and environmental problems are not necessarily observable even when an inspection is undertaken. As a result, acquired properties may prove to be worth less than we pay for them.
Future acquisitions could pose numerous additional risks to our operations and financial results, including:
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problems integrating the purchased operations, personnel or technologies;
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unanticipated costs;
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diversion of resources and management attention from our core business;
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entry into regions or markets in which we have limited or no prior experience; and
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potential loss of key employees, particularly those of any acquired organization.
Competition in the oil and natural gas industry is intense, and many of our competitors have greater financial, technological and other resources than we do.
We operate in the highly competitive areas of oil and natural gas exploration, development, production, leasing, and acquisition activities. The oil and natural gas industry is characterized by rapid and significant technological advancements and introductions of new products and services using new technologies. We face intense competition from independent, technology-driven companies as well as from both major and other independent oil and natural gas companies in each of the following areas:
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seeking to acquire desirable producing properties or new leases for future exploration;
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marketing our oil and natural gas production;
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integrating new technologies; and
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seeking to acquire the equipment and expertise necessary to develop and operate our properties.
Many of our competitors have financial, technological and other resources substantially greater than ours, and some of them are fully integrated oil and natural gas companies. These companies may be able to pay more for development prospects and productive oil and natural gas properties and may be able to define, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. Further, these companies may enjoy technological advantages and may be able to implement new technologies more rapidly than we can. Our ability to develop and exploit our oil and natural gas properties and to acquire additional properties in the future will depend upon our ability to successfully conduct operations, implement advanced technologies, evaluate and select suitable properties and consummate transactions in this highly competitive environment.
Our business exposes us to liability and extensive regulation on environmental matters.
Our operations are subject to foreign laws and regulations controlling the discharge of materials into the environment or otherwise relating to the protection of the environment. Such laws and regulations not only expose us to liability for our own negligence, but may also expose us to liability for the conduct of others or for our actions that were in compliance with all applicable laws at the time those actions were taken. We may incur significant costs as a result of environmental accidents, such as oil spills, natural gas leaks, ruptures, or discharges of hazardous materials into the environment, including clean-up costs and fines or penalties. Additionally, we may incur significant costs in order to comply with environmental laws and regulations and may be forced to pay fines or penalties if we do not comply.
All of our operations are conducted in Turkey, Hungary, Romania and France. Therefore, we are subject to political and economic risks and other uncertainties.
We have international operations and are subject to the following foreign issues and uncertainties that can affect our operations adversely:
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the risk of expropriation, nationalization, war, revolution, border disputes, renegotiation or modification of existing contracts, and import, export and transportation regulations and tariffs;
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taxation policies, including royalty and tax increases and retroactive tax claims;
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exchange controls, currency fluctuations and other uncertainties arising out of foreign government sovereignty over international operations;
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laws and policies of the United States affecting foreign trade, taxation and investment;
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the possibility of being subjected to the exclusive jurisdiction of foreign courts in connection with legal disputes and the possible inability to subject foreign persons to the jurisdiction of courts in the United States; and
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the possibility of restrictions on repatriation of earnings or capital from foreign countries.
Terrorist activities may adversely affect our business.
Terrorist activities, including events similar to those of September 11, 2001, or armed conflict involving the United States or any other country in which we hold interests, may adversely affect our business activities and financial condition. If events of this nature occur and persist, the resulting political and social instability could adversely affect prevailing oil and natural gas prices and cause a reduction in our revenues. In addition, oil and natural gas production facilities, transportation systems and storage facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our operations is destroyed or damaged. Costs associated with insurance and other security measures may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all.
We are highly dependent upon key personnel.
Our continued success is dependent to a significant degree upon the services of our executive officers and upon our ability to attract and retain qualified personnel who are experienced in the various phases of our business. In January 2007, we replaced G. Thomas Graves III when he resigned with Nigel Lovett. The duties of our former Chief Financial Officer, Douglas Weir, have been assumed by Nigel Lovett and Charles Campise. There can be no assurance that if we lose the services of one or more of our other executive officers, that we will be able to attract and retain qualified management, geologists, geophysicists and other technical personnel. If we are unable to attract and retain qualified management, including a chief executive officer, a chief financial officer, geologists, geophysicists and other technical personnel, our business, financial condition, results of operations or the market value of our common stock could be materially adversely affected.
We may not be able to renew our permits or obtain new ones which could reduce our proved reserves.
We do not hold title to properties in Turkey, Hungary, Romania and France, but have exploration and exploitation permits granted by these countries’ respective governments. Approximately 71% of our proved reserves are estimated to be recovered after the expiration of the applicable permit, as of December 31, 2007. There can be no assurance that we will be able to renew any of these permits when they expire, convert exploration permits into exploitation permits or obtain additional permits in the future. If we cannot renew some or all of these permits when they expire or convert exploration permits into exploitation permits, we will not be able to include the proved reserves associated with the permit.
Since we do not hold title to our properties but rather hold exploitation and exploration permits granted to us by the applicable governments, the Securities and Exchange Commission may require that a certain portion of proved reserves associated with these permits not be included in our proved reserves.
Rather than holding title to our properties, we hold exploitation and exploration permits that have been granted to us for a specific time period by the applicable governments. We must apply to have these permits renewed and extended in order to continue our exploration and development rights. Although we have always reported our proved reserves assuming that the permits will be extended in due course, the Securities and Exchange Commission may take the view that our ability to renew and extend our permits past their current expiration dates is not sufficiently certain such that we should not include the reserves that may be produced post expiration in our total proved reserves. Although we have previously been able to provide support to the Securities and Exchange Commission regarding the likelihood of extension, no assurance can be given that the Securities and Exchange Commission will allow us to continue to include these additional reserves in our proved reserves.
Any future hedging activities may require us to make significant payments that are not offset by sales of production and may prevent us from benefiting from increases in oil or natural gas prices.
Although we are not currently a party to a hedging transaction, occasionally we may reduce our exposure to the volatility of oil and natural gas prices by hedging a portion of our production. In a typical hedge transaction, we will have the right to receive from the counterparty to the hedge the excess of the fixed price specified in the hedge over a floating price based on a market index, multiplied by the quantity hedged. If the floating price exceeds the fixed price, we will be required to pay the counterparty this difference multiplied by the quantity hedged. In such case, we
will be required to pay the difference regardless of whether we have sufficient production to cover the quantities specified in the hedge. Significant reductions in production at times when the floating price exceeds the fixed price could require us to make payments under the hedge agreements even though such payments are not offset by sales of production. Hedging also could prevent us from receiving the full advantage of increases in oil or natural gas prices above the fixed amount specified in the hedge.
Our operations are subject to currency fluctuation risks.
We currently have operations involving the U.S. dollar, Euro, New Turkish Lira, Forint and Romanian Lei. We are subject to fluctuations in the value of the U.S. dollar as compared to the Euro, New Turkish Lira, Forint and Romanian Lei respectively. These fluctuations may adversely affect our results of operations.
Failure to maintain effective internal controls could have a material adverse effect on our operations and our stock price.
We are subject to Section 404 of the Sarbanes-Oxley Act which requires an annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors addressing our internal controls and management’s assessment. Effective internal controls are necessary for us to produce reliable financial reports. If, as a result of deficiencies in our internal controls, we cannot provide reliable financial reports, our business decision process may be adversely affected, our business and operating results could be harmed, we could be deemed in violation of our lending covenants, investors could lose confidence in our reported financial information and the price of our stock could decrease.
During the evaluation of disclosure controls and procedures for the year ended December 31, 2007, we concluded that our disclosure controls and procedures were not effective in reaching a reasonable level of assurance of achieving management’s desired controls and procedures objectives in our internal control over financial reporting. There is no guarantee that we will be able to resolve these material weaknesses or avoid other material weaknesses in the future.
Risks Related To Our Industry
A decline in oil and natural gas prices will have an adverse impact on our operations.
Our revenues, cash flows and profitability are substantially dependent upon prevailing prices for oil and natural gas. In recent years, oil and natural gas prices and, therefore, the level of drilling, exploration, development and production, have been extremely volatile. Any significant or extended decline in oil or natural gas prices will have a material adverse effect on our business, financial condition and results of operations and could impair access to future sources of capital. Volatility in the oil and natural gas industry results from numerous factors over which we have no control, including:
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the level of oil and natural gas prices, expectations about future oil and natural gas prices and the ability of international cartels to set and maintain production levels and prices;
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the cost of exploring for, producing and transporting oil and natural gas;
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the domestic and foreign supply of oil and natural gas;
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domestic and foreign governmental regulation;
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the level and price of foreign oil and natural gas transportation;
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available pipeline and other oil and natural gas transportation capacity;
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weather conditions;
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international political, military, regulatory and economic conditions;
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the level of consumer demand;
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the price and the availability of alternative fuels;
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the effect of worldwide energy conservation measures; and
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the ability of oil and natural gas companies to raise capital.
Significant declines in oil and natural gas prices for an extended period may:
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impair our financial condition, liquidity, ability to finance planned capital expenditures and results of operations;
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cause us to delay or postpone some of our capital projects;
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reduce our revenues, operating income and cash flow; and
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reduce the carrying value of our oil and natural gas properties.
No assurance can be given that current levels of oil and natural gas prices will continue. We expect oil and natural gas prices, as well as the oil and natural gas industry generally, to continue to be volatile.
Continued financial success depends on our ability to replace our reserves in the future.
Our future success as an oil and natural gas producer depends upon our ability to find, develop and acquire additional oil and natural gas reserves that are profitable. Oil and natural gas are depleting assets, and production from oil and natural gas from properties declines as reserves are depleted with the rate of decline depending on reservoir characteristics. If we are unable to conduct successful exploration or development activities or acquire properties containing proved reserves, our proved reserves generally will decline as the reserves are produced, and our level of production and cash flows will be adversely affected. Replacing our reserves through exploration or development activities or acquisitions will require significant capital which may not be available to us.
We face numerous risks in finding commercially productive oil and natural gas reservoirs.
Our drilling will involve numerous risks, including the risk that no commercially productive oil or natural gas reservoirs will be encountered. We may incur significant expenditures for the identification and acquisition of properties and for the drilling and completion of wells. The cost of drilling, completing and operating wells is often uncertain, and drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including unexpected drilling conditions, pressure or irregularities in formations, equipment failures or accidents, weather conditions and shortages or delays in the delivery of equipment.
In addition, any use by us of 3D seismic and other advanced technology to explore for oil and natural gas requires greater pre-drilling expenditures than traditional drilling methodologies. While we use advanced technology in our operations, this technology does not allow us to know conclusively prior to drilling a well that oil or natural gas is present or economically producible.
In addition, as a “successful efforts” company, we account for unsuccessful exploration efforts, i.e., the drilling of “dry holes,” as an expense of operations which impacts our earnings. Significant expensed exploration charges in any period would materially adversely affect our earnings for that period and could cause our earnings to be volatile from period to period.
We are exposed to operating hazards and uninsured risks.
Our operations are subject to the risks inherent in the oil and natural gas industry, including the risks of:
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fire, explosions and blowouts;
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pipe failure;
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abnormally pressured formations; and
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environmental accidents such as oil spills, natural gas leaks, ruptures or discharges of toxic gases, brine or well fluids into the environment (including groundwater contamination).
These events may result in substantial losses to us from:
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injury or loss of life;
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severe damage to or destruction of property, natural resources and equipment;
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pollution or other environmental damage;
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clean-up responsibilities;
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regulatory investigation;
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penalties and suspension of operations; and
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attorney’s fees and other expenses incurred in the prosecution or defense of litigation.
As is customary in our industry, we maintain insurance against some, but not all, of these risks. We cannot assure investors that our insurance will be adequate to cover these losses or liabilities. We do not carry business interruption insurance. Losses and liabilities arising from uninsured or underinsured events may have a material adverse effect on our financial condition and operations. We carry well control insurance for our drilling operations. Our coverage includes blowout protection and liability protection on international wells.
The producing wells in which we have an interest occasionally experience reduced or terminated production. These curtailments can result from mechanical failures, contract terms, pipeline and processing plant interruptions, market conditions and weather conditions. These curtailments can last from a few days to many months. As discussed above, in November 2007 production in the South Akcakoca Sub-basin project in the Black Sea offshore Turkey was shut down by the system operator due to damage to the pipeline spur. Underwater inspection revealed that the Akkaya pipeline spur had been separated at a pipeline flange and displaced approximately 20 feet from its original location. The likely cause was that a fishing boat, which was trawling through the exclusion zone around the platform, lifted the pipeline and caused the separation. In February 2008 natural gas production resumed in the South Akcakoca Sub-Basin natural gas project. Current production of approximately 15 MMcF of gas per day is from four wells. The Akkaya-1A, which was producing from a small zone low in the well, is currently shut-in and scheduled to be reentered as soon as equipment is available to start production from a previously perforated upper zone in the well.
Reserve estimates depend on many assumptions that may turn out to be inaccurate.
Any material inaccuracies in our reserve estimates or underlying assumptions could materially affect the quantities and present values of our reserves. The process of estimating natural gas and oil reserves is complex. It requires interpretations of available technical data and various assumptions, including assumptions relating to economic factors. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of reserves shown in this Form 10-K. In order to prepare these estimates, we must project production rates and timing of development expenditures. We must also analyze available geological, geophysical, production and engineering data, and the extent, quality and reliability of this data can vary. The process also requires economic assumptions relating to matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds.
Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves most likely will vary from our estimates. Any significant variance could materially affect the estimated quantities and pre-tax net present value of reserves shown in this Form 10-K. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond our control.
Investors should not assume that the pre-tax net present value of our proved reserves referred to in this Form 10-K is the current market value of our estimated oil and natural gas reserves. We base the pre-tax net present value of future net cash flows from our proved reserves on prices and costs on the date of the estimate. Actual future prices, costs, and the volume of produced reserves may differ materially from those used in the pre-tax net present value estimate.
Risks Related To Our Common Stock
Our stock’s public trading price has been volatile, which may depress the trading price of our common stock.
Our stock price is subject to significant volatility. Overall market conditions, in addition to other risks and uncertainties described in this “Risk Factors” section and elsewhere in this prospectus, may cause the market price of our common stock to fall. We participate in a price sensitive industry, which often results in significant volatility in the market price of common stock irrespective of company performance. As a result, our high and low closing stock prices for the twelve months ended March 12, 2008 were $23.22 and $5.79, respectively. Fluctuations in the price of our common stock may be exacerbated by conditions in the energy and oil and natural gas industries or conditions in the financial markets generally.
Our common stock is quoted on the Nasdaq Global Market under the symbol “TRGL.” However, daily trading volumes for our common stock are, and may continue to be, relatively small compared to many other publicly traded securities. It may be difficult for investors to sell their shares of common stock in the public market at any given time at prevailing prices, and the price of our common stock may, therefore, be volatile.
Numerous factors, including many over which we have no control, may have a significant impact on the market price of our common stock, including, among other things:
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current events affecting the political, economic and social situation in the United States and other countries where we operate;
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trends in our industry and the markets in which we operate;
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litigation involving or affecting us;
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changes in financial estimates and recommendations by securities analysts;
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acquisitions and financings by us or our competitors;
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quarterly variations in operating results;
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volatility in exchange rates between the US dollar and the currencies of the foreign countries in which we operate;
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the operating and stock price performance of other companies that investors may consider to be comparable; and
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purchases or sales of blocks of our securities.
In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations may adversely affect the price of our common stock, regardless of our operating performance. In addition, sales of substantial amounts of our common stock in the public market, or the perception that those sales may occur, could cause the market price of our common stock to decline. Furthermore, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly, which may cause us to incur substantial costs and could divert the time and attention of our management.
These factors, among others, could significantly depress the price of our common stock.
A large percentage of our common stock is owned by our officers and directors, and such stockholders may control our business and affairs.
At March 12, 2008, our executive officers and directors as a group beneficially owned approximately 16.39% of our common stock (including shares issuable upon exercise of stock options or warrants held by officers and directors). Due to their large ownership percentage interest, they may be able remain entrenched in their positions.
We do not intend to pay cash dividends on our common stock in the foreseeable future.
We currently intend to continue our policy of retaining earnings to finance the growth of our business. As a result, we do not anticipate paying cash dividends on our common stock in the foreseeable future. In addition, the terms of our loan and guarantee agreement with the International Finance Corporation restrict our ability to pay dividends on our common stock.
We may issue equity securities in the future which may depress the trading price of our common stock and may dilute the interests of our existing stockholders.
Future sales or issuances of common stock or the issuance of securities senior to our common stock may depress the trading price of our common stock.
Any issuance of equity securities, including the issuance of shares upon conversion of the Convertible Senior Notes, could dilute the interests of our existing stockholders and could substantially decrease the trading price of our common stock and the notes. We may issue equity securities in the future for a number of reasons, including to finance our operations and business strategy, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options, or upon conversion of debentures, or for other reasons. As of March 12, 2008, there were:
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338,170 shares of our common stock issuable upon exercise of outstanding options, at a weighted average exercise price of $4.85 per share, of which options to purchase 334,837 shares were exercisable;
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98,760 shares of our common stock issuable upon exercise of outstanding warrants, at a weighted average exercise price of $19.82 per share, all of which were exercisable;
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2,014,766 shares of our common stock issuable upon conversion of our Convertible Senior Notes; and
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257,587 shares of our common stock available for future grant under our equity incentive plan.
Our leverage may harm our financial condition and results of operations.
Our total consolidated long-term debt as of December 31, 2007 was approximately $116.3 million and represented approximately .71 of our total capitalization as of that date. Our level of indebtedness could have important consequences to investors, because:
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it could affect our ability to satisfy our payment obligations under our indebtedness;
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a substantial portion of our cash flows from operations will have to be dedicated to interest and principal payments and may not be available for operations, working capital, capital expenditures, expansion, acquisitions or general corporate or other purposes;
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it may impair our ability to obtain additional financing in the future;
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it may impair our ability to compete with companies that are not as highly leveraged;
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it may limit our flexibility in planning for, or reacting to, changes in our business and industry; and
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it may make us more vulnerable to downturns in our business, our industry or the economy in general.
Provisions in our charter documents, the indenture for the Convertible Senior Notes and Delaware law could discourage an acquisition of us by a third party, even if the acquisition would be favorable to holders of our common stock.
If a “change in control” (as defined in the indenture for the Convertible Senior Notes ) occurs, holders of the Convertible Senior Notes will have the right, at their option, to require us to repurchase all or a portion of their notes. In the event of certain “fundamental changes” (as defined in the indenture for the Convertible Senior Notes), we also may be required to increase the conversion rate applicable to notes surrendered for conversion upon the fundamental change. In addition, the indenture for the Convertible Senior Notes prohibits us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the notes.
These and other provisions, including the provisions of our charter documents and Delaware law, could prevent or deter a third party from acquiring us even where the acquisition could be beneficial to holders of our common stock or the notes.
Certain provisions of our charter documents may adversely impact our stockholders.
Our charter documents provide our board of directors the right to issue preferred stock upon such terms and conditions as it deems to be in our best interests. The terms of such preferred stock may adversely impact the dividend and liquidation rights of the common stockholders without the approval of the common stockholders.
ITEM 1B.
ITEM 1B.
Unresolved Staff Comments
None.
ITEM 2.
ITEM 2.
Properties (see Items 1 and 2. Business and Properties)
ITEM 3.
ITEM 3.
Legal Proceedings
Turkish Registered Capital
Under the existing Petroleum Law of Turkey, capital that is invested by foreign companies in projects such as oil and natural gas exploration can be registered with the General Directorate of Petroleum Affairs, thereby qualifying for protection against adverse changes in the exchange rate between the time of the initial investment and the time such capital is repatriated out of Turkey. Since 1997 the Turkish government has suspended such protection for repatriated capital. As the holder of more than $50 million of registered capital, we have filed suit in Turkey to attempt to restore the exchange rate protections afforded under the law. No amounts are accrued related to this gain contingency. In March 2002, a lower level court ruled in favor of Toreador. The ruling was subject to appeal that was heard in December 2002. The appellate court reversed the lower court’s ruling. All internal Turkish legal proceedings are exhausted and the rejection of the exchange protection award is final. We have appealed the case to the European Court of Human Rights which has refused to rule on the case. All appeals have now been exhausted and the rejection of the exchange protection award is final in all jurisdictions.
Black Sea Incidents
In October 2005, in an incident involving a vessel owned by Micoperi Srl, the Ayazli 2 and Ayazli 3 wells were damaged, and subsequently had to be re-drilled. We and our co-venturers have made a claim in respect of the cost of re-drilling and repeating flow-testing. The amount claimed is presently approximately $10.8 million before interest, subject to adjustment when the actual cost of flow-testing the re-drilled wells is known. In addition, we and our co-venturers have claimed to recover back from Micoperi a sum of about 5.9 million Euros, currently valued at $8.7 million, paid to Micoperi under the contract between us, our co-venturers and Micoperi. Micoperi has made a cross-claim for about 5.1 million Euros, currently valued at $7.5 million in respect of sums allegedly due to Micoperi under the contract between us, our co-venturers and Micoperi. Micoperi has also asserted a claim that the arrest of the vessel “MICOPERI 30” at Palermo, Italy was wrongful and have asserted a claim for damages in respect of such allegedly wrongful arrest. We and our co-ventures have received security from Micoperi by way of a letter of undertaking from their insurers, and have provided security to Micoperi in respect of their cross-claims by way of a bank guarantee of 5.9 million Euros, currently valued at $8.7 million.. The claims and cross-claims are subject to the jurisdiction of the English Court; however, neither side has yet commenced any court proceedings. All the amounts stated above are gross and our share would be equal to 36.75%. We have accrued our portion of the unpaid invoices and are accounting for the potential receivable from Micoperi as a gain contingency. Accordingly, the potential gain has not been recorded.
David M. Brewer
On March 12, 2008, we agreed in principle to make a payment of $97,500 to the J&D Madison Foundation, a private charitable foundation managed by David Brewer, one of our directors, in settlement of claims he made against the Company arising from an alleged prior agreement by G. Thomas Graves III, the former President and
Chief Executive Officer, to pay him $150,000 per year for three years as a consulting fee. We are working on finalizing a release agreement with Mr. Brewer. In 2007, Mr. Brewer brought to the attention of the Company correspondence from Mr. Graves in which, on behalf of the Company, Mr. Graves had promised to provide Mr. Brewer with certain consulting payments that had been previously agreed to by Mr. Graves in connection with the acquisition of Madison Oil Company, but never paid. In this letter, Mr. Graves stated that there was an oral, binding commitment of the Company to pay these amounts to Mr. Brewer. Mr. Brewer presented the letter to the Company and requested payments pursuant to this correspondence. Upon receiving a copy of this correspondence, certain members of the Board of Directors discussed with Mr. Brewer the facts giving rise to this request for payments and asked certain members of the Audit Committee of the Company to review this matter further, whereupon these certain members of the Audit Committee hired special counsel to assist them in the review and provide them with advice. These members of the Audit Committee determined that there were questions regarding this commitment to pay (including a failure to obtain approval from the Board of Directors for any such payment) and there were valid reasons not to pay these amounts to Mr. Brewer. Subsequently, on February 11, 2008, counsel to Mr. Brewer sent a demand letter to the Company requesting payment of these amounts. The Board of Directors discussed this matter and determined that it was in the best interests of the Company and its stockholders to compromise and settle this matter with Mr. Brewer, whereupon the settlement amount was agreed to in exchange for a release by Mr. Brewer of all claims against the Company and for him stepping down as Chairman of the Nominating and Corporate Governance Committee. In connection with this settlement, the Company does not admit that these amounts are owing or that Mr. Brewer has a valid claim for these consulting fees. Mr. Brewer and his father, both of whom are directors, did not participate in the Board of Directors approval of this settlement. Mr. Brewer has indicated that these funds will be distributed by the foundation for educational, medical research or social welfare purposes.
Other
From time to time, we are named as a defendant in other legal proceedings arising in the normal course of business. In our opinion, the final judgment or settlement, if any, that may be awarded with any suit or claim would not have a material adverse effect on our financial position.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended December 31, 2007.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock
Our shares of common stock, par value $.15625 per share, are traded on the Nasdaq Global Market under the trading symbol “TRGL.” The following table sets forth the high and low sale prices per share for the common stock for each quarterly period during the past two calendar years as reported by Nasdaq Global Market (previously known as the Nasdaq National Market) based upon quotations that reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of March 12, 2008, there were 19,944,943 shares of common stock outstanding and held of record by approximately 439 holders (inclusive of those brokerage firms, clearing houses, banks and other nominee holders, holding common stock for clients, with each such nominee being considered as one holder).
The closing price of the common stock on the Nasdaq Global Market on March 12, 2008 was $7.97.
Dividends on the common stock may be declared and paid out of funds legally available when and as determined by our board of directors. Our board of directors plans to continue our policy of holding and investing corporate funds on a conservative basis, retaining earnings to finance the growth of our business. Therefore, we do not anticipate paying cash dividends on our common stock in the foreseeable future. In addition, the terms of the loan and guarantee agreement with the International Finance Corporation restrict our ability to pay dividends to only those required by law and on the Series A-1 Convertible Preferred Stock, which series is no longer outstanding.
Until the Series A-1 Convertible Preferred Stock was no longer outstanding on December 31, 2007, dividends on our Series A-1 Convertible Preferred Stock were paid on a quarterly basis per the terms of such series. Cash dividends totaling $162,000, $162,000 and $186,000 were paid for the years ended December 31, 2007, December 31, 2006, and December 31, 2005, respectively, on the Series A-1 Convertible Preferred Stock. On December 31, 2004, 6,000 shares of Preferred Stock were converted into 37,500 common shares. On February 22, 2005, 82,000 shares of the Series A-1 Convertible Preferred Stock were exchanged into 532,664 common shares. In December 2007, the remaining 72,000 shares of the Series A-1 Convertible Preferred Stock were converted into 450,000 shares of common stock.
During 2007, there were no equity securities issued pursuant to transactions exempt from the registration requirements under the Securities Act of 1933, as amended, that were not disclosed previously in Current Reports on Form 8-K or Quarterly Reports on Form 10-Q.
During the fourth quarter 2007, we did not repurchase any of our registered equity securities.
Below is a line graph comparing the 5-year cumulative total stockholder return on our common stock with the Nasdaq Market Index and the Hemscott Group Index for oil and gas companies:
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG TOREADOR RESOURCES CORP.,
NASDAQ MARKET INDEX AND HEMSCOTT GROUP INDEX
ASSUMES $100 INVESTED ON DEC. 31, 2002
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2007
Item 6.
Item 6.
Selected Financial Data
The following selected financial information (which is not covered by the report of an independent registered public accounting firm) is summarized from our results of operations for the five-year period ended December 31, 2007 and as well as selected consolidated balance sheet data as of December 31, 2007, 2006, 2005, 2004 and 2003 and should be read in conjunction with the consolidated financial statements and the notes thereto included herewith.
The results of operations of assets in the United States have been presented as discontinued operations in the accompanying consolidated statements of operations.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed under the captions “Business and Properties,” “Legal Proceedings,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this annual report may constitute “forward-looking” statements for purposes of the Securities Act of 1933, and the Securities Exchange Act of 1934 and, as such, may involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. When used in this report, the words “anticipates,” “estimates,” “plans,” “believes,” “continues,” “expects,” “projections,” “forecasts,” “intends,” “may,” “might,” “could,” “should,” and similar expressions are intended to be among the statements that identify forward-looking statements. Various factors that could cause the actual results, performance or achievements to differ materially from our expectations are disclosed in this report (“Cautionary Statements”), including, without limitation, those statements made in conjunction with the forward-looking statements included under the captions identified above and otherwise herein. All written and oral forward-looking statements attributable to us are expressly qualified in their entirety by the Cautionary Statements.
Executive Overview
We are an independent international energy company engaged in oil and natural gas exploration, development, production, leasing and acquisition activities. Our strategy is to increase our oil and natural gas reserves through a balanced combination of exploratory drilling, development and exploitation projects and acquisitions. We focus on exploration activities in countries where we can establish large acreage positions. We also focus on prospects where we do not have to compete directly with major integrated or large independent oil and natural gas producers and where extensive geophysical and geological data is available. Our operations are located in European Union or European Union candidate countries that we believe have stable governments, have transportation infrastructure, attractive fiscal policies and are net-importers of oil and natural gas.
We currently hold interests in permits granting us the right to explore and develop oil and natural gas properties in the Paris Basin, France; onshore and offshore Turkey; onshore Romania; and Hungary.
Loss available to common shares for 2007 was $74.6 million, or a loss of $4.07 per diluted share, compared with income applicable to common shares of $2.4 million, or $0.15 per diluted share, in 2006. Operating loss for 2007 was $57.4 million, compared with operating income of $3.6 million in 2006.
Revenues for the year ended December 31, 2007 were $41.7 million, a 25% increase over 2006 revenues of $33.3 million.
In 2007, our oil and natural gas production was 724,324 BOE versus production of 741,609 BOE for 2006. Our average realized oil price per barrel for 2007 was $66.50, a 9% increase over the average realized oil price per barrel of $60.86 in 2006. The average realized gas price in 2007 was $7.00 per Mcf, 96% greater than the average realized gas price of $3.57 per Mcf in 2006.
For the twelve months ended December 31, 2007, we drilled three dry holes in Romania, two in Hungary, two in France and one in Turkey which resulted in an expense of $21.8 million and had a significant impact on income from operations and income available to common shares.
In 2007, we recorded an impairment of proved property in Romania totaling $13.4 million, due to one gas well watering out and another under performing based on previous projections. This non-cash charge had a significant impact on income from operations and income available to common shares.
For the twelve months ended December 31, 2007, we recorded a loss on foreign currency exchange of $26.3 million. This loss is due to the weakening of the U.S. Dollar as compared to the New Turkish Lira, Romanian Lei and the Hungarian Forint. In these countries the U.S. Dollar is the functional currency and foreign exchange translation gains and losses are charged to earnings.
In 2007, we recorded a $3.5 million gain on the sale of all our unconsolidated equity investments; ePsolutions, EnergyNet and Capstone Royalty.
In September 2007, we closed on the sale of all of our oil and natural gas properties located in the United States. The sales price was $19.1 million which resulted in a pre-tax gain of $9.2 million.
At December 31, 2007, we held interests in approximately 5.9 million gross acres (approximately 4.8 million net acres). For a more detailed description of our properties see “Items 1 and 2. Business and Properties.” At December 31, 2007, our net proved reserves were estimated at approximately 13.3 MMBOE.
Operations Update
Turkey
In the South Akcakoca Sub-basin project (SASB) located offshore Turkey in the Black Sea, the tie-in of the Ayazli platform is finished and production is expected to begin from that platform mid-March 2008. As of March 14, 2008, production from the Akkaya and Dogu Ayazli platforms is approximately 16 million cubic feet of gas per day (MMCFD) with the Ayazli platform expected to add another 15 MMCFD of production. The February 2008 wellhead price for natural gas from the SASB is approximately $10.21 per thousand cubic feet of gas (MCF) and is expected to be increased to over $11.00 per MCF in May by a mandated rise in the price charged for uninterruptible gas supply to industrial customers in Turkey by BÖTAŞ, the Turkish state pipeline operator.
Toreador is currently evaluating several offers for a portion of its working interest in the SASB and expects to receive another offer in early April. The evaluation process is expected to conclude soon after the receipt of the offer in April and public filing will be made should one of the offers be accepted. Currently Toreador holds a 36.75% working interest in the South Akcakoca Sub-basin and the eight adjacent offshore exploration blocks. The operator is TPAO, the Turkish national oil company which holds a 51% working interest, with the remaining 12.25% working interest held by Stratic Energy Corporation.
Hungary
Preparations are being made for the drilling of two exploration wells in Toreador’s Szolnok exploration block. As previously disclosed, four joint venture partners are providing approximately $10 million in capital for the drilling of two wells and a 3-D seismic program in return for a 75% working interest in the Szolnok block. Toreador is the operator and is being carried for its 25% working interest to the casing point in the two wells and the 3-D survey. It is anticipated that the first well will spud and the 3-D survey will commence in April. The second well will immediately follow the first.
Another joint venture in Hungary is expected to be completed before the end of March 2008 with a private European oil and gas company to drill and test a delineation well in Toreador’s Tompa exploration block. The well is to be drilled in an updip location to evaluate a deep gas play that was first detected by two wells drilled in the late 1980’s by OKGT (the former Hungarian state oil company) and the U.S. Geological Survey. The wells produced gas in drill stem tests from a conglomerate encountered below 3,200 meters depth in the northwestern corner of the Tompa block. The proposed terms of the joint venture are for the partner to drill, case and test a well projected to cost up to $16 million in return for a 75% interest in the Tompa block. Toreador will be carried for the first well and retain a 25% working interest in the block.
Romania
In the fourth quarter of 2007 we completed a 2D seismic survey of approximately 252 sq. km. in the Moinesti and Viperesti license areas. The data is currently being processed and final interpretation should be finalized in the second quarter of 2008.
Critical Accounting Policies and Management’s Estimates
The discussion and analysis of our financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our significant accounting policies are described in Note 2 to our consolidated financial statements included in this Form 10-K. We have identified below, policies that are of particular importance to the portrayal of our financial position and results of operations and which require the application of significant judgment by management. We analyze our estimates on a periodic basis and base our estimates on experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:
Successful Efforts Method of Accounting
We account for our oil and natural gas exploration and development activities utilizing the successful efforts method of accounting. Under this method, costs of productive exploratory wells, development dry holes and productive wells and undeveloped leases are capitalized. Oil and natural gas lease acquisition costs are also capitalized. Exploration costs, including personnel costs, certain geological and geophysical expenses and delay rentals for oil and natural gas leases, are charged to expense as incurred. Exploratory drilling costs are initially capitalized, but such costs are charged to expense if and when the well is determined not to have found reserves in commercial quantities. In most cases, a gain or loss is recognized for sales of producing properties.
As of December 31, 2007, we had no suspended costs associated with exploratory costs that had been capitalized for a period of one year or less.
As of December 31, 2007, we had no suspended costs associated with exploratory costs that had been capitalized for a period of greater than one year.
The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either developmental or exploratory, which will ultimately determine the proper accounting treatment of the costs incurred. The results from a drilling operation can take considerable time to analyze, and the determination that commercial reserves have been discovered requires both judgment and application of industry experience. Wells may be completed that are assumed to be productive and actually deliver oil and natural gas in quantities insufficient to be economic, which may result in the abandonment of the wells at a later date. On occasion, wells are drilled which have targeted geologic structures that are both developmental and exploratory in nature, and in such instances an allocation of costs is required to properly account for the results. Delineation seismic costs incurred to select development locations within a productive oil and natural gas field are typically treated as development costs and capitalized, but often these seismic programs extend beyond the proved reserve areas and, therefore, management must estimate the portion of seismic costs to expense as exploratory. The evaluation of oil and natural gas leasehold acquisition costs requires management’s judgment to estimate the fair value of exploratory costs related to drilling activity in a given area. Drilling activities in an area by other companies may also effectively condemn leasehold positions.
The successful efforts method of accounting can have a significant impact on the operational results reported when we enter a new exploratory area in hopes of finding oil and natural gas reserves. The initial exploratory wells may be unsuccessful and the associated costs will be expensed as dry hole costs. Seismic costs can be substantial which will result in additional exploration expenses when incurred.
Reserve Estimates
Proved reserves are estimated quantities of crude oil, natural gas and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods as well as oil and natural gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery after testing by a pilot project or after the operation of an installed program has been confirmed through production response that increased recovery will be achieved. Proved undeveloped reserves are reserves that are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required for recompletion. Proved
undeveloped reserves on undrilled acreage are limited (i) to those drilling units offsetting productive units that are reasonably certain of production when drilled and (ii) to other undrilled units where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. We emphasize that the volume of reserves are estimates that, by their nature are subject to revision. The estimates are made using geological and reservoir data, as well as production performance data. These estimates are reviewed annually and revised, either upward or downward, as warranted by additional performance data. These reserve revisions result primarily from improved or a decline in performance from a variety of sources such as an addition to or a reduction in recoveries below or above previously established lowest known hydrocarbon levels, improved or a decline in drainage from natural drive mechanisms, and the realization of improved or declined drainage areas. If the estimates of proved reserves were to decline, the rate at which we record depletion expense would increase.
For the year ended December 31, 2007, we had a downward reserve revision of 4.8% on a BOE basis. This was comprised of a 42.6% decline in the natural gas reserves and a 10.8% increase in oil reserves. This downward revision was due to the following factors: (i) in Hungary, due to the small volume of gas we were unable to secure a gas contract which caused a deletion of previously booked, technical recoverable reserves of 159 MBOE; (ii) in Romania, one gas well watered out and another is under performing based on previous projections resulting in a downward revision of 305.6 MBOE; (iii) in the South Akcakoca Sub-Basin in Turkey, new pressure information and early performance data refined the geological interpretation resulting in a downward revision of 1,369.4 MBOE. These downward revisions were partially offset by improved performance in the Neocomian Field in France and the Cendere Field in Turkey.
For the year ended December 31, 2006, we had a downward reserve revision of 9%. This downward revision was due to the following factors: (i) in the Charmottes Field in France, several high volume producing wells experienced rapidly increasing water production which caused performance declines resulting in a downward revision of 921 MBO; (ii) in Romania, two gas wells watered out after producing for short periods of time resulting in a downward revision of 197 MBOE; (iii) in the South Akcakoca Sub-Basin, due to new drilling, a previous geological interpretation was refined resulting in a downward revision of 192 MBOE, and (iv) there was a downward revision of 73 MBOE due to a decline in prices. These downward revisions were partially offset by upward revisions of 187 MBOE due to performance revisions over several fields, none of which individually contributed a significant portion of this upward revision.
For the year ended December 31, 2005, we had a downward reserve revision of 2.4% or 510 MBOE. The overall downward revision of 510 MBOE was primarily due to the decrease of 1,000 MBO in oil reserves in the Neocomian Field in France where new drilling diminished the estimated reserves in several existing proved undeveloped reserves and cause the removal of several proved undeveloped reserve locations which was partially offset primarily by new drilling in the Charmottes Field where a successful horizontal well established additional reserves of 438 MBO in an existing field, and by an upward revision of 52 MBOE due to an increase in prices.
Impairment of Oil and Natural Gas Properties
We review our proved oil and natural gas properties for impairment on an annual basis or whenever events and circumstances indicate a potential decline in the recoverability of their carrying value. We estimate the expected future cash flows from our proved oil and natural gas properties and compare these future cash flows to the carrying value of the oil and natural gas properties to determine if the carrying value is recoverable. If the carrying value exceeds the estimated undiscounted future cash flows, we will adjust the carrying value of the oil and natural gas properties to its fair value in the current period. The factors used to determine fair value include, but are not limited to, estimates of reserves, future commodity prices, future production estimates, anticipated capital expenditures, and a discount rate commensurate with the risk associated with realizing the expected cash flows projected. Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, with any such impairment charged to expense in the period. Given the complexities associated with oil and natural gas reserve estimates and the history of price volatility in the oil and natural gas markets, events may arise that will require us to record an impairment of our oil and natural gas properties and there can be no assurance that such impairments will not be required in the future nor that they will not be material.
Future Development and Abandonment Costs
Future development costs include costs to be incurred to obtain access to proved reserves, including drilling costs and the installation of production equipment. Future abandonment costs include costs to dismantle and relocate or dispose of our production equipment, gathering systems, wells and related structures and restoration costs of land. We develop estimates of these costs for each of our properties based upon the type of production structure, depth of water, reservoir characteristics, depth of the reservoir, market demand for equipment, currently available procedures and consultations with construction and engineering consultants. Because these costs typically extend many years into the future, estimating these future costs is difficult and requires management to make estimates and judgments that are subject to future revisions based upon numerous factors, including changing technology, the ultimate settlement amount, inflation factors, credit adjusted discount rates, timing of settlement and changes in the political, legal, environmental and regulatory environment. We review our assumptions and estimates of future abandonment costs on an annual basis. The accounting for future abandonment costs changed on January 1, 2003, with the adoption of SFAS 143 “Accounting for Asset Retirement Obligations”. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recorded in the period in which it is incurred and the corresponding cost capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, a gain or loss is recognized.
Holding all other factors constant, if our estimate of future abandonment costs is revised upward, earnings would decrease due to higher depreciation, depletion and amortization expense. Likewise, if these estimates were revised downward, earnings would increase due to lower depreciation, depletion and amortization expense.
Income Taxes
For financial reporting purposes, we generally provide taxes at the rate applicable for the appropriate tax jurisdiction. Because our present intention is to reinvest the unremitted earnings in our foreign operations, we do not provide U.S. income taxes on unremitted earnings of foreign subsidiaries. Management periodically assesses the need to utilize these unremitted earnings to finance our foreign operations. This assessment is based on cash flow projections that are the result of estimates of future production, commodity prices and expenditures by tax jurisdiction for our operations. Such estimates are inherently imprecise since many assumptions utilized in the cash flow projections are subject to revision in the future.
Management also periodically assesses, by tax jurisdiction, the probability of recovery of recorded deferred tax assets based on its assessment of future earnings estimates. Such estimates are inherently imprecise since many assumptions utilized in the assessments are subject to revision in the future.
Derivatives
We periodically utilize derivatives instruments such as futures and swaps for purposes of hedging our exposure to fluctuations in the price of crude oil sales. In accordance with SFAS No. 133, Accounting for “Derivative Instruments and Hedging Activities,” we have elected not to designate the derivative financial instruments to which we are a party as hedges, and accordingly, we record such contracts at fair value and recognize changes in such fair value in current earnings as they occur. We determine the fair value of futures and swap contracts based on the difference between their fixed contract price and the underlying market price at the determination date. The realized and unrealized gains and losses on derivatives are recorded as a derivative fair value gain or loss in the income statement.
Foreign Currency Translation
The functional currency for Turkey, Romania and Hungary is the United States Dollar and in France the functional currency is the Euro. Translation gains or losses resulting from transactions in the New Turkish Lira in Turkey, the Lei in Romania and the Forint in Hungary are included in income available to common shares for the current period. Translation gains and losses resulting from transactions in Euros are included in other comprehensive income for the current period. We periodically review the operations of our entities to ensure the functional currency of each entity is the currency of the primary economic environment in which we operate.
In October 2007, we made a change in accounting method regarding intercompany account receivables due from our subsidiaries in Turkey, Romania and Hungary. Pursuant to a Board of Directors resolution, we expect to be repaid the intercompany account receivable from our subsidiaries in Turkey, Romania and Hungary in the foreseeable future. Due to this resolution subsequent to October 1, 2007, the change in the intercompany account receivable balance will be reflected in current earnings, as a foreign exchange gain or loss rather than accumulated other comprehensive income. See Note 2 - Foreign Currency Translation.
New Accounting Pronouncements
In September 2006, Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, was issued. SFAS No. 157 provides guidance for using fair value to measure assets and liabilities. It applies whenever other standards require or permit assets or liabilities to be measured at fair value but it does not expand the use of fair value in any new circumstances. In November 2007, the effective date was deferred for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value on a recurring basis. The provisions of SFAS No. 157 that were not deferred are effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently assessing the effect, if any, the adoption of Statement 157 will have on our financial statements and related disclosures.
In February 2007, the FASB issued Statement 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement 115”. The statement permits entities to choose to measure certain financial instruments and other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Unrealized gains and losses on any items for which we elect the fair value measurement option would be reported in earnings. Statement 159 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the effect, if any, the adoption of Statement 159 will have on our financial statements and related disclosures.
In December 2007, SFAS No. 141R, Business Combinations, was issued. Under SFAS No. 141R, a company is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and any contingent consideration measured at their fair value at the acquisition date. It further requires that research and development assets acquired in a business combination that have no alternative future use to be measured at their acquisition-date fair value and then immediately charged to expense, and that acquisition-related costs are to be recognized separately from the acquisition and expensed as incurred. Among other changes, this statement also requires that “negative goodwill” be recognized in earnings as a gain attributable to the acquisition, and any deferred tax benefits resultant in a business combination are recognized in income from continuing operations in the period of the combination. SFAS No. 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008. The effect of adopting SFAS No. 141R has not been determined.
In December 2007, SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51, was issued. SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Among other requirements, this statement requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS No. 160 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008. The effect of adopting SFAS No. 160 is not expected to have an effect on our reported financial position or earnings.
LIQUIDITY AND CAPITAL RESOURCES
This section should be read in conjunction with Notes 8 and 9 to Notes to Consolidated Financial Statements included in this filing.
Liquidity
As of December 31, 2007, we had cash and cash equivalents and restricted cash of $23.5 million, a current ratio of approximately 1.5 to 1 and a debt (long-term debt and Convertible Senior Notes) to equity ratio of .71 to 1. For the twelve months ended December 31, 2007, we had an operating loss of $57.4 million and capital expenditures, excluding capitalized interest and changes in accounts payable, were $71 million. The restricted cash relates to a letter of credit relating to the dispute with Micoperi regarding the October 2005 well issues in the Black Sea and a letter of credit to secure additional permits in Hungary.
On March 23, 2007, we closed a $45 million private placement of equity. In the transaction, we issued an aggregate of 2,710,843 shares of common stock to six institutional investors, providing us with $45 million of gross proceeds at closing. We also granted the investors warrants to purchase an additional $8.1 million aggregate amount of common stock within the next 30-day period. On April 23, 2007, two of the institutional investors exercised their warrants for an aggregate of 326,104 additional shares of common stock, providing us with approximately $5.4 million of gross proceeds. The net proceeds from the private placement totaled approximately $48 million and were used to help fund our 2007 exploration and development activities.
On June 14, 2007, the Board of Directors authorized management to sell all oil and gas properties in the United States. The sale of these properties completed the divestiture of the company’s non-core domestic assets and allows us to focus exclusively on our international operations. The sale was closed on September 1, 2007. The sales price was $19.1 million and resulted in a pre-tax gain of $8.6 million. Prior year financial statements for 2006 and 2005 have been adjusted to present the operations of the U.S. properties as a discontinued operation. The assets and liabilities of the discontinued operations are presented separately under the captions “Oil and gas properties held for resale” and “Asset retirement obligations, oil and gas properties held for sale” respectively, in the Balance Sheet for the year ended December 31, 2006.
In connection with the private placement, we entered into a Registration Rights Agreement with the investors. The Registration Rights Agreement provided that we would file a registration statement with the Securities and Exchange Commission covering the resale of the common stock within 60 days after the closing date. If the registration statement was not filed with the Securities and Exchange Commission within such time, we had to pay 1.0% of the aggregate purchase price, an additional 1.0% on the one month anniversary of the 60th day after closing if the registration statement had not been filed by such date and an additional 2.0% of the aggregate purchase price for each 30 day period after the one month anniversary if the registration statement was not filed by such date. We filed the registration statement with the Securities and Exchange Commission on May 8, 2007. If the registration statement was not declared effective by the Securities and Exchange Commission within 150 days after the closing date, we had to pay 1.0% of the aggregate purchase price, an additional 1.0% on the one month anniversary of the 150th day after the closing if the registration statement had not been declared effective by the Securities and Exchange Commission by such date and an additional 2.0% of the aggregate purchase price for each 30 day period after the one month anniversary if the registration statement was not declared effective by such date. The registration statement was declared effective July 26, 2007. Now that the registration statement has been declared effective by the Securities and Exchange Commission, if, subject to certain exceptions, future sales cannot be made pursuant to the registration statement, we must pay 1.0% of the aggregate purchase price on the date sales cannot be made pursuant to the registration statement, an additional 1% on the one month anniversary of the date sales are not permitted under the registration statement if sales are not permitted under the registration statement by such date and an additional 2.0% of the aggregate purchase price for each 30 day period after the one month anniversary if sales under the registration statement are not permitted by such date. Any one month or 30 day periods during which we cure the violation will cause the payment for such period to be made on a pro rata basis. As a result of the change in the resale restrictions under Rule 144, effective February 15, 2008, we amended the Registration Rights Agreement to provide that we do not have to keep the registration statement effective if the holders of the shares covered by the Registration Rights Agreement can sell all of the shares pursuant to Rule 144.
Beginning in the fourth quarter of 2007, we made a strategic decision to no longer drill 100% exploratory wells or fund 100% seismic programs on exploratory acreage. We began a systematic process of farming out our exploratory prospects to industry partners. The terms of farm outs have been and will generally be structured so that
the farmee will pay 100% of all seismic costs and drill an exploratory well to casing point in order to earn a 50%-75% working interest in the prospect or concession.
We believe that our French oil production will generate sufficient free cash flow to cover all our costs and contribute to our share of development capital expenditures in the Black Sea. We believe that our Turkish cash flow, given our restoration of production following a November 2007 shipping accident, will provide the balance of those development expenditures and more. Our 2008 capital expenditure budget is $27.5 million which is the Company’s share of estimated Phase II development costs in the Black Sea.
We believe we will have sufficient cash flow from operations to meet all of our 2008 obligations. However, if the cash flow from our operations is less than anticipated and if we have used up our cash and drawn down our credit facility we may also seek additional capital by (i) forward selling our crude oil and natural gas production; (ii) selling our interest in prospects and or licenses; (iii) selling down our working interest in properties; or (iv) a combination of these actions in addition to issuing new debt or equity securities We believe such actions will allow us to meet our capital commitments and that as a result we will have sufficient liquidity for the remainder of 2008.
We will operate the Company, at a minimum, through 2009 in this manner. We will not incur costs to keep a permit or license in effect, but rather we will manage the Company’s resources so that only the areas that meet certain economic hurdles will be considered. We believe that this philosophy will not only strengthen the Company’s financial position in the short term, but will also ensure the Company’s position for the future.
Secured Revolving Facility
On December 28, 2006, we entered into a loan and guarantee agreement with International Finance Corporation. The loan and guarantee agreement provides for a $25 million facility which is a secured revolving facility with a current maximum facility amount of $25 million which maximum facility amount will increase to $40 million when the projected total borrowing base amount exceeds $50 million. The $25 million facility funded on March 2, 2007. The total proceeds received on March 2, 2007 were approximately $25 million, of which $11 million was used to retire the outstanding balance on the $15 million credit facility with Natixis Banques Populaires and the remaining $14 million of funds was used to finance our capital expenditures in Turkey and Romania. The loan and guarantee agreement also provides for an unsecured $10 million facility which funded on December 28, 2006 In September 2007, we repaid $5 million of the $25 million facility after the sale of the oil and natural gas properties in the United States were sold. Both the $25 million facility and the $10 million facility are to fund our operations in Turkey and Romania. As of December 31, 2007, the International Finance Corporation has reduced our borrowing base under both loans to $30 million from $35 million. Until the next redetermination date, the Company has no additional borrowing capacity under these facilities. We do not believe that the loss of $5 million in the borrowing base will materially effect our business strategy for 2008 and 2009.
Interest accrues on any loans under the $25 million facility at a rate of 2% over the six month LIBOR rate. Interest accrued on the $10 million facility at a rate of 1.5% over the six month LIBOR rate until the $25 million facility funded on March 2, 2007 after which the rate for the $10 million facility was lowered to 0.5% over the six month LIBOR rate. As of December 31, 2007 the interest rate on the $10 million facility was 5.329% and 6.829% on the $25 million facility. Interest is to be paid on each June 15 and December 15.
On December 31, 2011, the maximum amount available under the $25 million facility begins to decrease by $5 million every six months from $40 million (assuming the projected borrowing base amount exceeds $50 million) until the final portion of the $25 million facility is due on December 15, 2014. On December 15, 2014, $5 million of the $10 million facility is to be repaid with the remaining $5 million being due on June 15, 2015.
We are to meet the following ratios on a consolidated basis: (i) the life of loan coverage ratio of not less than: (a) 1.2:1.0 in 2006 and 2007; (b) 1.3:1.0 in 2008; and (c) 1.4:1.0 in 2009 and each subsequent year thereafter; (ii) reserve tail ratio of not less than 25%; (iii) adjusted financed debt to EBITDAX ratio of not more than 3.0:1.0; (iv) liabilities to tangible net worth ratio of not more than 60:40; and (v) interest coverage ratio of not less than 3.0:1.0. At December 31, 2007, we were not in compliance with the interest rate coverage ratio of not less than 3.0:1.0; the actual ratio was 2.8:1.0. The International Finance Corporation has granted us a temporary waiver for the interest coverage ratio provided we maintain EBITDAX to net interest expense ratio of 2.7:1.0 until July 2, 2008
and EBITDA to net interest expense ratio of a least 2.7:1.0 during the remaining period of the waiver effectiveness. The waiver is effective until March 8, 2009.
We are subject to certain negative covenants, including, but not limited to, the following: (i) except as required by law or to pay the dividends on the Series A-1 Convertible Preferred Stock, which is no longer outstanding, paying dividends; (ii) subject to certain exceptions, incurring debt, making guarantees or creating or permitting to exist any liens, (iii) subject to certain exceptions, making or permitting to exist loans or advances to, or deposits, with other persons or investments in any person or enterprise; (iv) subject to certain exceptions, selling, transferring, leasing or otherwise disposing of all or a material part of its borrowing base assets; and (v) subject to certain exceptions, undertaking or permitting any merger, spin-off, consolidation or reorganization.
5% Convertible Senior Notes Due 2025
On September 27, 2005, we sold $75 million of Convertible Senior Notes due October 1, 2025 to qualified institutional buyers pursuant to Rule 144A of the Securities Act of 1933. We also granted the initial purchasers the option to purchase an additional $11.25 million aggregate principal amount of Convertible Senior Notes to cover over-allotments. The option was exercised on September 30, 2005. The total principal amount of Convertible Senior Notes issued was $86.25 million and total net proceeds were approximately $82.2 million.
The Convertible Senior Notes bear interest at a rate of 5% per annum and can be converted into common stock at an initial conversion rate of 23.3596 shares of common stock per $1,000 principal amount of Convertible Senior Notes , subject to adjustment (equivalent to a conversion price of approximately $42.81 per share). We may redeem the Convertible Senior Notes, in whole or in part, on or after October 6, 2008, and prior to October 1, 2010, for cash at a redemption price equal to 100% of the principal amount of Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, if the closing price of its common stock exceeds 130% of the conversion price over a specified period. On or after October 1, 2010, we may redeem the Convertible Senior Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, irrespective of the price of its common stock. Holders may convert their Convertible Senior Notes at any time prior to the close of business on the business day immediately preceding their stated maturity, and holders may, upon the occurrence of certain fundamental changes, and on October 1, 2010, October 1, 2015, and October 1, 2020, require us to repurchase all or a portion of their Convertible Senior Notes for cash in an amount equal to 100% of the principal amount of such Convertible Senior Notes, plus any accrued and unpaid interest.
Due to our restating the consolidated financial statements for the years ended December 31, 2003, 2004 and 2005 and our consolidated financial statements for each of the quarters ended March 31 and June 30, 2006, we did not provide the trustee under the indenture of the Convertible Senior Notes with copies of our annual reports, information, documents and other reports that were required to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 within thirty (30) days of when such reports were required to be filed with the Securities and Exchange Commission.
On December 15, 2006, we received a notice from the trustee for failing to provide the trustee with a copy of our Form 10-Q for the nine month period ended September 30, 2006. Since we cured the covenant default within thirty (30) days after receiving the written notice from the trustee, we cured the default and an event of default did not occur.
The registration rights agreement covering the Convertible Senior Notes provides for a penalty if the registration statement is filed and declared effective but thereafter ceases to be effective (a “Suspension Period”) for an aggregate of forty-five (45) days in any three month period or ninety (90) days in any twelve month period (an “Event Date”). Such penalty calls for an additional 0.25% per annum in interest expense on the aggregate principal amount of the Convertible Senior Notes for the first ninety (90) days following an Event Date and an additional 0.50% per annum in interest expense on the aggregate principal amount of the Convertible Senior Notes thereafter, until such Suspension Period ends upon the registration statement again becoming effective or not being required to be effective pursuant to the registration rights agreement. Because we did not file our Quarterly Report on Form 10-Q for the nine month period ended September 30, 2006 in a timely manner, the registration statement for the Convertible Senior Notes became ineffective and we entered a Suspension Period on November 15, 2006. Such
Suspension Period ended on January 23, 2007 when we provided notice that the Form 10-Q had been filed and the Suspension Period was no longer in effect. Because the Suspension Period exceeded forty-five (45) days in any three month period, we paid approximately $14,375 in additional interest expense. On March 16, 2007, the date we filed our Form 10-K for the year ended December 31, 2006 we again entered a Suspension Period until all the Convertible Senior Notes became eligible for sale pursuant to Rule 144(k) on September 30, 2007. On October 1, 2007, $155,000 was deposited with the trustee for the Convertible Senior Notes as the penalty for any holders of the Notes who were eligible on October 1, 2007 to receive a pro rate portion of such payment. Such eligible holders had to have registered their Convertible Senior Notes on the registration statement and still held those Notes on October 1, 2007. Through March 12, 2008, we had released $4,043 of the penalty deposit to eligible holders of Convertible Senior Notes.
Preferred Stock
On February 22, 2005, 82,000 shares of Series A-1 Convertible Preferred Stock were exchanged for an aggregate of 512,000 shares of our common stock. As of December 31, 2006, there were 72,000 shares of Series A-1 Convertible Preferred Stock outstanding. At the option of the holder, the Series A-1 Convertible Preferred Stock could be converted into common shares at a price of $4.00 per common share. The Series A-1 Convertible Preferred Stock accrued dividends at an annual rate of $2.25 per share payable quarterly in cash. At any time on or after November 1, 2007, we had the right to redeem for cash any or all shares of Series A-1 Convertible Preferred Stock. In December 2007 the 72,000 shares of Series A-1 Convertible Preferred Stock were converted into 450,000 shares of common stock.
Dividend and Interest Requirements
Dividends on our common stock may be declared and paid out of funds legally available when and as determined by our board of directors. Our policy is to hold and invest corporate funds on a conservative basis, and, thus, we do not anticipate paying cash dividends on our common stock in the foreseeable future.
Dividends on our Series A-1 Convertible Preferred Stock were paid quarterly. For the year ended December 31, 2007 dividends totaled $162,000.
The terms of the loan and guarantee agreement with the International Finance Corporation limit the payment of dividends only to those that are required by law and to dividends associated with our Series A-1 Convertible Preferred Stock, which is no longer outstanding.
Contractual Obligations
The following table sets forth our contractual obligations in thousands at December 31, 2007 for the periods shown:
Contractual obligations for long-term debt above does not include amounts for interest payments.
We were not in compliance with certain financial covenants relating to the loan with the International Finance Corporation. We obtained a waiver through March 8, 2009. Accordingly, the amount is shown in the above table as maturing in accordance with the original terms of the loan facility.
In conjunction with FIN 48, we have no certainty as to when unrecognized tax benefits of $326,000 will become due.
Results of Operations
Comparison of Years Ended December 31, 2007 and 2006
Revenues
Oil and natural gas sales
Oil and natural gas sales for the twelve months ended December 31, 2007 were $41.7 million, as compared to $33.3 million for the comparable period in 2006. This increase is due to 1) the increase in the average realized price for oil and natural gas, $3.6 million and 2) Turkish gas sales which were not in production in 2006, $7.8 million. This was partially offset by a reduction in total oil production of 59 MBbls or $3 million. Total production increased by approximately 122 MBOE due primarily to the start of production in Turkey gas resulting in 151 MBOE and a full year production in Romania resulting in an additional 32 MBOE. This was partially offset by a decline in French and Turkey oil production of 61 MBOE.
The above table compares both volumes and prices received for oil and natural gas for the twelve months ended December 31, 2007 and 2006. Oil and natural gas prices are and probably will continue to be extremely volatile and a significant change will have a material impact on our revenue.
Costs and expenses
Lease operating
Lease operating expense was $12.6 million, or $17.46 per BOE produced for the twelve months ended December 31, 2007, as compared to $8.7 million, or $14.52 per BOE produced for the comparable period in 2006. This increase is primarily due to increased operating costs in France due to the age of the fields, increased operating costs in offshore Turkey due primarily to fixed operating costs for three tripods of which two were on production, increased operating expense in Romania due to increased workover cost incurred to increase production and the decline in value of the U.S. Dollar.
Exploration expense
Exploration expense for the twelve months ended December 31, 2007 was $14.7 million, as compared to $3.9 million for the comparable period in 2006. This change is primarily due to the 2D seismic survey that was done
in Romania during the third quarter and increased interpretation of existing seismic in order to prepare prospects for farmout consideration.
Dry hole and abandonment
Dry hole and abandonment cost for the twelve months ended December 31, 2007 was $21.8 million, as compared to $1.7 million in 2006. During 2007 we drilled two dry holes in France ($3.8 million), three dry holes in Romania ($10 million), two dry holes in Hungary ($3.5 million) and one dry hole in Turkey ($4.5 million). In the comparable period for 2006 we drilled one dry hole in Hungary for $1.7 million.
Depreciation, depletion and amortization.
For the twelve months ended December 31, 2007, depreciation, depletion and amortization expense was $21.3 million, or $29.36 per BOE produced, as compared to $6.3 million, or $10.43 per BOE produced for the twelve months ended December 31, 2006. This increase is primarily due to offshore Turkey starting production in May 2007 resulting in an additional $9.4 million in depreciation, depletion and amortization, an increase in Romania of $4.6 million due to a full year of production and a decline in proved reserves and a $1 million increase in France due primarily to the decline in the value of the U.S. Dollar.
Impairment of oil and natural gas properties
Impairment charged in 2007 was $13.4 million compared to zero in 2006. This increase was due to the downward revisions of proved reserves in the Fauresti Field in Romania. At December 31, 2007 the cash flow before income tax and the discounted future cash flows attributable to our proved oil and natural gas reserves before income tax, and discounted at 10% attributable to the 134 MBOE, in Romania, was $1.2 million and $1.1 million, respectively, and the net book value of asset was $14.5 million. This resulted in an impairment charge of $13.4 million.
General and administrative
General and administrative expense, not including stock compensation expense and amounts due the former President and CEO, was $12.2 million for the twelve months ended December 31, 2007, compared with $6.8 million for the comparable period of 2006. This increase is primarily due to $2.6 million restating the financial statements for the years ended December 31, 2003, 2004 and 2005 and the quarters ended March 31, 2006 and June 30, 2006, (accounting, legal and printing), the 2006 audit of approximately $1.1 million, a $1.8 million reduction in the amount of capitalized general and administrative costs incurred in Turkey in association with our Black Sea project, since it is now on production, increased professional fees for engineering and recruiters of $213,000 and increased travel costs of $353,000.
Stock compensation expense
Stock compensation expense was $2.9 million for the twelve months ended December 31, 2007, compared with $2.7 million for the comparable period of 2006. The increase is due to the restricted stock granted by the Board of Directors to certain employees, consultants and non-employee directors and the expensing of stock options as required by the adoption of SFAS 123(R).
Cost incurred related to the resignation of former President and Chief Executive Officer
In January 2007, Mr. G. Thomas Graves III resigned as President and Chief Executive Officer. The Separation Agreement between Mr. Graves and the Company called for the immediate vesting of all restricted stock grants which resulted in an expense of $1.1 million and two years of salary and one year of bonus of $1.1 million.
Loss on oil and gas derivative contracts
Loss on oil and gas derivative contracts represents the net realized loss on derivative financial instruments and fluctuates based on changes in the fair value of underlying commodities. We entered into futures and swap contracts
for approximately 15,000 Bbls per month for the months of June 2007 through December 2008 and subsequently sold all contracts as of September 30, 2007. This resulted in a net derivative fair value loss of $1 million for the twelve months ended December 31, 2007. We were not a party to any derivative contracts in the comparable period of 2006.
Gain on the sale of properties and other assets
For the twelve months ended December 31, 2007, we recorded a gain on the sale of the properties and other assets of $3.2 million, which was primarily attributable to the gain on the sale of our unconsolidated investments. A gain of $436,000 was recorded in the comparable period of 2006.
Foreign currency exchange gain (loss)
We recorded a loss on foreign currency exchange of $26.3 million for the twelve months ended December 31, 2007 compared with $605,000 loss for the comparable period of 2006. This loss is primarily due to the weakening of the U.S. Dollar as compared to the New Turkish Lira, Romanian Lei and the Hungarian Forint. In these countries the U.S. Dollar is the functional currency and foreign exchange translation gains and losses are charged to earnings.
Interest and other income
Interest and other income was $1.8 million for the period ended December 31, 2007 as compared with $2 million in the comparable period of 2006. For the twelve months ended December 31, 2006, our average cash balance was larger than our average cash balance for the twelve months ended December 31, 2007, which resulted in less interest income in the current period.
Interest expense, net of interest capitalization
Interest expense was $4.3 million for the twelve months ended December 31, 2007, as compared to $891,000 for the comparable period of 2006. The increase in interest expense is primarily due to expensing the deferred loan fees on the Natixis facility of $184,000 and the Texas Capital Bank facility of $108,000, since these facilities were paid off in the first quarter of 2007 and the increased debt level for the twelve months ended December 31, 2007 as compared to the comparable period in 2006.
Discontinued operations
On September 1, 2007, we sold all of our working interest properties located in the United States for $19.1 million which resulted in a pre-tax gain of $9.2 million. Prior year financial statements for 2006 and 2005 have been adjusted to present the operations of the U.S. properties as a discontinued operation. The assets and liabilities of the discontinued operations are presented separately under the caption “Oil and gas properties held for resale” and “Asset retirement obligations, oil and gas properties held for sale,” respectively, in the Balance Sheet as of December 31, 2006. The revenues received and the costs incurred after the effective date are due to adjustments made by the operator prior to the effective date of the sale. We do not have any involvement with the properties sold.
The results of operations of assets in the United States that were sold in September 2007 have been presented as discontinued operations in the accompanying consolidated statements of operations. Results for these assets reported as discontinued operations were as follows:
Provision for income taxes
At December 31, 2007, it was unlikely that the United States parent entity, Toreador Resources Corporation, would be able to generate sufficient future taxable income to utilize $21.7 million in net operating loss carryforwards. We therefore established a valuation allowance of $7.4 million which resulted in an increase to the provision for income taxes. In addition, we established a $5 million valuation allowance to reflect the likelihood that additional tax income of $14.5 million would not be generated to offset future temporary tax differences in the amount of $14.5 million.
Income (Loss) available to common shares
For the twelve months ended December 31, 2007, we reported a loss from continuing operations net of taxes of $81.5 million, compared with income of $1.5 million for the same period of 2006. For the twelve months ended December 31, 2007 we recorded a loss available to common shares of $74.6 million versus income available to common shares of $2.4 million for the year ended December 31, 2006.
Other comprehensive income
The most significant element of comprehensive income, other than net income, is foreign currency translation. As of December 31, 2007, we had an unrealized gain of $38.4 million as compared to an unrealized gain of $6.7 million in 2006. The reason for the increase in the unrealized gain is due to the weakening of the United States dollar compared to the currencies in countries in which we operate. The functional currency of our operations in France is the Euro and in Romania, Turkey and Hungary the functional currency is the United States Dollar. The
exchange rates used to translate the financial position of the French, Turkish, Romanian and Hungarian operations at December 31, 2007, 2006 and 2005 are shown below:
In October 2007, we changed our accounting method regarding intercompany account receivables due from our subsidiaries in Turkey, Romania and Hungary. Pursuant to a Board of Directors resolution, we expect to be repaid the intercompany account receivable from our subsidiaries in Turkey, Romania and Hungary in the foreseeable future. Due to this resolution, subsequent to October 1, 2007, the change in the intercompany account receivable balance will be reflected in current earnings, as a foreign exchange gain or loss rather than accumulated other comprehensive income. See Note 2 - Foreign Currency Translation.
Results of Operations - Comparison of Years Ended December 31, 2006 and 2005
Revenues
Oil and natural gas sales
Oil and natural gas sales for the twelve months ended December 31, 2006 were $33.3 million, as compared to $23.4 million for the comparable period in 2005. This increase is primarily due to a significant increase in the average realized price for oil. Production increased by approximately 133 MBOE due primarily to the start of production in Romania and increases in production in Turkey and France.
The above table compares both volumes and prices received for oil and natural gas for the twelve months ended December 31, 2006 and 2005. Oil and natural gas prices are and probably will continue to be extremely volatile and a significant change will have a material impact on our revenue.
We had no loss on commodity derivatives for the years ended December 31, 2006 and 2005.
Costs and expenses
Lease operating expense
Lease operating expense was $8.7 million, or $14.52 per BOE produced for the twelve months ended December 31, 2006, as compared to $6.1 million, or $13.01 per BOE produced for the comparable period in 2005. This increase is primarily due to increased operating costs in France, the start of production in Romania and higher costs associated with the age of our fields.
Exploration expense
Exploration expense for the twelve months ended December 31, 2006 was $3.9 million, as compared to $2.9 million for the comparable period in 2005. This change is primarily due to increased activity in Hungary and Romania in interpreting data in order to evaluate drilling locations for 2007.
Dry hole and abandonment
Dry hole and abandonment cost for the twelve months ended December 31, 2006 was $1.7 million due to one dry hole in Hungary, as compared to $1.7 million for one dry hole in Turkey in 2005.
Depreciation, depletion and amortization
For the twelve months ended December 31, 2006 depreciation, depletion and amortization expense was $6.3 million, or $10.43 per BOE produced, as compared to $4.3 million, or $9.16 per BOE produced for the twelve months ended December 31, 2005. This increase is primarily due to the downward revision of proved reserves in France of approximately 0.9 MBOE of proved reserves.
General and administrative expense
General and administrative expense, not including stock compensation expense, was $6.8 million for the twelve months ended December 31, 2006, compared with $6 million for the comparable period of 2005. This increase is primarily due to increased personnel costs of $1.1 million, the costs associated with the Hungarian office which was opened in July 2005 totaling $310,000 and the costs of restating the financial statements for the years ended December 31, 2003, 2004 and 2005 and the quarters ended March 31, 2006 and June 30, 2006 of approximately $820,000. These were reduced by an increase in the amounts allocated to development projects and exploration expense of approximately $1.7 million.
Stock compensation expense
Stock compensation expense was $2.7 million for the twelve months ended December 31, 2006, compared with $400,000 for the comparable period of 2005. The increase is due to the restricted stock granted by the Board of Directors to certain employees, consultants and non-employee directors and the expensing of stock options as required by the adoption of SFAS 123(R).
Other income and expense
Other income and expense resulted in income of $0.9 million for the twelve months ended December 31, 2006 versus income of $4 million in 2005. This decrease is primarily due to foreign exchange losses in Hungary and Turkey.
Discontinued operations
On September 1, 2007, we sold all of our working interest properties located in the United States for $19.1 million which resulted in a pre-tax gain of $8.6 million. Prior year financial statements for 2006 and 2005 have been adjusted to present the operations of the U.S. properties as a discontinued operation. The assets and liabilities of the discontinued operations are presented separately under the caption “Oil and gas properties held for
resale” and “Asset retirement obligations, oil and gas properties held for sale,” respectively, in the Balance Sheet as of December 31, 2006.
The results of operations of assets in the United States that were sold in January 2004 and September 2007 have been presented as discontinued operations in the accompanying consolidated statements of operations. Results for these assets reported as discontinued operations were as follows:
Provision for income taxes
At December 31, 2006, it was “unlikely” that the United States parent entity, Toreador Resources Corporation, would be able to generate sufficient future taxable income to utilize $1.2 million of a $6.3 million net operating loss carryforward. We therefore established a valuation allowance of $1.2 million which resulted in an increase to the provision for income taxes.
Income available to common shares
For the twelve months ended December 31, 2006, we reported income from continuing operations net of taxes of $1.5 million, compared with income of $7.8 million for the same period of 2005. For the twelve months ended December 31, 2006 income available to common shares was $2.4 million versus $9.9 million for the year ended December 31, 2005.
Other comprehensive income
The most significant element of comprehensive income, other than net income, is foreign currency translation. For the year ended December 31, 2006, we had an unrealized gain of $6.7 million, as compared to an unrealized loss of $8.1 million in 2005. The reason for the change in unrealized income is due to the strength of the U.S. dollar compared to the Euro in 2006.
The functional currency of our operations in France is the Euro and in Romania, Turkey and Hungary the functional currency is the United States Dollar. The exchange rates used to translate the financial position of the French, Turkish, Romanian and Hungarian operations at December 31, 2006 and 2005 are shown below:
Selected Quarterly Financial Data (Unaudited)
We derived the selected historical financial data in the table below from our unaudited interim consolidated financial statements. The sum of net income per share by quarter may not equal the net income per share for the year due to variations in the weighted average shares outstanding used in computing such amounts. The historical data presented here are only a summary and should be read in conjunction with the consolidated financial statements, related notes and other financial information included elsewhere in this annual report.
Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or material future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
The risks inherent in our market-sensitive instruments are the potential loss arising from adverse changes in oil and natural gas prices, interest rates and foreign currency exchange rates as discussed below. The sensitivity analysis however, neither considers the effects that such adverse changes may have on overall economic activity nor does it consider additional actions we may take to mitigate our exposure to such changes. Actual results may differ.
The following quantitative and qualitative information is provided about financial instruments to which we are a party as of December 31, 2007, and from which we may incur future earnings gains or losses from changes in commodity prices. We do not designate our derivatives as hedges; however, we do not enter into derivative or other financial instruments for trading purposes.
Oil and Natural Gas Prices
We market our oil and natural gas production primarily on a spot market basis. As a result, our earnings could be affected by changes in the prices for these commodities, regulatory matters or demand for the commodities. As market conditions dictate, from time to time we will lock in future oil and natural gas prices using various hedging techniques. We do not use such financial instruments for trading purposes, and we are not a party to any leveraged derivatives. Market risk is estimated as a 10% decrease in the prices of oil and natural gas. Based on our projections for 2008 sales volumes at fixed prices, such a decrease would result in a reduction to oil and natural gas sales revenue of approximately $7.5 million.
Foreign Currency Exchange Rates
The functional currency of our French operations is the Euro. While our oil sales are calculated on a U.S. dollar basis, we are exposed to the risk that the values of our French assets will decrease and that the amounts of our French liabilities will increase. Market risk is estimated as a 10% decrease in the exchange rate for Euros to U.S. dollars. Based on the net assets in our French operations at December 31, 2007, such a decrease would result in an unrealized loss of approximately $6.8 million due to foreign currency exchange rates.
Derivative Financial Instruments
At times we utilize commodity derivative instruments as part of our risk management program. These transactions are generally structured as either swaps or collar contracts. A swap has the effect of an outright sale at a specific price. A collar has the effect of creating a sale only if a floor or ceiling price is exceeded. These instruments (i) reduce the effect of the price fluctuations of the commodities we produce and sell and (ii) support our annual capital budgeting and expenditure plans. When we had our senior credit facilities that required these instruments, these instruments protected the amounts required for servicing outstanding debt and maximized the funds available under these facilities. The trading party that represents the other side of each of these transactions is known as a “counterparty.”
See Note 2 of Notes to Consolidated Financial Statements for a description of our accounting policies followed relative to derivative financial instruments and for specific information regarding the terms of our derivative financial instruments that are sensitive to changes in crude oil and natural gas commodity prices.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
The Report of Independent Registered Public Accounting Firm and Consolidated Financial Statements are set forth beginning on page of this annual report on Form 10-K and are incorporated herein.
The financial statement schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the Notes to the Consolidated Financial Statements.
ITEM 9.
ITEM 9.
Changes In And Disagreements With Accountants On Accounting And Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures
Corporate Disclosure Controls
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) that are designed to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Senior Vice President - Finance & Chief Accounting Officer of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this annual report. Based on that evaluation, our Chief Executive Officer and Senior Vice President - Finance & Chief Accounting Officer concluded that our disclosure controls and procedures as of December 31, 2007 were not effective as described below.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as that term is defined in Securities Exchange Act of 1934, as amended, Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our control environment is the foundation for our system of internal control over financial reporting and is an integral part of our Code of Ethical Conduct and Business Practices, which sets the tone of our Company. Our 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 our transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of our financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
In order to evaluate the effectiveness of our internal control over financial reporting as of December 31, 2007, as required by Section 404 of the Sarbanes-Oxley Act of 2002, our management conducted an assessment, including testing, based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Accounting Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting in connection with preparation of the annual report on Form 10-K for the year ended December 31, 2007. As a result of these assessments, one material weakness was identified. A material weakness is a control deficiency,
or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
•
Our accounting and financial reporting systems and procedures were not sufficiently designed to ensure consistent and complete application of our accounting policies and to prepare financial statements in accordance with generally accepted accounting principles. This includes not only the sufficiency of our review of sensitive calculations, reconciliations and spreadsheets but also the preparation and processing of financial accounting information.
Based on our assessment, and because of the material weakness described above, management has concluded that our internal control over financial reporting was not effective as of December 31, 2007 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.
Grant Thornton LLP, the independent registered public accounting firm that audited our consolidated financial statements included in this annual report on Form 10-K for the year ended December 31, 2007, has issued an attestation report on our internal control over financial reporting as of December 31, 2007, which is included in Item 8. “Financial Statements”.
Changes in Internal Controls
In the quarter ended December 31, 2007, we had the following changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting:
•
We hired an international accounting and financial reporting consultant, to review the accounting function both domestically and internationally.
•
We re-assigned an employee as an assistant to our Compliance Manager.
•
We assigned the Payroll Manager the responsibility to clerically check the Form 10-K and Form 10-Q for accuracy.
•
We established a new procedure for the 2007 year end close where each foreign accounting manager came to Dallas to offer assistance with the 2007 audit.
•
We established a new procedure that both the foreign accounting managers and branch managers certify that the financial statements do not contain any material misstatements.
•
We continued the automation of our foreign sub-consolidations. We expect this project to be completed in the second quarter of 2008.
ITEM 9B.
ITEM 9B.
Other Information.
None.
PART III
ITEM 10.
ITEM 10.
Directors, Executive Officers of the Registrant and Corporate Governance.
Information required by this item relating to our (i) directors, nominees for directors and executive officers, (ii) audit committee, (iii) Code of Ethical Conduct and Business Practices, (iv) changes in procedures by which security holders may recommend nominees to our board of directors, and (v) compliance with Section 16(a) of the Securities Exchange Act will be set forth in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders, that will be filed with the Securities and Exchange Commission on or prior to April 29, 2008, and that is incorporated herein by reference.
ITEM 11.
ITEM 11.
Executive Compensation.
Information required by this item relating to executive compensation will be set forth in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders, that will be filed with the Securities and Exchange Commission on or prior to April 29, 2008, and that is incorporated herein by reference.
ITEM 12.
ITEM 12.
Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters.
Information required by this item relating to (i) security ownership of certain beneficial owners and management and (ii) securities authorized for issuance under equity compensation plans will be set forth in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders, that will be filed with the Securities and Exchange Commission on or prior to April 29, 2008, and that is incorporated herein by reference.
ITEM 13.
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence.
Information required by this item relating to (i) certain business relationships and related transactions with management and (ii) other related parties and director independence will be set forth in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders, that will be filed with the Securities and Exchange Commission on or prior to April 29, 2008, and that is incorporated herein by reference.
ITEM 14.
ITEM 14.
Principal Accountant Fees And Services.
The information relating to (i) fees billed to the Company by the independent public accountants for services in 2007 and 2006 and (ii) audit committee’s pre-approval policies and procedures for audit and non-audit services, will be set in our Proxy Statement relating to the 2008 Annual Meeting of Stockholders, that will be filed with the Securities and Exchange Commission on or prior to April 29, 2008, and that is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
Exhibits and Financial Statement Schedules.
(a) The following documents are filed as part of this report:
1. Index to Consolidated Financial Statements, Reports of Independent Registered Public Accounting Firm, Consolidated Balance Sheets as of December 31, 2007 and 2006, Consolidated Statements of Operations and Comprehensive Income for the three years in the period ended December 31, 2007, Consolidated Statements of Changes in Stockholders’ Equity for each of the three years in the period ended December 31, 2007, Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2007, and Notes to Consolidated Financial Statements.
2. The financial statement schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the Notes to Consolidated Financial Statements.
3. Exhibits: The exhibits required to be filed by this Item 15 are set forth in the Index to Exhibits accompanying this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
TOREADOR RESOURCES CORPORATION
/s/ Nigel J. Lovett
Nigel J. Lovett,
President and Chief Executive Officer
March 17, 2008
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers and directors of Toreador Resources Corporation hereby constitutes and appoints Nigel J. Lovett and Charles J. Campise, or either of them (with full power to each of them to act alone), his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and on his behalf and in his name, place and stead, in any and all capacities, to sign, execute and file any and all amendments (including post-effective amendments) to this Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys, and each of them, full power and authority to do so and perform each and every act and thing requisite and necessary to be done in and about the premises in order to effectuate the same as full to all intents and purposes as he himself might or could do if personally present, thereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their or his substitute or substitutes, may lawfully do or cause to be done.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates as indicated therein.
INDEX TO EXHIBITS
*
Filed herewith
+
Management contract or compensatory plan
Item 8.
Financial Statements
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Toreador Resources Corporation
We have audited Toreador Resources Corporation (a Delaware Corporation) and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control Over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) 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.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment.
•
The Company’s accounting and financial reporting systems and procedures were not sufficiently designed to ensure consistent and complete application of accounting policies and to prepare financial statements in accordance with generally accepted accounting principles. This includes not only the sufficiency of review of sensitive calculations, reconciliations and spreadsheets but also the preparation and processing of financial accounting information
In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Toreador Resources Corporation and subsidiaries as of December 31, 2007 and 2006, and the related statements of operations and comprehensive income (loss), changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2007. The
material weakness identified above was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2007 financial statements, and this report does not affect our report dated March 17, 2008, which expressed an unqualified opinion on those financial statements.
/s/ GRANT THORNTON LLP
Houston, Texas
March 17, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Toreador Resources Corporation
We have audited the accompanying consolidated balance sheets of Toreador Resources Corporation (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations and comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Toreador Resources Corporation and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for unrecognized tax benefits as of January 1, 2007, in connection with the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109. Also, as discussed in Note 2 to the consolidated financial statements, effective January 1, 2006, the Company changed its method of accounting for stock-based compensation to conform to Statement of Financial Accounting Standards No. 123R, Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 17, 2008 expressed an adverse opinion thereon.
/s/ GRANT THORNTON LLP
Houston, Texas
March 17, 2008
TOREADOR RESOURCES CORPORATION
CONSOLIDATED BALANCE SHEETS
See accompanying notes to the consolidated financial statements
TOREADOR RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
See accompanying notes to the consolidated financial statements
TOREADOR RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
See accompanying notes to the consolidated financial statements
TOREADOR RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to the consolidated financial statements
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -
DESCRIPTION OF BUSINESS
Toreador Resources Corporation (“Toreador”) is an independent energy company engaged in foreign (France, Turkey, Romania and Hungary) oil and natural gas exploration, development, production, leasing and acquisition activities. The accompanying consolidated financial statements are presented in U.S. dollars and in accordance with accounting principles generally accepted in the United States.
BASIS OF PRESENTATION
Toreador consolidates all of its majority-owned subsidiaries (collectively, “we,” “us,” “our,” or the “Company”). All intercompany accounts and transactions are eliminated in consolidation. We account for our investments in entities in which we hold less than a majority interest under the equity method.
NOTE 2 -
SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
The Company’s estimates of crude oil and natural gas reserves are the most significant estimates used. All of the reserve data in the Form 10-K for the year ended December 31, 2007 are estimates. Reservoir engineering is a subjective process of estimating underground accumulations of crude oil and natural gas. There are numerous uncertainties inherent in estimating quantities of proved crude oil and natural gas reserves. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, reserve estimates may be different from the quantities of crude oil and natural gas that are ultimately recovered.
Other items subject to estimates and assumptions include the carrying amounts of oil and natural gas properties, goodwill, asset retirement obligations and deferred income tax assets. Actual results could differ significantly from those estimates.
CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash and cash equivalents include cash on hand, amounts due from banks and all highly liquid investments with original maturities of three months or less. We maintain our cash in bank deposit accounts, substantially all of which exceeds federally insured limits. We have not experienced any losses in such accounts.
As of December 31, 2007 and 2006 we had $10.7 million and $11.2 million, respectively, on deposit in foreign banks.
RESTRICTED CASH
Restricted cash consists of an $8.7 million deposit used to secure a bank “Letter of Guarantee” that was issued as required under the mediation proceedings with Micoperi, Srl. and $2.1 million for a letter of credit to secure additional permits in Hungary. The total amount of $10.7 million is on deposit in foreign banks.
CONCENTRATION OF CREDIT RISK AND ACCOUNTS RECEIVABLE
Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash, accounts receivable, and our hedging and derivative financial instruments. We place our cash with high credit quality financial institutions. We sell oil and natural gas to multiple customers. At December 31, 2007 an allowance
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
for doubtful accounts of $120,000 was established for accounts receivable in Romania. An allowance for doubtful accounts did not exist at December 31, 2006. Substantially all of our accounts receivable are due from purchasers of oil and natural gas. We place our hedging and derivative financial instruments with financial institutions and other firms that we believe have high credit ratings. For a discussion of the credit risks associated with our hedging activities, please see “Derivative Financial Instruments” below.
We periodically review the collectability of accounts receivable and record a valuation allowance for those accounts which are, in our judgment, unlikely to be collected. We have not had any significant credit losses in the past and we believe our accounts receivable, net of allowance for doubtful accounts, are fully collectable.
FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments including cash and cash equivalents, short-term investments, accounts receivable, accounts payable, derivative financial instruments and accrued liabilities approximate fair value, at December 31, 2007 and 2006, due to the short-term nature or maturity of the instruments.
Long-term debt approximated fair value based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same maturities.
On December 31, 2007 the convertible subordinate notes which had a book value of $86.25 million, were trading at $810.00, which would equal a fair market value of approximately $70 million.
DERIVATIVE FINANCIAL INSTRUMENTS
We periodically utilize derivatives instruments such as futures and swaps for purposes of hedging our exposure to fluctuations in the price of crude oil and natural gas sales. We entered into futures and swap contracts with FC Stone, counter party for approximately 15,000 Bbls per month for the months of June 2007 through December 2008. When actual commodity prices exceeded the fixed price provided by these contracts, we paid this excess to FC Stone, and when actual commodity prices were below the contractually provided fixed price, we received this difference from FC Stone. We subsequently sold all of these contracts as of September 30, 2007 which resulted in a realized net loss of $813,000.
As of December 31, 2007 we had the following open commodity derivative contract with Total Oil Trading SA:
As of December 31, 2007, we recorded a net unrealized loss of $192,000 on the above open derivative contract. For the year ended December 31, 2007 we recognized a total derivative fair value loss of $1 million. We were not a party to any commodity contracts in the comparable period of 2006 or 2005
In 2006, we purchased and sold 6 foreign currency forward contracts for New Turkish Lira, two foreign currency forward contracts for Euros and two call options to purchase Euros. The contracts were purchased primarily to protect our exposure to foreign exchange changes in France and Turkey. When these contracts were settled we recognized a loss of approximately $464,000 that was recorded to foreign currency exchange gain (loss) on the Statement of Operations.
We are exposed to credit losses on derivative financial instruments in the event of nonperformance by the counterparties to our financial instruments. We anticipate, however, that such counterparties will be able to fully satisfy their obligations under the contracts. We do not obtain collateral or other security to support financial instruments subject to credit risk but we monitor the credit standing of the counterparties. At December 31, 2007 and 2006, we had no receivables from counterparties.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
We have elected not to designate the derivative financial instruments to which we are a party as hedges, and accordingly, we record such contracts at fair value and recognize changes in such fair value in current earnings as they occur.
INVENTORIES
At December 31, 2007 and 2006, other current assets included $2.5 million and $1.2 million of inventory, respectively. Those amounts consist of tubular goods and crude oil held in storage tanks. Inventories are stated at the lower of actual cost or market based on the average cost method.
ADVANCES PAID TO VENDORS
At December 31, 2007 and 2006, other current assets included zero and $3.8 million, respectively, of payments made to vendors in advance of performing the services or receiving the equipment.
OIL AND NATURAL GAS PROPERTIES
We follow the successful efforts method of accounting for oil and natural gas exploration and development expenditures. Under this method, costs of successful exploratory wells and all development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves are expensed. Significant costs associated with the acquisition of oil and natural gas properties are capitalized. Upon sale or abandonment of units of property or the disposition of miscellaneous equipment, the cost is removed from the asset account, net of the accumulated depreciation or depletion, and the gain or loss is credited to or charged against operations.
Maintenance and repairs are charged to expense; betterments of property are capitalized and depreciated as described above.
We capitalize interest on major projects that require an extended period of time to complete. Interest capitalized in 2007, 2006 and 2005 was $3.7 million, $4.3 million, and $1.4 million, respectively.
We record furniture, fixtures and equipment at cost.
DEPRECIATION, DEPLETION AND AMORTIZATION
We provide depreciation, depletion and amortization of our investment in producing oil and natural gas properties on the units-of-production method, based upon independent reserve engineers’ estimates of recoverable oil and natural gas reserves from the property. Depreciation expense for furniture, fixtures and equipment is generally calculated on a straight-line basis based upon estimated useful lives of three to seven years.
IMPAIRMENT OF ASSETS
We evaluate producing property costs for impairment and reduce such costs to fair value if the sum of expected undiscounted future cash flows is less than net book value pursuant to Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“Statement 144”). We assess impairment of non-producing leasehold costs and undeveloped mineral and royalty interests periodically on a field-by-field basis. We charge any impairment in value to expense in the period incurred. In 2007 we incurred impairment losses of $13.4 million on our Romanian oil and natural gas producing properties.
ASSET RETIREMENT OBLIGATIONS
We account for our asset retirement obligations in accordance with Statement No. 143, “Accounting for Asset Retirement Obligations” (“Statement 143”), which requires us to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, we either settle the obligation for its recorded amount or incur a gain or loss upon settlement.
The following table summarizes the changes in our asset retirement liability during the years ended December 31, 2007 and 2006:
GOODWILL
We account for goodwill in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“Statement 142”). Under Statement 142, goodwill and indefinite-lived intangible assets are not amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have an indefinite life are amortized over their useful lives. At December 31, 2007 and 2006, we did not have any intangible assets that did not have an indefinite life.
We review annually the value of goodwill recorded or more frequently if impairment indicators arise. We recognized no goodwill impairment during 2007, 2006 or 2005. Goodwill was reduced by $1.6 million in 2005 for a corresponding reduction in deferred tax liabilities which resulted from the recognition of prior Madison Oil Company net operating losses that were reserved at the date of acquisition. Goodwill was also adjusted $391,000 in 2007 and $356,000 in 2006 for the foreign currency translation adjustment. The balance of goodwill at December 31, 2007 and 2006 is approximately $4.9 million and $4.6 million, respectively.
REVENUE RECOGNITION
Our French crude oil production accounts for the majority of our sales. We sell our French crude oil to Elf Antar France S.A. (“ELF”), and recognize the related revenues when the production is delivered to ELF’s refinery, typically via truck. At the time of delivery to the plant, title to the crude oil transfers to ELF. The terms of the contract with ELF state that the price received for oil sold will be the arithmetic mean of all average daily quotations of Dated Brent published in Platt’s Oil Market Wire for the month of production less a specified differential per barrel. The pricing of oil sales is done on the first day of the month following the month of production. In accordance with the terms of the contract, payment is made within six working days of the date of issue of the invoice. The contract with ELF is automatically extended for a period of one year unless either party cancels it in writing no later than six months prior to the beginning of the next year. We periodically review ELF’s payment timing to ensure that receivables from ELF for crude oil sales are collectible. In 2007, 2006 and 2005 sales to ELF represents approximately 62%, 67% and 66%, respectively, of the Company’s total revenue and approximately 21% and 20% of the Company’s accounts receivable at December 31, 2007 and 2006, respectively. No collateral is required against the current outstanding accounts receivable balance from ELF.
We recognize revenue for our remaining production when the quantities are delivered to or collected by the respective purchaser. Title to the produced quantities transfers to the purchaser at the time the purchaser collects or receives the quantities. Prices for such production are defined in sales contracts and are readily determinable based
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
on certain publicly available indices. The purchasers of such production have historically made payment for crude oil and natural gas purchases within thirty and sixty days of the end of each production month, respectively. We periodically review the difference between the dates of production and the dates we collect payment for such production to ensure that receivables from those purchasers are collectible. Taxes associated with production are classified as lease operating expense.
STOCK-BASED COMPENSATION
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment,” (SFAS 123R). SFAS 123R establishes the accounting for transactions in which an entity pays for employee services in share-based payment transactions. SFAS 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for the unique characteristics of those instruments. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. The Company adopted SFAS 123R effective January 1, 2006, using the modified-prospective transition method. Under this method, compensation cost is recognized for awards granted and for awards modified, repurchased or cancelled in the period after adoption. Compensation cost is also recognized for the unvested portion of awards granted prior to adoption. Prior year financial statements are not restated. The Company’s results for the year ended December 31, 2006, include an additional compensation expense of $65,916, that is included in general and administrative expenses relating to the adoption of SFAS 123R. Additionally, upon adoption of SFAS 123R, excess tax benefits related to stock option exercises of $293,000 were presented as a cash inflow from financing activities.
Prior to adoption of SFAS 123 R, the Company accounted for stock based compensation plans under APB Opinion No. 25 “Accounting for Stock Issued to Employees.” Compensation cost related to stock options issued to employees was recorded only if the grant-date market price of the underlying stock exceeded the exercise price. The following table illustrates the effect on income available to common shares and earnings available to common shares per share if a fair value based method had been applied to all awards.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
FOREIGN CURRENCY TRANSLATION
The functional currency of the countries in which we operate is the U.S. dollar in the United States, Turkey, Romania and Hungary and the Euro in France. Gains and losses resulting from the translations of Euros into U.S. dollars are included in other comprehensive income for the current period. Gains and losses resulting from the transactions in the New Turkish Lira in Turkey, the Lei in Romania and the Forint in Hungary are included in income available to common shares for the current period. We periodically review the operations of our entities to ensure the functional currency of each entity is the currency of the primary economic environment in which we operate.
In October 2007, we made a change in accounting method regarding intercompany account receivables due from our subsidiaries in Turkey, Romania and Hungary. Pursuant to a Board of Directors resolution, we expect to be repaid the intercompany account receivable from our subsidiaries in Turkey, Romania and Hungary in the foreseeable future. Due to this resolution, subsequent to October 1, 2007, the change in the intercompany account receivable balance will be reflected in current earnings, as a foreign exchange gain or loss rather than accumulated other comprehensive income. The impact of this change results in a foreign exchange gain of $5.9 million for the year ended December 31, 2007, which is included in the consolidated statements of operations.
INCOME TAXES
We are subject to income taxes in the United States, France, Turkey, Hungary and Romania. The current provision for taxes on income consists primarily of income taxes based on the tax laws and rates of the countries in which operations were conducted during the periods presented. All interest and penalties related to income tax is charged to general and administrative expense. We compute our provision for deferred income taxes using the liability method. Under the liability method, deferred income tax assets and liabilities are determined based on differences between financial reporting and income tax basis of assets and liabilities and are measured using the enacted tax rates and laws. The measurement of deferred tax assets is adjusted by a valuation allowance, if necessary, to reduce the future tax benefits to the amount, based on available evidence it is more likely than not deferred tax assets will be realized. We made a commitment to be fully reinvested in our international subsidiaries.
Effective January 1, 2007, we adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109. FIN No. 48 clarifies financial statement recognition and disclosure requirements for uncertain tax positions taken or expected to be taken in a tax return. Financial statement recognition of the tax position is dependent on an assessment of a 50% or greater likelihood that the tax position will be sustained upon examination, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions are recorded as interest expense and general and administrative expense, respectively. The adoption of FIN No. 48 did not have a significant effect on our reported financial position or earnings. See Note 9.
LEGAL FEES
We do not accrue for estimated legal fees or other related costs when accruing for loss contingencies, rather they are expensed as incurred.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DEFERRED DEBT ISSUE COST
Deferred debt issue costs are amortized on a straight line basis, which approximates the effective interest method over the term of the loan as a component of interest expense. Deferred debt issue costs totaled approximately of $4,652,000 and $5,117,000 net of accumulated amortization of $552,000 and $361,000 as of December 31, 2007 and 2006, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, was issued. SFAS No. 157 provides guidance for using fair value to measure assets and liabilities. It applies whenever other standards require or permit assets or liabilities to be measured at fair value but it does not expand the use of fair value in any new circumstances. In November 2007, the effective date was deferred for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value on a recurring basis. The provisions of SFAS No. 157 that were not deferred are effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 157, effective January 1, 2008, did not have a significant effect on our reported financial position or earnings.
In February 2007, the FASB issued Statement 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement 115”. The statement permits entities to choose to measure certain financial instruments and other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Unrealized gains and losses on any items for which we elect the fair value measurement option would be reported in earnings. Statement 159 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the effect, if any, the adoption of Statement 159 will have on our financial statements and related disclosures.
In December 2007, SFAS No. 141R, Business Combinations, was issued. Under SFAS No. 141R, a company is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and any contingent consideration measured at their fair value at the acquisition date. It further requires that research and development assets acquired in a business combination that have no alternative future use to be measured at their acquisition-date fair value and then immediately charged to expense, and that acquisition-related costs are to be recognized separately from the acquisition and expensed as incurred. Among other changes, this statement also requires that “negative goodwill” be recognized in earnings as a gain attributable to the acquisition, and any deferred tax benefits resultant in a business combination are recognized in income from continuing operations in the period of the combination. SFAS No. 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008. The effect of adopting SFAS No. 141R has not been determined, but it is not expected to have a significant effect on our reported financial position or earnings
In December 2007, SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51, was issued. SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Among other requirements, this statement requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS No. 160 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008. The effect of adopting SFAS No. 160 is not expected to have an effect on our reported financial position or earnings.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 3 -
EARNINGS PER SHARE
In accordance with the provisions of FASB Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“Statement 128”), basic earnings per share are computed on the basis of the weighted-average number of common shares outstanding during the periods. Diluted earnings per share are computed based upon the weighted-average number of common shares plus the assumed issuance of common shares for all potentially dilutive securities.
(1)
Conversion of these securities would be antidilutive; therefore, there are no dilutive shares.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(2)
5% Senior Convertible Notes were issued on September 27, 2005.
(3)
7.85% Notes Payable were issued in July 2004 and subsequently exchanged in January 2005
NOTE 4 -
ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
Accrued oil and natural gas sales receivables are due from either purchasers of oil and gas or operators in oil and natural gas wells for which the Company owns an interest. Oil and natural gas sales are generally unsecured and such amounts are generally due within 30 days after the month of sale.
Trade receivables are the amounts due from our joint interest partners and amounts due from contractors where we have paid for supplies on their behalf. These receivables are generally due within 15 days after receipt of monthly joint interest billing or they are offset against invoices from contractors when billed.
Other receivables at December 31, 2007 and 2006 consist of accrued interest receivable on time deposits, value added tax refunds and travel advances to employees.
NOTE 5 -
OIL AND NATURAL GAS PROPERTIES
Oil and natural gas properties consist of the following:
The Company capitalizes exploratory well costs until a determination is made that the well has found proved reserves or is deemed noncommercial, in the latter case the well costs are immediately charged to exploration expense.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table reflects the Company’s capitalized exploratory well activity and does not include amounts that were capitalized and subsequently expensed in the same period:
The following table provides an aging of capitalized exploratory well costs (suspended well costs), as of December 31 of each year, based on the date the drilling was completed:
NOTE 6 -
INVESTMENTS IN UNCONSOLIDATED ENTITIES
In February 2004, we acquired 45% of ePsolutions. Based in Austin, Texas, ePsolutions is a software and energy services company in the electric industry and deregulated energy markets. ePsolutions is the developer of emPower system, a CIS, EDI and billing solution for energy companies within deregulated energy markets. At December 31, 2007 and 2006 our investment in ePsolutions amounted to zero and $1.5 million, respectively. For the years ended December 31, 2007 and 2006 we advanced zero and $257,000, respectively, and we recorded equity in ePsolutions of $41,000 in 2007, a loss of $70,000 in 2006 and a loss of $238,000 in 2005. In April 2007, we sold our interest in ePsolutions to ePsolutions for $3.9 million and recorded a gain on the sale of $2.3 million.
In July 2000, we acquired 35% of EnergyNet.com, Inc. (“EnergyNet”), an Internet based oil and natural gas property auction company. At December 31, 2007 and 2006, our investment in EnergyNet amounted to zero and $997,000, respectively. We recorded equity in the loss of EnergyNet of $45,000 in 2007, earnings of $340,000 in 2006 and earnings of $409,000 in 2005. We received a dividend from EnergyNet of zero in 2007, $175,000 in 2006 and $131,250 in 2005. In April 2007, we sold our interest in EnergyNet.com to EnergyNet.com for $2 million and recorded a gain on the sale of $1.1 million.
In April 2000, we acquired a 50% interest in Capstone Royalty, LLC (“Capstone”), a joint venture formed to acquire mineral interests at county auctions in west Texas and develop those interests. Our investment in Capstone amounted to zero and $160,000 at December 31, 2007 and 2006, respectively. We recorded equity in the earnings of Capstone amounting to $26,000 in 2007, $131,000 in 2006 and $51,000 in 2005. We received a distribution from Capstone of $60,000 in 2007, $75,000 in 2006 and $60,000 in 2005. In April 2007, we sold our interest in Capstone Royalty, LLC to Capstone Royalty, LLC for $250,000 and recorded a gain on the sale of $124,000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 7 -
LONG-TERM DEBT
Long-term debt consisted of the following:
CONVERTIBLE SENIOR NOTES DUE OCTOBER 1, 2025
On September 27, 2005, we issued $75 million of Convertible Senior Notes due October 1, 2025 (“Notes”) to qualified institutional buyers pursuant to Rule 144A of the Securities Act of 1933. The Company also granted the initial purchasers the option to purchase an additional $11.25 million aggregate principal amount of Notes to cover over-allotments. The option was exercised on September 30, 2005. The total principal amount of Notes issued was $86.25 million and total net proceeds were approximately $82.2 million. We incurred approximately $4.1 million of costs associated with the issuance of the Notes; these costs have been recorded in other assets on the balance sheet and are being amortized to interest expense using the straight-line interest rate method over the term of the Notes.
The net proceeds were used for general corporate purposes, including funding a portion of the Company’s 2005 and 2006 exploration and development activities.
The Notes bear interest at a rate of 5% per annum and can be converted into common stock at an initial conversion rate of 23.3596 shares of common stock per $1,000 principal amount of Notes, subject to adjustment in an event of a fundamental change, as defined, (equivalent to a conversion price of approximately $42.81 per share). The Company may redeem the Notes, in whole or in part, on or after October 6, 2008, and prior to October 1, 2010, for cash at a redemption price equal to 100% of the principal amount of Notes to be redeemed, plus any accrued and unpaid interest, if the closing price of its common stock exceeds 130% of the conversion price over a specified period. On or after October 1, 2010, the Company may redeem the Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of Notes to be redeemed, plus any accrued and unpaid interest, irrespective of the price of its common stock. Holders may convert their Notes at any time prior to the close of business on the business day immediately preceding their stated maturity, and holders may, upon the occurrence of certain fundamental changes, and on October 1, 2010, October 1, 2015, and October 1, 2020, require the Company to repurchase all or a portion of their Notes for cash in an amount equal to 100% of the principal amount of such Notes, plus any accrued and unpaid interest.
Due to our restating the consolidated financial statements for the years ended December 31, 2003, 2004 and 2005 and our consolidated financial statements for each of the quarters ended March 31 and June 30, 2006, we did not provide the trustee under the indenture of the Convertible Senior Notes with copies of our annual reports, information, documents and other reports that we are required to file with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 within thirty (30) days of when such reports are required to be filed with the Securities and Exchange Commission.
On December 15, 2006, we received a notice from the trustee for failing to provide the trustee with a copy of our Form 10-Q for the nine month period ended September 30, 2006. Since we cured the covenant default within
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
thirty (30) days after receiving the written notice from the trustee, we cured the default and an event of default did not occur.
The registration rights agreement covering the Notes provides for a penalty if the registration statement is filed and declared effective but thereafter ceases to be effective (a “Suspension Period”) for an aggregate of forty-five (45) days in any three month period or ninety (90) days in any twelve month period (an “Event Date”). Such penalty calls for an additional 0.25% per annum in interest expense on the aggregate principal amount of the Notes for the first ninety (90) days following an Event Date and an additional 0.50% per annum in interest expense on the aggregate principal amount of the Notes thereafter, until such Suspension Period ends upon the registration statement again becoming effective or not being required to be effective pursuant to the registration rights agreement. Because we did not file our Quarterly Report on Form 10-Q for the nine month period ended September 30, 2006 in a timely manner, the registration statement for the Notes became ineffective and we entered a Suspension Period on November 15, 2006. Such Suspension Period ended on January 23, 2007 when we provided notice that the Form 10-Q had been filed and the Suspension Period was no longer in effect. Because the Suspension Period exceeded forty-five (45) days in any three month period, we paid approximately $14,375 in additional interest expense. On March 16, 2007, the date we filed our Form 10-K for the year ended December 31, 2006, we again entered a Suspension Period until all the Notes became eligible for sale pursuant to Rule 144(k) on September 30, 2007. On October 1, 2007, $155,000 was deposited with the trustee for the Notes as the penalty for any holders of the Notes who were eligible on October 1, 2007 to receive a pro rate portion of such payment. Such eligible holders had to have registered their Notes on the registration statement and still held those Notes on October 1, 2007. Through March 12, 2008, we had released $4,043 of the penalty deposit to eligible holders of Notes.
REVOLVING LINE OF CREDIT WITH NATIXIS BANQUES POPULAIRES
On December 23, 2004, we entered into a five-year $15.0 million reserve-based borrowing facility with a French lender to finance the development of our existing French fields, acquisitions of new fields, general working capital and other corporate purposes. The facility bore interest at a floating rate of 2.25-2.75% above LIBOR (8.053% at March 2, 2007) depending on the principal outstanding. The facility was collateralized by certain of our French assets, including contracts relating to our rights and interests in our French fields, our direct and indirect equity interests in certain of our subsidiaries and payments received from the sale of our French production. The Company and certain of its U.S. and French subsidiaries were each guaranteed the obligations under the facility. This facility required monthly interest payments until December 23, 2009, at which time all unpaid principal and interest were to be due. We were subject to a commitment fee of one half (1/2) of the applicable margin, 1.25% as of December 31, 2006, on the available and unused facility borrowings. Under the $15.0 million facility, at December 31, 2006, borrowings of approximately $909,000 were available and $11 million was outstanding. The $15.0 million facility contains various affirmative and negative covenants. These covenants, among other things, limited additional indebtedness, the sale of assets, change of control and management, limitations on the distribution of stock dividends and required us to meet certain financial requirements. Specifically, we had to maintain an interest cost ratio of not less than 4.00 to 1.00, an indebtedness ratio of not less than 1.00 to 1.00, asset life cover ratio of not less than 1.25 to 1.00, a loan life cover ratio equal to or greater than 1.15 to 1.00 and a debt service coverage ratio equal to or greater than 1.10 to 1.00.
As a result of not providing Natixis with our unaudited consolidated financial statements for the nine month period ended September 30, 2006 within forty-five (45) days after the end of such quarter, we were in default under the $15 million facility. Until January 16, 2007, Natixis waived such default and any other default under the facility as a result of us not yet providing such financial statements. On January 16, 2007, we filed the Form 10-Q for the quarter ended September 30, 2006 and provided the unaudited consolidated financial statements contained in the Form 10-Q to Natixis which cured the default.
On March 2, 2007, the facility was retired and all amounts due were paid.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SECURED REVOLVING FACILITY WITH THE INTERNATIONAL FINANCE CORPORATION
On December 28, 2006, we guaranteed the obligations of certain of our direct and indirect subsidiaries in a loan and guarantee agreement with International Finance Corporation. The loan and guarantee agreement provides for the $25 million loan facility which is a secured revolving facility with a current maximum facility amount of $25 million which maximum facility amount will increase to $40 million when the projected total borrowing base amount exceeds $50 million. The $25 million facility was funded on March 2, 2007. The loan and guarantee agreement also provides for a $10 million facility which was funded on December 28, 2006. In September 2007, we repaid $5 million on the $25 million facility from proceeds received on the U.S. oil and gas property sale. As of December 31, 2007, the International Finance Corporation has reduced our borrowing base under both loans to $30 million from $35 million. Until the next redetermination date, the Company has no additional borrowing capacity under these facilities. Both the $25 million facility and $10 million facility are to fund our operations in Turkey and Romania.
Interest accrues on any loans under the $25 million facility at a rate of 2% over the six month LIBOR rate. Interest accrued on the $10 million facility at a rate of 1.5% over the six month LIBOR rate until the $25 million facility was funded after which the rate for the $10 million facility was lowered to 0.5% over the six month LIBOR rate. As of December 31, 2007, the interest rate on the $10 million facility was 5.329% and the interest rate on the $25 million facility was 6.829%. Interest is to be paid on each June 15 and December 15.
The $25 million facility provided the following: (i) the lender has a first ranking security interest (a) in certain proceeds, receivables and contract rights relating to and from the sale of oil or gas production in France, Turkey and Romania and (b) in funds held in certain bank accounts; (ii) the lender has an assignment of all rights and claims to any compensation or other special payments in respect of all concessions other than those arising in the normal course of operations payable by the government of Turkey and Romania; and (iii) the lender has a first ranking pledge (a) by Toreador International Holding, LLC of all its shares in the borrowers; (b) by Madison Oil France SAS of all its shares in Toreador France; and (c) by the Company of all its shares in Toreador International Holding, LLC.
On December 31, 2011, the maximum amount available under the $25 million facility begins to decrease by $5 million every six months from $40 million (assuming the projected borrowing base amount exceeds $50 million) until the final portion of the $25 million facility is due on December 15, 2014. On December 15, 2014, $5 million of the $10 million facility is to be repaid with the remaining $5 million being due on June 15, 2015.
The Company is required to meet the following ratios on a consolidated basis: (i) the life of loan coverage ratio of not less than: (a) 1.2:1.0 in 2006 and 2007; (b) 1.3:1.0 in 2008; and (c) 1.4:1.0 in 2009 and each subsequent year thereafter; (ii) reserve tail ratio of not less than 25%; (iii) adjusted financed debt to EBITDAX ratio of not more than 3.0:1.0; (iv) liabilities to tangible net worth ratio of not more than 60:40; and (v) interest coverage ratio of not less than 3.0:1.0. On August 9, 2007, the covenant requirements were amended to replace the adjusted financial debt to EBITDA ratio not being more than 3.0:1.0 with the adjusted financial debt to EBITDAX ratio not being more than 3.0:1.0 and the definition of interest coverage ratio was adjusted to include EBITDAX instead of EBITDA for calculation purposes. At December 31, 2007, we were not in compliance with the interest rate coverage ratio of not less than 3.0:1.0; the actual ratio was 2.8:1.0. The International Finance Corporation has granted the Company a temporary waiver for the interest coverage ratio provided the Company maintains EBITDAX to net interest expense ratio of 2.7:1.0 until July 2, 2008 and EBITDA to net interest expense ratio of a least 2.7:1.0 during the remaining period of the waiver effectiveness. The waiver is effective until March 8, 2009.
We are subject to certain negative covenants, including, but not limited to, the following: (i) subject to certain exceptions, paying dividends; (ii) subject to certain exceptions, incurring debt, making guarantees or creating or permitting to exist any liens, (iii) subject to certain exceptions, making or permitting to exist loans or advances to, or deposits, with other persons or investments in any person or enterprise; (iv) subject to certain exceptions, selling,
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
transferring, leasing or otherwise disposing of all or a material part of its borrowing base assets; and (v) subject to certain exceptions, undertaking or permitting any merger, spin-off, consolidation or reorganization.
REVOLVING LINE OF CREDIT WITH TEXAS CAPITAL BANK, N.A.
On December 30, 2004, we entered into a five-year $25.0 million reserve-based borrowing facility with Texas Capital Bank, N.A. in order to finance the development and acquisition of oil and natural-gas interests both domestically and internationally and for working capital purposes. On March 30, 2007, the Texas Capital facility was retired and all amounts due were paid. The facility bore interest at a rate of prime less 0.5% (7.75% total rate at March 30, 2007) and was collateralized by our domestic working interests. The borrowers under this facility were two of our domestic subsidiaries, and the Company has guaranteed the obligations. The Texas Capital facility required monthly interest payments until January 1, 2010 at which time all unpaid principal and interest were to be due. The Texas Capital facility contained various affirmative and negative covenants. These covenants, among other things, limited additional indebtedness, the sale of assets, change of control and management and required us to meet certain financial requirements. Specifically, we had to maintain a current ratio of 1.25 to 1.00 (exclusive of amounts due under revolving credit arrangements) and an interest coverage ratio of not less than 3.00 to 1.00.
We were in default under the Texas Capital facility for failing to provide Texas Capital on or before the 60th day after the last day of the fiscal quarter ended September 30, 2006 with a copy of the unaudited consolidated financial statements of Toreador and there was an event of default under the Texas Capital facility for defaulting in the performance or observance of a provision under the Senior Convertible Notes. Texas Capital waived the default and event of default until January 16, 2007. On January 16, 2007, we filed the Form 10-Q for the quarter ended September 30, 2006 and provided the unaudited consolidated financial statements contained in the Form 10-Q to Texas Capital which cured the default.
CONVERTIBLE SUBORDINATED NOTES
In July 2004, we sold to certain institutional investors pursuant to a private offering $7.5 million aggregate principal amount of 7.85% convertible subordinated notes due June 30, 2009. We used the net proceeds of the offering to accelerate our oil development program in France’s Paris Basin and for general corporate purposes. The 7.85% convertible subordinated notes due June 30, 2009 bore interest at the rate of 7.85% per annum and were convertible into shares of Toreador common stock at a conversion price of $8.20 per share. Toreador had the right to cause the 7.85% notes to be converted on or after February 22, 2005, if the closing price of Toreador’s common stock was greater than $14.35 for the 30 consecutive trading days prior to the date of Toreador’s conversion notice. On January 13, 2005, we provided the conversion notice to the holders of the 7.85% notes to require the holders to exchange their notes for the aggregate number of shares of our common stock issuable upon conversion of each of their notes and that portion of interest payable pursuant to the notes that would otherwise have been payable to the holders through the required conversion date. On or prior to January 20, 2005, all of our 7.85% convertible subordinated notes due June 30, 2009 (with a carrying value, net of unamortized loan fees of $6.4 million) were exchanged for an aggregate of 914,634 shares of our common stock and an aggregate cash payment for interest of approximately $85,000 which is included in interest expense in 2005.
CONVERTIBLE DEBENTURE
As part of our acquisition of Madison Oil Company, we assumed and amended a convertible debenture (“Debenture”) payable to PHD Partners LP. The general partner of PHD Partners LP is a corporation wholly owned by David M. Brewer, a director and significant stockholder of Toreador. The amended and restated debenture used to bear interest at 10% per annum and was due on March 31, 2006. At the holders’ option, the amended and restated debenture could be converted into common stock at a ratio of $6.75 per share. We originally had 319,962 common shares reserved for issuance related to the conversion of the amended and restated debenture. As of March 31, 2004, the amended and restated debenture was amended and restated to bear interest at 6% per annum, eliminate the
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Company’s right under certain circumstances to force a conversion of the principal into shares of Toreador common stock and eliminate the Company’s ability to repay principal prior to maturity. The maturity date remained March 31, 2006. At the holder’s option, the second amended and restated convertible debenture could be converted into Toreador common stock at a conversion price of $6.75 per share. In December 2004, PHD Partners LP converted $675,000 of the second amended and restated debenture into 100,000 shares of our common stock. As a result, at December 31, 2004 the outstanding principal amount of the second amended and restated convertible debenture was approximately $1.5 million. On August 10, 2005, PHD Partners converted $675,000 of the second amended and restated debenture into 100,000 shares of our common stock, resulting in an outstanding principal balance of $810,000 at December 31, 2005. In February 2006, PHD Partners LP converted the $135,000 of the second amended and restated debenture into 19,962 shares of our common stock and in March 2006, PHD Partners converted the remaining balance of $675,000 of the second amended and restated debenture into 100,000 shares of our common stock. Interest payments made to PHD Partners LP were zero, $9,682 and $73,195 in 2007, 2006 and 2005, respectively.
The following table summarizes the principal maturities under our long-term debt arrangements at December 31, 2007, (in thousands):
We were not in compliance with certain financial covenants relating to the loan with the International Finance Corporation. We obtained a waiver through March 8, 2009. Accordingly, the amount is shown in the above table as maturing in accordance with the original terms of the loan facility.
NOTE 8 -
CAPITAL
On March 23, 2007, we closed a $45 million private placement of equity. In the transaction, we issued an aggregate of 2,710,843 shares of common stock to six institutional investors, providing us with $45 million of gross proceeds at closing. We also granted the investors the right to purchase an additional $8.1 million aggregate amount of common stock within the next 30-day period. On April 24, 2007, two of the institutional investors exercised their warrants for an aggregate of 326,104 additional shares of common stock, providing us with approximately $5.4 million of gross proceeds. The net proceeds from the private placement totaled approximately $47 million and were used to help fund our 2007 exploration and development activities.
In connection with the private placement, we entered into a Registration Rights Agreement with the investors. The Registration Rights Agreement provided that we would file a registration statement with the Securities and Exchange Commission covering the resale of the common stock within 60 days after the closing date. If the registration statement was not filed with the Securities and Exchange Commission within such time, we had to pay 1.0% of the aggregate purchase price, an additional 1.0% on the one month anniversary of the 60th day after closing if the registration statement had not been filed by such date and an additional 2.0% of the aggregate purchase price for each 30 day period after the one month anniversary if the registration statement was not filed by such date. We filed the registration statement with the Securities and Exchange Commission on May 8, 2007. If the registration statement was not declared effective by the Securities and Exchange Commission within 150 days after the closing date, we had to pay 1.0% of the aggregate purchase price, an additional 1.0% on the one month anniversary of the 150th day after the closing if the registration statement had not been declared effective by the Securities and Exchange Commission by such date and an additional 2.0% of the aggregate purchase price for each 30 day period after the one month anniversary if the registration statement was not declared effective by such date. The registration statement was declared effective July 26, 2007. Now that the registration statement has been declared effective by the Securities and Exchange Commission, if, subject to certain exceptions, future sales cannot be made pursuant to the registration statement after 60 days has elapsed, we must pay 1.0% of the aggregate purchase price on the date sales cannot be made pursuant to the registration statement, an additional 1% on the one month
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
anniversary of the date sales are not permitted under the registration statement if sales are not permitted under the registration statement by such date and an additional 2.0% of the aggregate purchase price for each 30 day period after the one month anniversary if sales under the registration statement are not permitted by such date. Any one month or 30 day periods during which we cure the violation will cause the payment for such period to be made on a pro rata basis. As a result of the change in the resale restrictions under Rule 144, effective February 15, 2008, we amended the Registration Rights Agreement to provide that we do not have to keep the registration statement effective if the holders of the shares covered by the Registration Rights Agreement can sell all of the shares pursuant to Rule 144.
The Company accounts for registration rights agreements containing a contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, in accordance with EITF Issue No. 00-19-2, “Accounting for Registration Payment Arrangements”. Under this approach, the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement shall be recognized and measured separately in accordance with “FAS No. 5, Accounting for Contingencies” and “FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss”.
Toreador had zero and 72,000 shares of nonvoting Series A-1 Convertible Preferred Stock outstanding at December 31, 2007 and 2006. At the option of the holder, the Series A-1 Convertible Preferred Stock may be converted into common shares at a price of $4.00 per common share (conversion would have amounted to 450,000 Toreador common shares at December 31, 2007). The Series A-1 Convertible Preferred Stock accrued dividends at an annual rate of $2.25 per share payable quarterly in cash. At any time on or after November 1, 2007, we had the right to redeem for cash any or all shares of Series A-1 Convertible Preferred Stock. The optional redemption price per share was the sum of (1) $25.00 per share of the Series A-1 Convertible Preferred Stock plus (2) any accrued unpaid dividends, and such sum is multiplied by a declining multiplier. The multiplier is 105% until October 31, 2008, 104% until October 31, 2009, 103% until October 31, 2010, 102% until October 31, 2011, 101% until October 31, 2012, and 100% thereafter. In December 2007, all the Series A-1 Convertible Preferred Stock was converted into common shares.
On February 22, 2005, 82,000 shares of our Series A-1 Convertible Preferred Stock were exchanged for an aggregate of 512,500 shares of Toreador common stock pursuant to an offer made by the Company to each holder of its Series A-1 Convertible Preferred Stock. Each holder was given the opportunity to convert such shares of Preferred Stock into shares of common stock of the Company pursuant to the terms of conversion of the Preferred Stock. In addition the Company offered additional shares of common stock as an inducement for the holders to convert the Preferred Stock at a time when the Company could not mandatorily redeem the Preferred Stock and in lieu of dividends that would otherwise accrue until such mandatory redemption date to the terms thereof and an additional 20,164 shares of our common stock which were issued as an inducement to convert such shares of Series A-1 Convertible Preferred Stock. Fair market value of common stock on the date of issue was $24.70 per share.
On July 22, 2004, we issued warrants for the purchase of 40,000 shares of our common stock at $8.20 per share. The warrant was issued pursuant to the terms of the letter agreement dated July 19, 2004. At December 31, 2006 there were 36,400 warrants outstanding all of which expire July 22, 2009. We recognized $58,410 in expense relating to the issuance of the warrants.
On July 11, 2005, we issued warrants for the purchase of 50,000 shares of our common stock at $27.40 per share. The warrant was issued pursuant to the terms of the Fee Letter, dated February 21, 2005, between the Company, Natexis Banques Populaires and Madison Energy France. At December 31, 2006 all 50,000 warrants were outstanding and expire on December 23, 2009. In 2005 and 2006, we recognized $836,000 in expense relating to the issuance of the warrants.
On January 3, 2006, we issued warrants for the purchase of 10,000 shares of our common stock at $27.65 per share. The warrant was issued pursuant to the terms of the Engagement Letter, dated January 3, 2006, between the
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Company and ParCon Consulting. At December 31, 2006 all 10,000 warrants were outstanding and expire on January 3, 2011. We recognized $106,800 in expense relating to the issuance of the warrants.
On February 16, 2005, we sold 1,437,500 shares of our common stock pursuant to a public offering at a price to the public of $24.25 per share. The sale resulted in net proceeds of approximately $32.3 million.
On September 16, 2005, we sold 806,450 shares of our common stock to certain accredited investors pursuant to a private placement. The sale resulted in net proceeds of approximately $23.6 million.
NOTE 9 -
INCOME TAXES
The Company’s provision (benefit) for income taxes consists of the following at December 31:
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The primary reasons for the difference between tax expense at the statutory federal income tax rate and our provision for income taxes were:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2007 and 2006 were as follows:
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2007, Toreador had the following carryforwards available to reduce future taxable income (in thousands):
Realization of net operating loss carryforwards depends on our ability to generate taxable income within the carryforward period. Due to uncertainty related to the Company’s ability to generate taxable income in the respective countries sufficient to realize all of our deferred tax assets we have recorded the following valuation allowances:
Future net operating loss carryforwards for which a valuation allowance has been provided will be realized when taxable income amounts below are generated in the following countries:
A portion of the Hungarian net operating loss was acquired in a purchase, therefore realization of $25 million of the Hungarian net operating loss will be credited to oil and natural gas properties rather than a credit to income tax expense.
Under APB 23, we have elected to treat our foreign earnings as permanently reinvested outside the US and are not providing US tax expense on those earnings. However, Romania has a US branch which is not permanently reinvested outside the US. Consequently the US tax on its earnings is reflected in consolidated income tax expense at the US tax rate of 34%.
We adopted FIN No. 48, “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. As a result of the adoption the Company recognized an increase in the liability for unrecognized tax benefits of approximately $45,000, which was accounted for as a decrease to the January 1, 2007 balance of retained earnings. As of the date of adoption and after the impact of recognizing the increase in liability noted above, our unrecognized tax benefits totaled approximately $357,000, the disallowance of which would not materially affect the effective income tax rate. There are no tax positions for which a material change in the unrecognized tax benefit liability is reasonably possible in the next 12 months.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
We recognize potential accrued interest and penalties related to unrecognized tax benefits within our global operations in income tax expense. In conjunction with the adoption of FIN 48, we recognized approximately $28,000 for the accrual of interest and penalties at January 1, 2007 which is included as a component of $357,000 unrecognized tax benefit noted above. During the year 2007 we recognized $22,000 in potential interest and penalties associated with uncertain tax positions. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
The following table summarizes the changes in our liability for unrecognized tax benefits for the year ended December 31, 2007:
We have not paid any significant interest or penalties associated with our income taxes, but classify both interest expense and penalties as part of our income tax expense. We have no certainty as to when the unrecognized tax benefits will become due.
The Company files several state and foreign tax returns, many of which remain open for examination for five years.
NOTE 10 -
BENEFIT PLANS
We have a 401(k) retirement savings plan. Employees are eligible to defer portions of their salaries, limited by Internal Revenue Service regulations. The Company is subject to the 3% safe harbor rule and contributed $115,000 in 2007. Discretionary employer matches are determined annually by the board of directors and such discretionary matches amounted to $112,500 in 2007, $74,000 in 2006 and $52,000 in 2005.
NOTE 11 -
STOCK COMPENSATION PLANS
We have granted stock options to key employees and outside directors of Toreador as described below.
In May 1990, we adopted the 1990 Stock Option Plan (“1990 Plan”). The 1990 Plan, as amended and restated, provides for grants of up to 1,000,000 stock options to employees and directors at exercise prices greater than or equal to market on the date of the grant.
In December 2001, we adopted the 2002 Stock Option Plan (“2002 Plan”). The 2002 Plan provides for grants of up to 500,000 stock options to employees and outside directors at exercise prices greater than or equal to market on the date of the grant.
In September 1994, we adopted the 1994 Non-employee Director Stock Option Plan (“1994 Plan”). The 1994 Plan, as amended and restated, provides for grants of up to 500,000 stock options to non-employee directors of Toreador at exercise prices greater than or equal to market on the date of the grant.
The Board of Directors grants options under our plans periodically. Generally, option grants are exercisable in equal increments over a three-year period, and have a maximum term of 10 years. However, the 2004 stock grants were immediately vested.
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
A summary of stock option transactions is as follows:
The intrinsic value of the options exercised in 2007 was $5.3 million. For the year ended December 31, 2007, 2006 and 2005 we received cash from stock option exercises of $1.6 million $866,000 and $2.6 million, respectively and the Company recognized a tax benefit related to exercises of stock options of $0 in 2007, $293,000 in 2006 and $2.5 million in 2005. During 2007, 3,334 shares vested having a fair value on the date of vesting of approximately $45,380. As of December 31, 2007, the total compensation cost related to nonvested stock options not yet recognized is approximately $18,685. This amount will be recognized as compensation expense over the next 5 months.
For stock options granted the following table represents the weighted-average exercise prices and the weighted-average fair value based upon whether or not the exercise price of the option was greater than, less than or equal to the market price of the stock on the grant date:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information about the fixed price stock options outstanding at December 31, 2007:
At December 31, 2007, there were 120,208, remaining shares available for grant under the plans collectively.
In May 2005, stockholders approved the Toreador Resources Corporation 2005 Long-Term Incentive Plan (the “Plan”). The Plan, as amended, authorizes the issuance of up to 750,000 shares of the Company’s common stock to key employees, key consultants and outside directors of the Company. The Board of Directors has authorized a total of 328,385 shares of restricted stock be granted to employees and non-employee directors. The compensation cost is measured by the difference between the quoted market price of the stock at the date of grant and the price, if any, to be paid by an employee and is recognized as expense over the period the recipient performs related services. The restricted stock grants vest over a one to four year period depending on the grant and the average price of the stock on the date of the grants was $24.53 for the year ended December 31, 2007. Stock compensation expense of $3.9 million and $2.7 million is included in the Statement of Operations for the years ended December 31, 2007 and 2006, which represents the cost recognized from the date of the grants through December 31, 2007 and 2006. During 2007, 168,633 shares vested having a fair value of approximately $3.4 million on the date of vesting. As of December 31, 2007, the total compensation cost related to nonvested restricted stock grants not yet recognized is approximately $4.1 million. This amount will be recognized as compensation expense over the next 29 months.
In January 2007, 55,900 shares of restricted stock grants awarded to the former President and CEO, were immediately vested and resulted in an expense of $1.1 million.
For the years ended December 31, 2007 and 2006 we recognized a current tax benefit related to restricted stock grants of approximately $0 and $362,000 and a deferred tax benefit of approximately $1.3 million and $561,000, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes the changes in outstanding restricted stock grants along with their related grant-date fair values for the year ended December 31, 2007:
NOTE 12 -
COMMITMENTS AND CONTINGENCIES
We lease our office space under non-cancelable operating leases, expiring during 2008 through 2014. We also subleased portions of the leased space to one related party and two unrelated parties under non-cancelable sub-leases which expired on June 30, 2006. The following is a schedule of minimum future rentals under our non-cancelable operating leases as of December 31, 2007 (in thousands):
Net rent expense totaled $828,590 in 2007, $699,000 in 2006 and $354,000 in 2005.
In conjunction with FIN 48, we have no certainty as to when the unrecognized tax benefits of $326,000 will become due.
Black Sea Incidents. In October 2005, in an incident involving a vessel owned by Micoperi Srl, the Ayazli 2 and Ayazli 3 wells were damaged, and subsequently had to be re-drilled. We and our co-venturers have made a claim in respect of the cost of re-drilling and repeating flow-testing. The claim is currently approximately 8.2 million Euros, valued at $12.7 million before interest, subject to adjustment when the actual cost of flow-testing the re-drilled wells is known. In addition, we and our co-venturers have claimed to recover back from Micoperi a sum of about 5.9 million Euros, currently valued at $8.7 million, paid to Micoperi under the contract between us, our co-venturers and Micoperi. Micoperi has made a cross-claim for about 5.1 million Euros, currently valued at $7.5 million in respect of sums allegedly due to Micoperi under the contract between us, our co-venturers and Micoperi. Micoperi has also asserted a claim that the arrest of the vessel “MICOPERI 30” at Palermo, Italy was wrongful and have asserted a claim for damages in respect of such allegedly wrongful arrest. We and our co-ventures have received security from Micoperi by way of a letter of undertaking from their insurers, and have provided security to Micoperi in respect of their cross-claims by way of a bank guarantee of 5.9 million Euros, currently valued at $8.7 million.. The claims and cross-claims are subject to the jurisdiction of the English Court; however, neither side has yet commenced any court proceedings. All the amounts stated above are gross and our share would be equal to 36.75%. We have accrued our portion of the unpaid invoices and are accounting for the potential receivable from Micoperi as a gain contingency. Accordingly, the potential gain has not been recorded.
David M. Drewer. On March 12, 2008, we agreed in principle to make a payment of $97,500 to the J&D Madison Foundation, a private charitable foundation managed by David Brewer, one of our directors, in settlement
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of claims he made against the Company arising from an alleged prior agreement by G. Thomas Graves III, the former President and Chief Executive Officer, to pay him $150,000 per year for three years as a consulting fee. We are working on finalizing a release agreement with Mr. Brewer. In 2007, Mr. Brewer brought to the attention of the Company correspondence from Mr. Graves in which, on behalf of the Company, Mr. Graves had promised to provide Mr. Brewer with certain consulting payments that had been previously agreed to by Mr. Graves in connection with the acquisition of Madison Oil Company, but never paid. In this letter, Mr. Graves stated that there was an oral, binding commitment of the Company to pay these amounts to Mr. Brewer. Mr. Brewer presented the letter to the Company and requested payments pursuant to this correspondence. Upon receiving a copy of this correspondence, certain members of the Board of Directors discussed with Mr. Brewer the facts giving rise to this request for payments and asked certain members of the Audit Committee of the Company to review this matter further, whereupon these certain members of the Audit Committee hired special counsel to assist them in the review and provide them with advice. These members of the Audit Committee determined that there were questions regarding this commitment to pay (including a failure to obtain approval from the Board of Directors for any such payment) and there were valid reasons not to pay these amounts to Mr. Brewer. Subsequently, on February 11, 2008, counsel to Mr. Brewer sent a demand letter to the Company requesting payment of these amounts. The Board of Directors discussed this matter and determined that it was in the best interests of the Company and its stockholders to compromise and settle this matter with Mr. Brewer, whereupon the settlement amount was agreed to in exchange for a release by Mr. Brewer of all claims against the Company and for him stepping down as Chairman of the Nominating and Corporate Governance Committee. In connection with this settlement, the Company does not admit that these amounts are owing or that Mr. Brewer has a valid claim for these consulting fees. Mr. Brewer and his father, both of whom are directors, did not participate in the Board of Directors approval of this settlement. Mr. Brewer has indicated that these funds will be distributed by the foundation for educational, medical research or social welfare purposes.
From time to time, we are named as a defendant in other legal proceedings arising in the normal course of business. In our opinion, the final judgment or settlement, if any, which may be awarded with any suit or claim would not have a material adverse effect on our financial position.
NOTE 13 -
RELATED PARTY TRANSACTIONS
William I. Lee (deceased), was a former director of the Company and the majority owner of Wilco Properties, Inc (“Wilco”). The Company subleased office space to Wilco pursuant to a sub-lease agreement that expired on July 1, 2007. We recorded reductions to rent expense totaling $25,000 in 2007, $50,000 in 2006 and $48,000 in 2005 related to the sublease with Wilco. We had an informal agreement with Wilco under which one of the two companies incurred, on behalf of the other, certain miscellaneous expenses that are subsequently reimbursed by the other company. We had amounts receivable related to this arrangement of zero, zero and $146 at December 31, 2007, 2006 and 2005, respectively.
On November 1, 2002, pursuant to a private placement we issued $925,000 of Series A-1 Convertible Preferred Stock to certain of our directors or entities controlled by certain of our directors. In connection with the securities purchase agreements, Toreador entered into a registration rights agreement effective November 1, 2002, among Toreador and the purchasers which provided for the registration of the common stock issuable upon conversion of the Series A-1 Convertible Preferred Stock. During 2003, pursuant to private placements we issued 41,000 shares of our Series A-1 Convertible Preferred Stock for the total amount of $1,025,000 to William I. Lee and Wilco as follows: (i) in October 2003, 34,000 shares were issued to William I. Lee and Wilco, an entity controlled by Mr. Lee; and (ii) in December 2003, 7,000 shares were issued to Wilco. The Series A-1 Convertible Preferred Stock was governed by a certificate of designation. The Series A-1 Convertible Preferred Stock was sold for a face value of $25.00 per share, and paid an annual cash dividend of $2.25 per share that result in an annual yield of 9.0%. At the option of the holder, the Series A-1 Convertible Preferred Stock could be converted into common shares at a price of $4.00 per common share. The $4.00 conversion price was higher than the market price of our common stock at the time of issuances. The Series A-1 Convertible Preferred Stock was redeemable at our option, in whole or in part, at
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
any time on or after November 1, 2007. The optional redemption price per share was the sum of (1) $25.00 per share of the Series A-1 Convertible Preferred Stock plus (2) any accrued unpaid dividends, and such sum is multiplied by a declining multiplier. The multiplier was 105% until October 31, 2008, 104% until October 31, 2009, 103% until October 31, 2010, 102% until October 31, 2011, 101% until October 31, 2012, and 100% thereafter. In connection with the securities purchase agreements entered into with William I. Lee and Wilco, Toreador granted certain “piggy-back” registration rights relating to the common stock issuable upon conversion of the Series A-1 Convertible Preferred Stock. The sale of the Series A-1 Convertible Preferred Stock was effected in reliance upon the exemption from securities registration afforded by the provisions of Section 4(2) of the Securities Act of 1933, as amended, and Regulation D as promulgated by the Securities and Exchange Commission under the Securities Act of 1933, as amended. In December 2007, all the Series A-1 Convertible Preferred Stock was converted into common shares.
NOTE 14 -
DISCONTINUED OPERATIONS
On June 14, 2007, the Board of Directors authorized management to sell all oil and gas properties in the United States. The sale of these properties completed the divestiture of the company’s non-core domestic assets and allows us to focus exclusively on our international operations. The sale was closed on September 1, 2007. The sales price was $19.1 million which resulted in a pre-tax gain of $9.2 million. Prior year financial statements for 2006 and 2005 have been adjusted to present the operations of the U.S. properties as a discontinued operation. The assets and liabilities of the discontinued operations are presented separately under the captions “Oil and gas properties held for resale” and “Asset retirement obligations, oil and gas properties held for sale” respectively, in the Balance Sheet as of December 31, 2006. The table below compares discontinued operations for the year ended December 31, 2007, 2006 and 2005:
NOTE 15 -
INFORMATION ABOUT OIL AND NATURAL GAS PRODUCING ACTIVITIES AND OPERATING SEGMENTS
We have operations in only one industry segment, the oil and natural gas exploration and production industry. We are structured along geographic operating segments or regions. As a result, we have reportable operations in the United States (Corporate Headquarters), Western Europe (France) and Eastern Europe (Hungary, Romania and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Turkey). Geographic operating segment income tax expenses have been determined based on statutory rates existing in the various tax jurisdictions where we have oil and natural gas producing activities.
We allocate a portion of certain United States based employees salaries to our foreign subsidiaries. The amount allocated is based on an estimate of the time that employee has spent working on that on that subsidiary. We periodically review these percentages to make sure that our assumptions are valid.
The following tables provide the geographic operating segment data required by Statement of Financial Accounting Standards No. 131, “Disclosure about Segments of an Enterprise and Related Information”. The United States segment data for the years ended December 31, 2007, 2006, and 2005 has been adjusted to reflect the sale of oil and natural gas properties in the United States as of September 1, 2007 (see Note 15).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
TOREADOR RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1)
Amounts reflect reclassifications to discontinued operations.
The following table reconciles the total assets for reportable segments to consolidated assets.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 16 -
Subsequent Event
On February 20, 2008 we entered into the following commodity derivative contracts with Total Oil Trading SA:
NOTE 17 -
SUPPLEMENTAL OIL AND NATURAL GAS RESERVES AND STANDARDIZED MEASURE INFORMATION (UNAUDITED)
We retain an independent engineering firm to provide annual year-end estimates of our future net recoverable oil and natural gas reserves. Estimated proved net recoverable reserves we have shown below include only those quantities that we can expect to be commercially recoverable at prices and costs in effect at the balance sheet dates under existing regulatory practices and with conventional equipment and operating methods. Proved developed reserves represent only those reserves that we may recover through existing wells. Proved undeveloped reserves include those reserves that we may recover from new wells on undrilled acreage or from existing wells on which we must make a relatively major expenditure for recompletion or secondary recovery operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Discounted future cash flow estimates like those shown below are not intended to represent estimates of the fair value of oil and natural gas properties. Estimates of fair value should also consider probable reserves, anticipated future oil and natural gas prices, interest rates, changes in development and production costs and risks associated with future production. Because of these and other considerations, any estimate of fair value is necessarily subjective and imprecise.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
We have summarized the standardized measure of discounted future net cash flows related to our proved oil and natural gas reserves. We have based the following summary on a valuation of proved reserves using discounted cash flows based on year-end prices, costs and economic conditions and a 10% discount rate. The additions to proved reserves from purchase of reserves in place and new discoveries and extensions could vary significantly from year to year; additionally, the impact of changes to reflect current prices and costs of proved reserves in prior years could also be significant. Accordingly, investors should not view the information presented below as an estimate of the fair value of our oil and natural gas properties, nor should investors consider the information indicative of any trends.
The prices of oil and natural gas at December 31, 2007, 2006, and 2005 used in the table shown below, were $95.72, $57.75 and $56.24 per Bbl of oil, respectively, and $8.91, $6.98 and $5.99 per Mcf of natural gas, respectively
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following are the principal sources of change in the standardized measure: