Item 1. Business, Operations, Budong-Budong, Onshore Indonesia - Drilling and Development Activity and Block 64 EPSA, Oman - Drilling and Development Activity.
The increase in general and administrative costs in the year ended December 31, 2012 from the year ended December 31, 2011, was primarily due to increases in employee related costs ($3.3 million, of which $2.2 million was non-cash related to equity compensation), public relations ($0.1 million) and audit fees ($2.0 million) offset by a decrease in general office expense and overhead ($0.4 million), contract services ($0.2 million) and travel costs ($0.2 million).
The decrease in investment earnings and other in the year ended December 31, 2012 from the year ended December 31, 2011 was due to the receipt during the year ended December 31, 2011 of payment for transition services provided on the Antelope Project after closing of the sale.
The decrease in unrealized gain on warrant derivatives in the year ended December 31, 2012 from the year ended December 31, 2011 was due to the change in fair value for our warrant derivative liabilities: $3.18 per warrant at December 31, 2012 and $3.04 per warrant at December 31, 2011.
The decrease in interest expense in the year ended December 31, 2012 from the year ended December 31, 2011 was due to the conversion of $31.5 million of our 8.25 percent senior convertible notes in the year ended December 31, 2012, offset by our $79.8 million senior unsecure note offering in October 2012, repayment in May 2011 of our $60 million term loan facility, and interest capitalized to oil and gas properties of $3.0 million.
During the year ended December 31, 2012, we incurred debt conversion expense of $2.9 million related to the issuance of 0.4 million common shares issued as an inducement for completing the exchange and legal and other professional fees ($0.7 million).
During the year ended December 31, 2012, we incurred a loss on extinguishment of debt of $5.4 million related to the early conversion of our 8.25 percent senior convertible notes. The loss on extinguishment of debt includes the difference between the carrying value of the 8.25 percent senior convertible notes and the amount received for the 11 percent senior unsecured notes ($5.0 million), expensing of deferred financing costs related to the 8.25 percent senior convertible notes ($0.1 million) and issuance of 30,000 shares of Harvest common stock issued in exchange for a waiver agreement ($0.3 million). During the year ended December 31, 2011, we incurred a loss on extinguishment of debt related to early payment of our $60 million term loan facility. The loss on extinguishment of debt includes the write off of the discount on debt ($10.6 million), prepayment premium of 3.5 percent of the amount outstanding ($2.1 million), expensing of financing costs related to the term loan facility ($0.4 million), and the cost to redeem 4.4 million unvested warrants issued in connection with the term loan facility.
The loss on exchange rates for the year ended December 31, 2012 was consistent with the year ended December 31, 2011.
The increase in other non-operating expense in the year ended December 31, 2012 from the year ended December 31, 2011 was due to costs incurred related to our strategic alternative process and evaluation which resulted in the SPA for the sale of our 32 percent interest in Petrodelta.
The change in income tax expense in the year ended December 31, 2012 from the year ended December 31, 2011 is due to a net operating loss incurred in 2012 while we had taxable income in 2011 as a result of the sale of interest in the Antelope Project.
Equity in Earnings from Equity Affiliates
For the year ended December 31, 2012, net income from equity affiliates reflects an increase in Petrodelta’s revenue from oil sales due to higher sales volumes ($170.8 million) offset by lower prices ($29.6 million). Royalties, which is a function of revenue, increased $49.0 million due to the increase in revenue (net increase in revenue of $141.2 million at 30 percent royalty). Windfall Profits Tax, which is a function of volume and price received per barrel, increased $53.8 million due to an increase in volumes (2012: 13.2 MBls vs.
2011: 11.4 MBls) offset by lower price received per barrel (2012: $95.91 per barrel vs. 2011: $98.52 per barrel). The increase in operating expense in the year ended December 31, 2012 from the year ended December 31, 2011 was due to increased oil production and also includes $3.8 million of additional expense related to the labor law which was recorded in December 2012. The decrease in workover expense in the year ended December 31, 2012 from the year ended December 31, 2011 was due to fewer workovers being performed. Petrodelta’s effective tax rate (inclusive of the adjustments to reconcile to reported net income from equity affiliate) for the year ended December 31, 2012 was not materially different with the effective tax rate for the year ended December 31, 2011.
Discontinued Operations
On May 17, 2011, we closed the transaction to sell the Antelope Project. The sale had an effective date of March 1, 2011. We received cash proceeds of approximately $217.8 million which reflects increases to the purchase price for customary adjustments and deductions for transaction related costs. We do not have any continuing involvement with the Antelope Project. The related gain on the sale was reported in discontinued operations in the second quarter of 2011.
During the year ended December 31, 2012, we incurred $0.1 million of expense related to settlement of royalty payments to the Mineral Management Services and write-offs of $5.2 million of accounts and note receivable and $3.6 million of accounts payable and carry obligation related to the settlement of all outstanding claims with a private third party on the Antelope Project. See Item 15. Exhibits and Financial Statement Schedules, Notes to Consolidated Financial Statements, Note 3 - Summary of Significant Accounting Policies, Notes Receivable.
Revenue and net loss on the disposition of the Antelope Project are shown in the table below:
Years Ended December 31, 2011 and 2010
We reported net income attributable to Harvest of $56.0 million, or $1.64 diluted earnings per share, for the year ended December 31, 2011, compared with net income attributable to Harvest of $14.4 million, or $0.39 diluted earnings per share, for the year ended December 31, 2010.
Total expenses and other non-operating (income) expense (in millions):
Our accounting method for oil and gas properties is the successful efforts method. During the year ended December 31, 2011, we incurred $10.1 million of exploration costs for the acquisition, processing and reprocessing of seismic data related to ongoing operations, $0.3 million related to other general business development activities, and $2.2 million related to lease maintenance. During the year ended December 31, 2010, we incurred $6.4 million of exploration costs for seismic, geological and geophysical, $1.6 million related to other general business development activities and $0.3 million related to lease maintenance. Included in the $6.4 million of exploration costs is the one-time charge of $1.2 million for acquisition of seismic data for the Budong PSC related to our partner in the Budong PSC exercising their option to increase the carry obligation.
During the year ended December 31, 2011, we impaired $3.3 million related to the carrying value of West Bay. During the year ended December 31, 2010, we did not impair any oil and gas properties costs.
During the year ended December 31, 2011, we expensed to dry hole costs $14.0 million related to the drilling of the LG-1 on the Budong PSC, $26.0 million related to the drilling of the KD-1 and KD-1ST on the Budong PSC, $6.9 million related to the drilling of the MFS-1 on Block 64 ESPA and $2.8 million related to the drilling of the AGN-1 on Block 64 EPSA. See Item 1. Business, Operations, Budong-Budong, Onshore Indonesia - Drilling and Development Activity and Block 64 EPSA, Oman - Drilling and Development Activity.
The decrease in general and administrative costs in the year ended December 31, 2011 from the year ended December 31, 2010 was primarily due to lower general office expense and overhead ($2.7 million), employee related costs ($0.9 million) and public relations ($0.3 million) offset by higher travel costs ($0.3 million) and contract services ($0.2 million). The employee related costs include $0.5 million of special consideration bonuses related to the sale of our Antelope Project.
The increase in investment earnings and other in the year ended December 31, 2011 from the year ended December 31, 2010 was due to income earned on transition services provided on the Antelope Project after closing of the sale.
The increase in unrealized gain on warrant derivative in the year ended December 31, 2011 from the year ended December 31, 2010 was due to the change in fair value for our warrant derivative liabilities: $3.04 per warrant at December 31, 2011 and $7.37 weighted average price per warrant at December 31, 2010.
The increase in interest expense in the year ended December 31, 2011 from the year ended December 31, 2010 was due to the interest associated with our $32 million convertible debt offering in February 2010, our $60 million term loan facility occurring in October 2010 and amortization of discount on the term loan facility related to the warrants issued in connection with the $60 million term loan facility offset by interest capitalized to oil and gas properties of $2.3 million.
During the year ended December 31, 2011, we incurred a loss on extinguishment of debt related to early payment of our $60 million term loan facility. The loss on extinguishment of debt includes the write off of the discount on debt ($10.6 million), prepayment premium of 3.5 percent of the amount outstanding ($2.1 million), expensing of financing costs related to the term loan facility ($0.4 million), and the cost to redeem 4.4 million unvested warrants issued in connection with the term loan facility.
The decrease in loss on exchange rates in the year ended December 31, 2011 from the year ended December 31, 2010 is due to the Bolivar/U.S. Dollar currency exchange rate devaluation announced on January 8, 2010. There was no Bolivar/U.S. Dollar exchange rate devaluations in the year ended December 31, 2011.
The decrease in other non-operating expense in the year ended December 31, 2011 from the year ended December 31, 2010 was due to costs incurred related to our strategic alternative process and evaluation which resulted in the sale of our Antelope Project.
The increase in income tax expense in the year ended December 31, 2011 from the year ended December 31, 2010 was due to higher income tax assessed in 2011 in the Netherlands offset by a U.S. tax refund received in 2010.
For the year ended December 31, 2011, net income from equity affiliates reflects an increase in Petrodelta’s revenue from oil sales due to higher sales volumes and prices which was partially offset by
the amended Windfall Profits Tax. The increase in operating expense and workovers in the year ended December 31, 2011 from the year ended December 31, 2010 was due to increased oil production and having a workover rig on location for the full year of 2011. Petrodelta took possession of the workover rig in September 2010 and operated it for only four months in the year ending December 31, 2010. The decrease in gain on exchange rates in the year ended December 31, 2011 from the year ended December 31, 2010 was due to there not being a Bolivar/U.S. Dollar currency exchange rate devaluation during 2011. There was a Bolivar/U.S. Dollar currency exchange rate devaluation announced on January 8, 2010. The decrease in Petrodelta’s effective tax rate (inclusive of the adjustments to reconcile to reported net income from equity affiliate) in the year ended December 31, 2011 from the year ended December 31, 2010 was primarily due to the tax effects of the currency devaluation in 2010 partially offset by an increase in current tax on increased earnings.
At December 31, 2009, we fully impaired the carrying value of our equity investment in Fusion. Accordingly, we did not record net losses incurred by Fusion of $0.2 million ($0.1 million net to our 49 percent interest) in the year ended December 31, 2011 (2010: $2.4 million [$1.2 million net to our 49 percent interest]), as doing so would have caused our equity investment to go into a negative position. However, we have recognized a $1.4 million gain on the sale of Fusion in the year ended December 31, 2011.
Discontinued Operations
On May 17, 2011, we closed the transaction to sell our Antelope Project. The sale had an effective date of March 1, 2011. We received cash proceeds of approximately $217.8 million which reflects increases to the purchase price for customary adjustments and deductions for transaction related costs. We do not have any continuing involvement with the Antelope Project. The related gain on the sale was reported in the second quarter of 2011.
Revenue and net income on discontinued operations for the years ended December 31, 2011 and 2010 are shown in the table below:
Net income from discontinued operations for the year ended December 31, 2011 includes $106.0 million gain on the sale of our Antelope Project, $3.8 million for employee severance and special accomplishment bonuses, and $5.7 million of U.S. income tax related to the sale of our Antelope Project. Severance costs for key employees include 58,000 stock appreciation rights (“SAR”) granted at an exercise price of $4.595 per SAR. These SARs are exercisable by the key employee for up to one year after termination.
Risks, Uncertainties, Capital Resources and Liquidity
Our financial statements for the year ended December 31, 2012 have been prepared under the assumption that we will continue as a going concern. Our independent registered public accounting firm has included in their audit report an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our current capital resources may not be sufficient to support our liquidity requirements through 2013. However, we believe certain cost reduction measures could be put into place which would not jeopardize our operations and future growth plans. In addition, we could delay the discretionary portion of our capital spending to future periods and/or sell or farm down assets as necessary to maintain the liquidity required to run our operations, as warranted. There are no assurances that we will be successful in selling or farming-down our assets.
Our ability to continue as a going concern depends upon the success of our planned exploration and development activities and the ability to secure additional financing as needed to fund our current operations. There can be no guarantee of future capital acquisition, fundraising or exploration success or that we will realize the
value of our unevaluated exploratory well costs. We believe that we will continue to be successful in securing any funds necessary to continue as a going concern. However, our current cash position and our ability to access additional capital may limit our available opportunities or not provide sufficient cash for operations.
We may be able to meet future liquidity needs through the issuance of additional equity securities, and/or short or long-term debt financing, although there can be no assurance that such financing will be available to us or on terms that are acceptable to us, farm-downs or possible sales of assets.
The long-term continuation of our business plan through 2013 and beyond is dependent upon the generation of sufficient cash flow to offset expenses. We will be required to obtain additional funding through public or private financing, farm-downs, further reduce operating costs, and/or possible sales of assets. Failure to generate sufficient cash flow by raising additional capital through debt or equity financings, reducing operating costs, or by farm-downs and/or selling of assets further could have a material adverse effect on our ability to meet our short- and long-term liquidity needs and achieve our intended long-term business objectives.
The oil and gas industry is a highly capital intensive and cyclical business with unique operating and financial risks. In Item 1A.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Effects of Changing Prices, Foreign Exchange Rates and Inflation above.
Item 8. Financial Statements and Supplementary Data
The information required by this item is included herein on pages S-1 through S-68.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We have established disclosure controls and procedures that are designed to ensure the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Management of the Company, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures. Based on their evaluation as of December 31, 2012, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective because of the material weaknesses in our internal control over financial reporting described below. Notwithstanding this determination, our management concluded that the consolidated financial statements (as restated for 2010 and 2011) in this Annual Report on Form 10-K fairly present, in all material respects, our financial position and results of operations and cash flows as of the dates and for the periods presented, in conformity with accounting principles generally accepted in the United States of America (“USGAAP”).
Management’s Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f). Internal control over financial reporting is defined as a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officer’s, or persons performing similar functions, and effected by the Company’s board of directors, management, and other personnel, to provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures which (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company, (b) 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 are being made only in accordance with authorizations of management and the board of directors, and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of The Treadway Commission. Based on our evaluation under the Internal Control Integrated Framework, our management concluded that our internal control over financial reporting was not effective as of December 31, 2012 as a result of material weaknesses described below.
Sufficient Complement of Accounting and Financial Reporting Resources
In certain areas, we did not maintain a sufficient complement of resources with an appropriate level of accounting knowledge, experience and training commensurate with our financial reporting requirements. This limited our ability, in certain areas, to ensure the necessary consistent communication, reinforcement, and application of accounting policies to make appropriate accounting and disclosure decisions. This material weakness contributed to the material weaknesses set forth below.
Accounting for Certain Transactions for Oil and Gas Properties
We did not maintain effective internal control over the accuracy, valuation and application of USGAAP related to capitalization, classification, and impairment of certain costs related to oil and gas properties. Specifically, effective controls were not designed or effectively operating to review the nature and classification of costs to be capitalized to oil and gas properties which impacts the accurate calculation of oil and gas property impairments. This control deficiency resulted in the misstatement of oil and gas properties, exploration expense, and related financial statement disclosures.
Accounting for Income Taxes
We did not maintain effective controls over the completeness, accuracy, presentation and disclosure of our accounting for income taxes, including income tax expense and income tax assets and liabilities. Specifically, we did not maintain effective controls to (1) document our analysis, considerations and evaluation of relevant facts related to our accounting judgments for income taxes, (2) account for uncertain tax positions, and (3) ensure appropriate recording and presentation of our net operating losses and associated valuation allowance and related footnote disclosures. This control deficiency resulted in the misstatement of income tax expense, deferred tax assets, our valuation allowance, related financial statement disclosures, and our financial statement schedule.
Financial Reporting Process
We did not maintain effective internal control over certain of our financial close and reporting processes because of the following material weaknesses:
(a) We did not maintain effective controls over segregation of duties related to certain system access rights and the recording and review of journal entries for validity, accuracy, and completeness for substantially all significant accounts. Specifically, certain individuals have incompatible access rights within key IT systems and certain accounting personnel have the ability to prepare and post journal entries without an independent review that is designed with sufficient rigor and precision to prevent or detect an error.
(b) We did not maintain effective controls over the preparation and review of certain classification and disclosure matters impacting the financial statements and related notes. Specifically, controls are not designed and operating effectively to accumulate and review all information required to ensure complete, accurate, and proper presentation of the statement of cash flows and financial statement disclosures. This control deficiency resulted in the misstatement of cash provided by or used in investing and operating activities and related financial statement disclosures and the misstatement of segment information.
(c) We did not maintain effective controls over significant and complex debt and equity transactions. Specifically, controls were not designed and operating effectively to ensure completeness and accuracy over the identification, evaluation, analysis and recording of significant and complex debt and equity transactions and the associated financial statement impact. This control deficiency resulted in the misstatement of debt, additional paid-in capital, debt conversion expense, interest expense, unrealized gain (loss) on warrant derivatives, loss on extinguishment of debt and related financial statement disclosures.
Additionally, each of the control deficiencies described above could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements and financial statement schedule that would not be prevented or detected. Certain of these material weaknesses resulted in errors which required the restatement of our annual consolidated financial statements for the years ended December 31, 2010 and 2011 and the unaudited interim consolidated financial statements for all quarters in 2011 and the first three quarters of 2012 and also resulted in recorded audit adjustments for the fourth quarter and annual period ended December 31, 2012.
The effectiveness of our internal control over financial reporting as of December 31, 2012 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Remediation Plan. In response to the identified material weaknesses, our management, with oversight from our Audit Committee will dedicate appropriate resources to remediate the material weaknesses described above. Until the remediation steps set forth below are fully implemented, the material weaknesses described above will continue to exist.
Management is taking the following actions to remediate the material weakness related to oil and gas properties described above:
•
Formalize policies and procedures for the appropriate recording of oil and gas property transactions.
•
Train the accounting staff on the above policies and procedures.
•
Establish timely independent review and approval of oil and gas property transactions and schedules.
•
Redesign the controls for the evaluation, analysis, recording and review of oil and gas property transactions.
Management is taking the following actions to remediate the material weakness related to income tax accounting described above:
•
Formalize the policies and procedures for appropriate recording of income taxes.
•
Maintain and update memorandum to reflect the current status of income tax accounting positions and the relevant analysis, considerations and conclusions.
•
Redesign the controls for income taxes to ensure the level of precision and operating effectiveness required by management.
•
Redesign the controls for income taxes to ensure appropriate presentation and disclosure of the associated footnotes and financial statement schedule.
•
Supplement existing resources with additional personnel and additional training.
Management is taking the following actions to remediate the material weaknesses related to our Financial Reporting Process and complement of accounting and financial reporting resources:
•
Implement a sufficiently-designed control that is intended to ensure functions are appropriately segregated and that all journal entries are reviewed by an appropriate person.
•
Modify the system access of individuals with incompatible responsibilities and/or design compensating controls that operate at the appropriate level of precision to address the associated conflict.
•
Redesign the controls for the preparation, execution and review of the cash flow statement and financial statement disclosures.
•
Redesign certain entity-level monitoring controls and certain transaction level controls in order to achieve the level of precision and operating effectiveness required by management.
•
Redesign the controls over significant and complex debt and equity transactions to ensure appropriate identification, evaluation, analysis and recording of such transactions.
•
Supplement our accounting department with additional personnel and provide additional training to our personnel regarding the application of USGAAP.
Inherent Limitations of Internal Controls. Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Changes in Internal Control over Financial Reporting. There have been no changes in internal control over financial reporting during the quarter ended December 31, 2012 that have materially affected or are reasonably likely to materially affect that Company’s internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
DIRECTORS
There are currently seven members of our Board of Directors (the “Board”), each of whom has been nominated for reelection to the Board this year and will stand for election at our annual meeting. Information regarding the business experience of each nominee is provided below. All directors are elected annually to serve until the next annual meeting and until their respective successors are elected.
When considering whether directors and nominees have the experience, qualifications, attributes and skills, taken as a whole, to enable the Board to satisfy its oversight responsibilities effectively in light of the Company’s business and structure, the Nominating and Corporate Governance Committee, which is a Committee of the Board responsible for recommending director candidates to be nominated by the Board, and the Board focused primarily on the information discussed in each of the directors’ individual biographies set forth below.
In particular, with regard to Messrs. Chesebro’, Edmiston, Irelan and Stinson and Dr. Effimoff, the Nominating and Corporate Governance Committee considered their strong backgrounds in the oil and gas sector, believing that their individual experiences at management levels with large multinational corporations engaged in oil and gas exploration and production are invaluable in evaluating the performance of management and other aspects of the Company. The Nominating and Corporate Governance Committee considered Mr. Murray’s individual experiences at management levels with large multinational corporations engaged in oil and gas services as a valuable complement to the experiences of the other directors. Additionally, the Nominating and Corporate Governance Committee considered the engineering education and experiences of Messrs. Chesebro’, Edmiston, Stinson and Irelan and Dr. Effimoff important to understand the goals and challenges of the Company and to effectively advise the direction of the Company in the oil and gas industry. With respect to Messrs. Hardee and Murray, the Nominating and Corporate Governance Committee considered their significant experience, expertise and background with regard to financials and financial and accounting matters and business management. The Nominating and Corporate Governance Committee also considered the broad perspective brought by Mr. Hardee’s and Dr. Effimoff’s experiences in consulting to clients and, with respect to Messrs. Hardee and Murray, serving in directorships in many diverse industries. The Nominating and Corporate Governance Committee also considered the many years of experience with the Company and in the industry represented by Mr. Edmiston, our Chief Executive Officer (“CEO”). Additionally, with respect to Messrs. Chesebro’, Edmiston, Irelan, Murray and Stinson and Dr. Effimoff, the Nominating and Corporate Governance Committee considered their experience in international business vital to the Company’s global strategy. With respect to Mr. Stinson, the Nominating and Corporate Governance Committee believes that his experience in governmental relations on an international level provides valuable insight to assist management in establishing and maintaining their relationships with foreign governments, which is a primary focus of the Company.
Stephen D. Chesebro’
Appointed Director in October 2000
Age
Mr. Chesebro’ has served as the Chairman of the Board of Harvest since 2001. From December 1998 until he retired in 1999, he served as President and Chief exploration and production company that was formerly a business unit of Pennzoil Company. From February 1997 to December 1997, Mr. Chesebro’ served as Group Vice President - Oil and Gas and from December 1997 until December 1998 he served as
President and Chief Operating Officer of Pennzoil Company, an integrated oil and gas company. From 1993 to 1996, Mr. Chesebro’ was Chairman and Chief Executive Officer of Tenneco Energy. Tenneco Energy was part of Tenneco, Inc., a worldwide corporation that owned diversified holdings in six major industries. Mr. Chesebro’ is an advisory director to Preng & Associates, an executive search consulting firm. In 1964, Mr. Chesebro’ graduated from the Colorado School of Mines. He was awarded the school’s Distinguished Achievement Medal in 1991 and received his honorary doctorate from the institution in 1998. He currently serves on the school’s visiting committee for petroleum engineering and is a member of the Colorado School of Mines Foundation Board of Governors. In 1994, Mr. Chesebro’ was the first American awarded the H. E. Jones London Medal by the Institution of Gas Engineers, a British professional association. Since December 2005, he has served as the President of the Chesebro’ Foundation, Inc., a private charitable foundation incorporated in Delaware.
James A. Edmiston
Elected Director in May 2005
Age
Mr. Edmiston was elected President and Chief Executive Officer of Harvest on October 1, 2005. He joined the Company as Executive Vice President and Chief Operating Officer on September 1, 2004. Prior to joining Harvest, Mr. Edmiston was with Conoco and ConocoPhillips for 22 years in various management positions including President, Dubai Petroleum Company (2002-2004), a ConocoPhillips affiliate company in the United Arab Emirates, and General Manager, Petrozuata, C.A., in Puerto La Cruz, Venezuela (1999-2001). Prior to 1999, Mr. Edmiston also served as Vice President and General Manager of Conoco Russia and then as Asset Manager of Conoco’s South Texas Lobo Trend gas operations. Mr. Edmiston earned a Bachelor of Science degree in Petroleum Engineering from Texas Tech University and a Masters of Business Administration from the Fuqua School of Business at Duke University. Mr. Edmiston was inducted into the Petroleum Engineering Academy and was recognized as a Distinguished Engineer by Texas Tech College of Engineering in 2009. Mr. Edmiston is a Member of the Society of Petroleum Engineers.
Dr. Igor Effimoff
Appointed Director in February 2008
Age
Dr. Igor Effimoff is founder and principal of a firm which provides upstream and midstream consulting services since 2005. From 2002 until 2005 he was Chief Operating Officer for Teton Petroleum
Company. Between 1996 and 2001, he was President of Pennzoil Caspian Corporation, managing their interests in the Caspian Region. Between 1994 and 1996 he was the Chief Executive Officer of Larmag Energy, NV, a privately held Dutch oil and gas production company with its primary assets in the Caspian Sea. He has served in senior executive roles with Ashland Exploration Inc., Zilkha Energy Company and Kriti Exploration, Inc. Dr. Effimoff has authored numerous technical and business articles. He is a member of American Association of Petroleum Geology, the Society of Petroleum Engineers, the Society of Exploration Geophysicists and the Geological Society of America. Dr. Effimoff served on the audit and compensation committees of TrueStar Petroleum Corporation in 2007. He currently serves on the board of IPC Oil and Gas Holdings Ltd. He has a Doctorate in Geology from the University of Cincinnati and completed the Harvard Advanced Management Program.
H. H. Hardee
Appointed Director in October 2000
Age 58
Mr. Hardee is a Senior Vice President-Financial Advisor with RBC Wealth Management, since 1994. From 1991 through 1994, Mr. Hardee was a Senior Vice President with Kidder Peabody. From 1977 through 1991, Mr. Hardee was a Senior Vice President at Rotan Mosle/Paine Webber Inc. Mr. Hardee was named as one of America’s best financial advisors for 2009, 2010, 2011 and 2012 by Barron’s financial newspaper and by Reuters AdvicePoint. Furthermore, Mr. Hardee has been recognized by NABCAP, the National Association of Board Certified Advisory Practices, as a Premier Wealth Advisor. He currently advises/manages over $400 million in assets. Mr. Hardee’s expertise is advising high net worth individuals and small to mid-sized corporations. Mr. Hardee is a former director of the Bank of Almeda and Gamma Biologicals. He is also a former limited partner and advisory director of the Houston Rockets of the National Basketball Association. Mr. Hardee has a finance degree from the McCombs School of Business at the University of Texas. He has earned an Accredited Wealth Management designation through the Estate and Wealth Strategies Institute of Michigan State University. Mr. Hardee is a National Association of Corporate Directors (“NACD”) Board Leadership Fellow. He has demonstrated his commitment to boardroom excellence by completing NACD’s comprehensive program of study for corporate directors. He supplements his skill sets through ongoing engagement with the director community and access to leading practices.
Robert E. Irelan
Appointed Director in February 2008
Age 66
Mr. Irelan has over 37 years of experience in the oil and gas industry. He retired from Occidental Petroleum as Executive Vice President of Worldwide Operations in April 2004, having started there in 1998. Prior to Occidental Petroleum, Mr. Irelan held various positions at Conoco, Inc. from 1967 until 1998. Upon his retirement he opened his own company, Naleri Investments LLC. He also partnered in several entrepreneurial ventures including Rapid Retail Solutions LLC, BISS Product Development LLC and All About Baby LLC. Mr. Irelan earned his Professional Engineering degree in Petroleum Engineering from Colorado School of Mines. He also has advanced studies in Mineral Economics. He was awarded the Distinguished Achievement Award from the school in 1998.
Patrick M. Murray
Appointed Director in October 2000
Age
In 2007, Mr. Murray retired from Dresser, Inc. He had been the Chairman of the Board and Chief Executive Officer since 2004. Dresser, Inc. is an energy infrastructure and oilfield products and services company. From 2000 until becoming Chairman of the Board, Mr. Murray served as President and Chief Executive Officer of Dresser, Inc. Mr. Murray was President of Halliburton Company’s Dresser Equipment Group, Inc., Vice President, Strategic Initiatives of Dresser Industries, Inc. and Vice President, Operations of Dresser, Inc. from 1996 to 2000. Mr. Murray has also served as the President of Sperry-Sun Drilling Services from 1988 through 1996. Mr. Murray joined NL Industries in 1973 as a Systems Application Consultant and served in a variety of increasingly senior management positions. Mr. Murray currently serves on the board and audit committee of Precision Drilling Corporation, a publicly-held contract drilling company. Mr. Murray is also on the board of the World Affairs Council of Dallas Fort Worth. He is on the board of advisors for White Deer Energy, the Maguire Energy Institute at the Edwin L. Cox School of Business, Southern Methodist University and a member of the Board of Regents of Seton Hall University. Mr. Murray holds a Bachelor of Science degree in Accounting and a Master of Business Administration from Seton Hall University. He served for two years in the U.S. Army as a commissioned officer.
J. Michael Stinson
Appointed Director in November 2005
Age
From September 2006 to December 2011, Mr. Stinson was Chairman of TORP Terminal LP, the U.S. unit of a Norwegian LNG technology company. From 2004 until November of 2009, he served as a director of Enventure Global Technology, Inc., an oil equipment company, most recently as the Chairman of its Audit and Finance Committee. From January 2005 until November 2009, he was Chairman of the Board of Paulsson Geophysical Services, Inc., a vertical seismic profiling technology company. From February through August 2004, Mr. Stinson served with the U.S. Department of Defense and the Coalition Provisional Authority as Senior Advisor to the Iraqi Ministry of Oil. From 1965 to 2003, Mr. Stinson was with Conoco and ConocoPhillips in a number of assignments in operations and management. His last position at ConocoPhillips was as Senior Vice President, Government Affairs in which he was responsible for government relations with particular emphasis on developing and facilitating international business development opportunities in various countries. Previous positions included Senior Vice President - Business Development, Vice President - Exploration and Production, Chairman and Managing Director of Conoco (UK) Limited, Vice President/General Manager of International Production for Europe, Africa and the Far East and President and Managing Director of Conoco Norway, Inc. Mr. Stinson earned a Bachelor of Science degree in Industrial Engineering from Texas Tech University and a Master of Business Administration from Arizona State University. He is a member of the Society of Petroleum Engineers and the American Association of Petroleum Geologists.
EXECUTIVE OFFICERS
The following table provides information regarding each of our executive officers.
* See Mr. Edmiston’s biography under the section entitled “Directors” above.
Stephen C. Haynes has served as our Vice President, Chief Financial Officer and Treasurer since May 19, 2008. Mr. Haynes performed various financial consulting engagements from January 1, 2008 until his
appointment with Harvest. Previously, he served as Chief Financial Officer for Cygnus Oil and Gas Corporation for the period February 1, 2006 through December 31, 2007. Before joining Cygnus, Mr. Haynes was the Corporate Controller with Carrizo Oil and Gas for the period January 1, 2005 through January 31, 2006. Mr. Haynes served as an independent consultant from March 2001 through end of 2004. From March 1990 through December 2000, Mr. Haynes served in a series of increasing responsibilities in international managerial and executive positions with British Gas, culminating in his appointments as Vice President-Finance of Atlantic LNG, a joint venture of British Gas and several industry partners in Trinidad and Tobago. Mr. Haynes is a Certified Public Accountant, holds a Master of Business Administration degree with a concentration in Finance from the University of Houston and a Bachelor of Business Administration degree in Accounting from Sam Houston State University. He also attended the Executive Development Program at Harvard University.
Keith L. Head has served as our Vice President, General Counsel and Corporate Secretary since May 7, 2007. He joined Texas Eastern upon graduation from law school and remained with the same organization through mergers with Panhandle Eastern, Duke Energy Corporation and Cinergy Corp. Mr. Head held various business development positions with Duke Energy Corporation from 1995 to 2001. His corporate development work included the identification, evaluation and negotiation of acquisitions in Latin America, North America and the United Kingdom. Mr. Head was Senior Vice President and General Counsel at Duke Energy North America from 2001 to 2004 and Associate General Counsel of Duke Energy Corporation from 2004 through December 2006. After leaving Duke Energy, Mr. Head joined Harvest in May 2007. He currently serves on two non-profit boards: MentorCONNECT and the Texas Accountants and Lawyers for the Arts. He is also a board member of the Houston chapter of The General Counsel Forum. Mr. Head holds a Bachelor of Science degree in Business Administration from the University of North Carolina. He received both a Juris Doctorate and Master of Business Administration from the University of Texas in 1983.
Karl L. Nesselrode has served as Vice President, Engineering and Business Development of the Company since November 17, 2003. From August 9, 2007 to August 2, 2010, he accepted a long-term secondment to Petrodelta as its Operations and Technical Manager while remaining an officer of Harvest. From February 2002 until November 2003, Mr. Nesselrode was President of Reserve Insights, LLC, a strategy and management consulting company for oil and gas. He was employed with Anadarko Petroleum Corporation as Manager Minerals and Special Projects from July 2000 to February 2002. Mr. Nesselrode served in various managerial positions with Union Pacific Resources Company from August 1979 to July 2000. Mr. Nesselrode earned a Bachelor of Science in Petroleum Engineering from the University of Tulsa in 1979 and completed the Harvard Business School Program for Management Development in 1995.
Robert Speirs has served as Senior Vice President, Eastern Operations since July of 2011. Prior to his promotion, his title had been Vice President, Eastern Operations since December 6, 2007. He joined Harvest in June 2006 as President and General Manager, Russia. Previously Mr. Speirs was President of Marathon Petroleum Russia and General Director of their wholly-owned subsidiary, KhantyMansciskNefte Gas Geologia from March 2004 through May 2006. Prior to joining Marathon, Mr. Speirs was Executive Vice President of YUKOS EP responsible for engineering and construction from June 2001. During both these periods, Mr. Speirs spent considerable time in West Siberia where he oversaw substantial increases in production at both companies. From November 1997 until March 2001, Mr. Speirs resided in Jakarta where he served as President of Premier Oil Indonesia. During this period, Premier was active in all phases of the Upstream business, culminating in the commissioning of the West Natuna Gas Project. Prior to 1997, Mr. Speirs was with Conoco for 21 years in various leadership positions in the US, UK, Russia, Indonesia, Singapore and Dubai, UAE. Mr. Speirs earned a Bachelor of Science degree with Honors in Engineering Science from the University of Edinburgh. He also attended the Executive Management Program at INSEAD.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act (“Section 16(a)”) requires our directors, executive officers and beneficial holders of more than 10% of our common stock to file reports with the SEC regarding their ownership and changes in ownership of our stock. Based solely upon our review of SEC Forms 3, 4 and 5 and any amendments thereto furnished to us, to our knowledge, during fiscal year 2012, our officers, directors and 10% stockholders complied with all Section 16(a) filing requirements. In making this statement, we have relied upon the written representations of our directors and officers.
CODE OF BUSINESS CONDUCT AND ETHICS
The Board has adopted a Code of Business Conduct and Ethics, which applies to all of our directors, officers and employees. The Board last amended the Code of Business Conduct and Ethics in December 2010. The Board has not granted any waivers to the Code of Business Conduct and Ethics.
The Code of Business Conduct and Ethics is accessible on our website under the Corporate Governance section at http://www.harvestnr.com. Any amendments to or waivers of the Code of Conduct and Business Ethics will also be posted on our website.
AUDIT COMMITTEE
The Board has a standing Audit Committee. The Audit Committee assists the Board in its oversight of: our accounting and financial reporting policies and practices; the integrity of our financial statements; the independent registered public accounting firm’s qualifications, independence and objectivity; the performance of our internal audit function and our independent registered public accounting firm; and our compliance with legal and regulatory requirements. The Audit Committee acts as a liaison between our independent registered public accounting firm and the Board, and it has the sole authority to appoint or replace the independent registered public accounting firm and to approve any non-audit relationship with the independent registered public accounting firm. Our internal auditor and the independent registered public accounting firm report directly to the Audit Committee.
Dr. Effimoff and Messrs. Hardee, Murray and Stinson are members of the Audit Committee. The Board has determined that each member of the Audit Committee meets the independence standards of the SEC’s requirements, the rules of the NYSE and the Company Guidelines for Corporate Governance, which is an internal policy that requires independent directors comprise a majority of the Board and that the Chairman of the Board be elected from the independent directors. No member of the Audit Committee serves on the audit committee of more than three public companies. The Board has further determined that each member of the Audit Committee is financially literate and that Mr. Murray qualifies as an audit committee financial expert, as defined in Item 407(d)(5) of SEC Regulation S-K. Information on the relevant experience of Mr. Murray is set forth above under the section entitled “Directors.”
Item 11. Executive Compensation
COMPENSATION DISCUSSION AND ANALYSIS
Introduction
Harvest’s Compensation Discussion and Analysis describes the Company’s compensation program for the executive officers identified in the Summary Compensation Table. Throughout this proxy statement we refer to these individuals as “named executive officers.” They are James A. Edmiston, President and CEO; Stephen C. Haynes, Vice President, Chief Financial Officer and Treasurer; Robert Speirs, Senior Vice President - Eastern Operations; Karl L. Nesselrode, Vice President - Engineering & Business Development; and Keith L. Head, Vice President - General Counsel and Corporate Secretary.
Summary of Executive Compensation Decisions Made in 2012/2013
During 2012, our executive compensation decisions included:
•
Base salary increases of 1.8% for the CEO and averaging 3.3% for the other named executive officers were effective in March 2012;
•
In addition to individual performance objectives, the Human Resources Committee, which is a Committee of the Board that is responsible for establishing and recommending to the Board all elements of executive and Board compensation (the “HR Committee”), established Company annual incentive performance measures as follows:
•
Total Shareholder Return (weight 60%)
•
Reserve Additions/Production (weight 30%)
•
Social Responsibility and Governance (including safety) (weight 10%)
•
Annual cash incentive awards were paid in February 2013. The CEO received 137% of his target incentive and the other named executive officers also received an average of 137% of their target incentives. This reflects an increase in the annual incentive target for the named executives to 60% of base salary. Since 2008, we have been consistently low for this benchmark. This increase was approved at the February 2013 HR Committee meeting and effective for the 2012 incentive awards.
•
Long-term incentive awards were paid with approximately 30% restricted stock and 70% stock options valued at the closing stock price on May 17, 2012.
During 2013, our executive compensation decisions included:
•
Base salary increases of 3.5% for the CEO and averaging 3.5% for the other named executive officers were effective in March 2013.
Company Overview and Compensation Objectives
As a Company, our focus is on acquiring exploration, development, and producing properties in proven and active hydrocarbon systems. We operate from our Houston, Texas headquarters with regional/technical offices in the United Kingdom and Singapore and field offices in Jakarta, Indonesia; Port Gentil, Gabon; and Muscat, Oman.
In 2012, we achieved the following results:
•
Increased gross production in Venezuela to 13.2 million barrels of oil or an average of 36,979 barrels of oil per day, an increase of 14.7% over 2011;
•
Agreed third production phase with the Republic of Gabon to four years until May 2016.
•
Completed drilling of the Dussafu Tortue well in the fourth quarter of 2012 and announced an oil discovery of approximately 42 feet of pay in the Gamba formation and 123 feet of pay in the Dentale formation.
•
Received a four-year extension by the Indonesian government until January 2017 for the Budong Budong Block and agreed with our partner to assume operatorship of the block.
•
Maintained proved and probable (2P) reserve level from 2011, net of 2012 production.
•
Signed Sales Purchase Agreement with Pertamina, National Oil Company of Indonesia, which set the benchmark price for our Venezuelan Assets.
The following graphs highlight the Company results for 2012:
Note: Annual Net Production and Net Proved and Probable Reserves for 2010 include production and reserves from the Utah asset which were sold in 2011. (MBOE = Thousand Barrels of Oil Equivalent)
The HR Committee has the discretion to exercise their judgment in weighing the achievement of specific performance measures. For 2012, it considered total shareholder return, reserves, social responsibility/governance and safety as well as strategic individual objectives for the named executive officers. Total shareholder return (“TSR”) was up 22.9% in 2012 and the Company remained in the top quartile of its Peer Group over a three-year period from 2010-2012. Proved and probable reserves were down slightly by 4% from the prior year. We calculate TSR as year-end share price minus beginning year share price divided by beginning year share price. Annual net production in 2012 was up 14% over the prior year. Companywide health and safety programs were implemented in 2012. There were no Foreign Corrupt Practices Act (“FCPA”) incidents in 2012. Ethics and compliance guidelines were revised in 2012, and there was one contractor lost time accident in 2012. Given the operational and technical challenges faced by the Company, the Committee determined that the management team effectively managed the exploration assets we controlled and operated during the year.
Compensation Philosophy
Our compensation philosophy is to offer a competitive total compensation package to enable us to attract, motivate and retain key executives. Our compensation objectives include:
•
Offering total compensation that is competitive with the select peer group of globally-focused oil and gas companies with which we compete for executive talent;
•
Providing annual cash incentive awards that take into account performance factors weighted by both corporate and individual goals;
•
Aligning the interest of executive officers and directors with stockholder value creation by providing significant equity-based, long-term incentives; and
•
Providing incentives to executives for achieving challenging corporate goals.
The HR Committee oversees the development and execution of our compensation program. The HR Committee annually reviews our compensation philosophy and tests its ability to promote meeting the objectives stated above. The HR Committee recommends compensation for the named executive officers, short-term cash bonuses, long-term cash and non-cash compensation and submits its recommendations to the Board for approval. Three independent directors comprise the HR Committee. The HR Committee meets as needed, but no less than quarterly to review compensation and benefit programs with management. It subsequently approves any changes. Our Human Resources, Accounting and Legal Department employees handle the day-to-day design and administration of employee compensation and benefit programs available to our employees.
Setting Executive Compensation
Our compensation program consists of several forms of compensation: base salary, annual performance-based incentive awards, long-term incentives and personal benefits. Base salary and annual performance-based incentive awards are generally cash-based. Long-term incentives typically consist of stock options, stock appreciation rights, restricted stock units and/or restricted stock awards. The Committee reviews the compensation recommendations from the CEO and our independent consultants’ advice on competitive trends regarding base salary, annual incentive awards and long-term incentives. The Committee exercises its collective judgment in establishing executive compensation based on performance, compensation history and market information. The recommendations are then made to the full Board for its approval.
The Role of the Compensation Consultant-Compensation Consultant Independence
In 2012, the HR Committee engaged Frost Human Resource Consulting (“Frost HR Consulting”), as the HR Committee’s independent compensation consultant, to benchmark our executive officer compensation levels with similar positions in our industry peer group. The Committee reviews the relationship annually for any conflicts of interest. To ensure Frost HR Consulting’s independence:
•
The HR Committee directly retained and has the authority to terminate Frost HR Consulting.
•
Frost HR Consulting reports directly to the HR Committee and its Chairperson.
•
Frost HR Consulting meets regularly in executive sessions with the HR Committee.
•
Frost HR Consulting has direct access to all members of the HR Committee during and between meetings.
•
Interactions between Frost HR Consulting and management generally are limited to data gathering and discussions regarding information that has or will be presented to the HR Committee.
•
Frost HR Consulting has procedures in place to prevent conflicts of interest.
•
Frost HR Consulting does not have any business or personal relationship with any member of management or the HR Committee.
•
Frost HR Consulting consultants do not own any of our Company stock.
Peer Group and Compensation Surveys
The HR Committee considers market information from compensation surveys and peer company proxy statements when determining compensation for each of the executive officers. In May 2012, the HR Committee reviewed proxy statement data from a peer group of companies. The surveys used for benchmarking included:
•
Towers Watson 2011 Top Management Compensation Survey
•
William M. Mercer 2011 Energy Industry Compensation Survey
•
Effective Compensation Inc.’s (“ECI”) 2011 Oil and Gas Industry Compensation Survey
Each year, the HR Committee reviews the composition of the peer group and the compensation paid at these companies, as well as their corporate performance and other comparative factors in determining the appropriate compensation levels for our executives. No company in our peer group shares our unique risk profile, which is a function of our portfolio of producing assets and exploratory prospects, as well as the regulatory and political environments in which we operate. Therefore, the HR Committee uses its judgment and business experience in addition to the peer group data in determining executive compensation.
The HR Committee selects peer companies for their shared similarities, including a common industry oil exploration focus, assets, market capitalization and enterprise value, among other factors. Revenue at the peer companies ranges from $35 million to $423 million for 2012 versus $405 million for Harvest, which is our 32% interest of gross revenue from oil sales in our unconsolidated affiliate, Petrodelta, S.A. Our peer companies typically compete with us for executive talent. Our current industry peer group consists of the following companies:
• BPZ Resources, Inc.
• GeoResources, Inc. (later in 2012 acquired by Halcón Resources, LLC)
• Carrizo Oil and Gas Inc.
• Halcón Resources, LLC (formerly Ram Energy Resources, Inc.)
• Crimson Exploration Inc.
• Gulfport Energy, Corp.
• Endeavour International Corp.
• Petroleum Development Corp.
• Energy Partners Ltd (now ELP Oil & Gas Inc.)
• PetroQuest Energy, Inc.
• FX Energy, Inc.
• Toreador Resources, Corp. (later in 2012 acquired by ZaZa Energy Corp) and
• Gastar Exploration Ltd
• VAALCO Energy, Inc.
For 2012, Frost HR Consulting benchmarked the 25th, 50th and 75th percentiles for the data sources mentioned above to provide the HR Committee with an understanding of competitive pay practices. These surveys, equally weighted with the proxy data, consider each element of compensation and are collectively referred to as the “market data” throughout this Compensation Discussion and Analysis. Frost HR Consulting also provides the HR Committee with advice on equity incentive compensation trends, including types and value of awards being used by other public companies.
The Role of the Executives in Human Resources Committee Meetings
The HR Committee invites our CEO, Vice President, Administration and Human Resources and Vice President, General Counsel and Corporate Secretary to attend their meetings. The Vice President, Administration and Human Resources acts as the HR Committee Secretary and provides reports on plan administration and human resources policies and programs. The Vice President, General Counsel and Corporate Secretary provides legal advice on human resource matters. The CEO makes recommendations with respect to specific compensation decisions. The HR Committee, without management present, regularly meets in executive session and with its compensation consultant to review executive compensation matters including market data as well as peer group information.
The CEO makes detailed recommendations to the HR Committee on performance evaluations, base salary changes, and both equity and annual incentive-based compensation for executive officers and senior management (other than the CEO). From time to time, the CEO and members of management are invited to participate in HR Committee meetings to provide information regarding our strategic objectives, financial performance and recommendations regarding compensation plans. Management may be asked to prepare information for any HR Committee meeting. Depending on the agenda for a particular meeting, these materials may include:
•
Reports on our strategic objectives;
•
Financial reports;
•
Reports on achievement of individual and corporate performance objectives;
•
Information regarding compensation programs and compensation levels for executive officers, directors and other employees at peer companies;
•
Information on the total compensation of the executive officers, including base salary, cash incentives, equity awards, and other compensation, and any amounts payable to the executive officers upon voluntary or involuntary termination or following a severance with or without a change in control; and
•
Information regarding all annual and equity incentive-based compensation and health and welfare plans.
Executive Compensation Components
Our compensation program components are designed to reward executive officers’ contributions, while considering our specific operating situation and how they manage this situation consistent with our strategy. Factors considered in compensating our executives include individual experience, skill sets that are required for multi-national oil and gas operations and their proven record of performance. It is essential that we recruit and retain executives that understand the risk and complexity of global operations and our unique business strategy. All of our executive officers are mid-to-late career executives who have worked for larger energy companies and have alternatives; they decided to join the Company for the challenge and potential reward of working for a small, entrepreneurial organization.
The principal components of compensation and their purpose for executive officers in 2012 are:
Element
Form of Compensation
Purpose
Base salary
Cash
Provide competitive, fixed
compensation to attract and retain
executive talent
Annual performance based incentive awards
Cash
Create strong financial incentive for
achieving financial and strategic
successes
Long-term incentive compensation
Stock Options, Stock Appreciation Rights (SARs), Restricted Stock Units (RSU) and Restricted Stock Grants
Provides alignment between executive
and shareholder interests by rewarding
executives for performance based on
appreciation in the Company’s share
price and for retaining executives
Personal benefits
Eligibility to participate in plans extends to all employees
Broad-based employee benefits for
health and welfare and retirement
Base Salary
We pay base salaries to our executive officers to compensate them for specific job responsibilities during the calendar year. In determining base salaries for our executive officers, the HR Committee considers market and competitive benchmark data for the executive’s level of responsibility targeting between the 50th and 75th percentile of executive officers in comparable companies, with variation based on individual executive skill sets. Compared to 2011 market data, our base salaries were between 95.6% and 106.2% of the target market median.
For 2012, the HR Committee moved the Company’s salary management review to February from May to better address cash compensation decisions for both salaries and bonuses. Consequently, in March 2012 the CEO received an annualized salary increase for 2012 of 1.8% and the other named executive officers received an average annualized increase of 3.3%. In March 2013, the CEO received an annual salary increase of 3.5% and the other named executive officers each received an annualized increase of 3.5% as well.
Annual Performance-Based Incentive Awards
Each year, in addition to individual performance objectives, the HR Committee establishes Company performance measures for determining annual incentive awards as follows:
•
Total Shareholder Return (weight 60%)
•
Reserve Additions/Production/Estimated Market Value (“EMV”) (weight 30%)
•
Social Responsibility and Governance (including safety) (weight 10%)
These measures and their weightings are reviewed and modified, if appropriate, in light of changing Company priorities and strategic objectives. The corporate targets and weightings are set by the CEO and reviewed and approved by the HR Committee. The HR Committee focuses on these corporate goals in evaluating Company performance for the purpose of compensation. Individual performance results of the named executive officers are measured and assessed by the CEO.
Among these corporate goals, Total Shareholder Return was weighted at 60%. In 2012, the Company realized a Total Shareholder Return of 22.9% placing it in the first quartile among its selected peer group.
Reserves/Production/EMV was weighted at 30%. The primary measurement for this target is year-over-year P2 reserve additions; although 3P and contingent resources are also taken into consideration. For 2012, proved and probable reserves remained essentially flat over 2011, net of 2012 production. However, production increased by 14.7% over 2011 at Petrodelta, our Venezuelan affiliate.
Social Responsibility and Governance was weighted at 10% and is used at the discretion of the CEO and the Committee in deciding the final corporate rating. As expected, there were no violations of our FCPA policies or our Code of Business Conduct and Ethics. One of our contractors did experience a lost time accident in 2012.
Individual performance and operational results were combined with the Company performance results and weighted equally to determine each executive’s final annual incentive award. Target award levels for annual incentives are set at 100% of base salary for the CEO and 60% of base salary for the other named executive officers. For 2012 performance, awarded in February 2013, the CEO received 137% of his bonus target as a performance-based incentive award. The other named executive officers individual awards ranged from 130% to 143% of their bonus targets.
The HR Committee and the Board each determined that management exceeded expectations in meeting the 2012 Company and individual performance targets.
We believe the Company should have the ability to recover compensation paid to executive officers and key employees under certain circumstances. As a result, the HR Committee adopted the following policy statement in 2011:
“In the event the Board of Directors determines that any fraud or intentional misconduct caused or was a substantial contributing factor to a restatement of our financial statements, the Board of Directors may require reimbursement of any annual incentive compensation paid to an executive officer or certain other key employees to the extent the bonus paid exceeded what would have been paid had the financial results been properly reported. This policy will apply to all annual incentives paid after January 2012.”
Long-Term Incentive Compensation
On May 20, 2010, our stockholders approved the 2010 Long-Term Incentive Plan (the “2010 Plan”). This 2010 Plan allows us to recover any award that the Company deems was not warranted after any restatement of corporate performance.
Long-term incentive awards have been granted under our 2001, 2004, 2006 and 2010 Long Term Incentive Plans (“LTIPs”) and the awards are granted to our executive officers to align their personal financial interests with our stockholders. The LTIPs include provisions for stock options, stock appreciation rights, restricted stock, restricted stock units and cash awards.
Our policy on stock awards is focused on determining the right mix of retention and ownership requirements to drive and motivate our executive officers’ behavior consistent with long-term interests of stockholders. The HR Committee is the administrator of our LTIPs and, subject to Board approval, has full power to determine the size of awards to our executives, to determine the terms and conditions of grants in a manner consistent with the LTIPs and to amend the terms and conditions of any outstanding award.
The CEO presents individual stock award recommendations for executive officers to the HR Committee, and after review and discussion the HR Committee submits its recommendation to the Board for approval. The HR Committee’s policy is to grant awards on the date the Board approves them. Stock options and restricted stock will be granted once each calendar year on a predetermined date or at the effective date of a new hire or promotion, but not within six months of a previous award to the same individual. The price of options and the value of a restricted stock award issued to a new employee will be set at the closing price on the employee’s effective start date. The price of options and the value of a restricted stock award issued to an employee as a result of a promotion will be set at the closing price on the effective date of that promotion. Under no circumstances will a grant date be set retroactively.
The Board has adopted stock retention guidelines as an additional means to promote ownership of stock by executive officers and directors. The guidelines apply to any award of restricted stock or options to purchase our stock granted to executive officers and directors after February 2004. Under these guidelines, an executive officer or director must retain at least 50% of the shares of restricted stock for at least three years after the restriction lapses. Consequences for failure to adhere to these guidelines shall be determined by the HR Committee in its discretion including, without limitation, actions with respect to future compensation and future grants of stock options or restricted stock and performance measures. Under our Insider Trading Policy, executive officers and directors are strictly prohibited from speculative trading in the Company’s securities, including short sales and buying or selling puts or calls on the Company’s securities.
The long-term incentive awards for 2012 included stock options, stock appreciation rights (“SARs”), which can be settled as cash or equity, and restricted stock units (“RSUs”), which can be settled as cash or equity. This mix provides upside potential with the stock options and a more stable award in the form of restricted stock units. Of the total award value, 70% was allocated to options and 30% to restricted shares.
Mix of Long Term Incentives Awarded in 2012
As of December 31, 2012, almost all of the total shares available for grant as options under the LTIPs approved by our stockholders have been granted:
Personal Benefits
Our executive officers are covered under the same health and welfare plans, including our 401(k) plan, as all employees. The executive officers also receive supplemental life insurance to cover the risks of extensive travel required in conducting our global business. We pay 100% of all premiums for the following benefits for employees and their eligible dependents:
•
All employees are entitled to a medical benefit with unlimited maximum lifetime benefits, with an annual out-of-pocket deductible of $3,000 per individual and $9,000 per family.
•
Life and accidental death and dismemberment (“AD&D”) insurance equal to two times annual salary with a minimum of $200,000 and a cap of $300,000 (or $400,000 with evidence of insurability), and additional coverage equal to five times annual salary ($1.0 million maximum) while traveling outside their home country on Company business.
•
Long-term disability benefits provide a monthly benefit of 60% of base salary up to a maximum of $10,000 per month.
•
Participation in our Statutory Profit Sharing Plan 401(k). Eligibility is effective the first day of the month following the date of hire. We use a safe harbor matching formula for Company contributions (dollar for dollar match up to 3% of pay, $0.50 for every dollar on the next 2% of pay subject to the statutory maximum salary limits). Participant and Company contributions are 100% vested from the date of contribution. At termination of employment, employees are eligible to receive their account balance in a lump sum.
•
All employees and their dependents receive annual dental and vision care benefits of $1,500 and $250, respectively, per employee and dependent.
We do not offer a pension plan or a non-qualified deferred compensation plan for executive officers or employees. In 2012, we did not offer perquisites to executive officers or other employees. We offer relocation and Foreign Service premiums to employees serving in an international location. The amount of the premium will vary depending upon the living conditions, political situation and general safety conditions of the international location. Expatriate employees are also provided housing and utilities allowances where applicable. They also receive a cost of living allowance to cover the differential between normal living expenses in the host and home countries and will continue to participate in the employee benefit plans available to home country employees.
Total Direct Compensation
Executive Compensation Compared to Market Data
Compared to 2011 market data, total direct compensation ranged between 82% and 128% of the target market median for all named executive officers. In 2012, their compensation (after their March 2012 base salary increases) fell at the following percentiles:
Executive Compensation Mix
The general mix of compensation for target-level performances in the annual incentive plan, plus the net annualized present value of long-term compensation grants, can range as follows, depending upon the executive officer. The Committee considered the following general percentage mix in establishing the total compensation for the Company’s executive officers for 2012 target performance. It is important to note that the influences on Company financial performance and stock price performance could significantly change the basic mix of compensation components as a percentage of total compensation:
For the CEO, 73.6% of his total direct compensation is considered “at-risk.” The other named executive officers have 67% of their total direct compensation at risk.
Note: Annual incentive (“AI”) for Messrs. Edmiston, Nesselrode and Head includes a special accomplishment award for the sale of Utah in 2011.
Tax and Accounting Implications of Executive Compensation
Deductibility of Executive Compensation
As part of its role, the HR Committee reviews and considers the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended, which imposes a limit of $1.0 million on the amount that a publicly-held corporation may deduct in any year for the compensation paid or accrued with respect to its named executive officers unless the compensation is performance based. None of our executive officers currently receives compensation exceeding the limits imposed by Section 162(m). While we cannot predict with certainty how executive compensation might be affected in the future by Section 162(m) or applicable tax regulations issued, we intend to preserve the tax deductibility of all executive compensation while maintaining our executive compensation program as described in this Compensation Discussion and Analysis.
Employment Agreements
We have entered into Executive Employee Agreements with our current named executive officers: Messrs. Edmiston, Haynes, Speirs, Nesselrode and Head. Two other executive officers who are not named also have executive employment agreements. The contracts have an initial term, which automatically extends for one year upon each anniversary unless a one-year notice not to extend is given by the executive. The current term of the Executive Employment Agreements is through May 31, 2013.
Entitlements based on Terms in Executive
Employment Agreements if we terminate the
employment without cause or notice (not
related to Change of Control) OR the
executive terminates employment for good
reason
Mr.
Edmiston
Mr. Haynes
Mr. Speirs
Mr. Nesselrode
Mr. Head
A lump sum amount equal to a certain multiple of base salary
3 times
2 times
2 times
2 times
2 times
An amount equal to a certain number of years times the maximum annual employer contributions made under out 401(k) plan
3 years
2 years
2 years
2 years
2 years
Vesting of all stock options
Yes
Yes
Yes
Yes
Yes
Vesting of all restricted stock awards
Yes
Yes
Yes
Yes
Yes
Reimbursement of Outplacement Services
Yes
Yes
Yes
Yes
Yes
Restrictions on ability to compete with the Company after termination of employment
2 years
2 years
2 years
2 years
2 years
See the table titled “Potential Payments under Termination or Change of Control” in the Compensation of Executive Officers section below for details on the above information.
The HR Committee believes the termination payment included in these Executive Employment Agreements is needed to attract and retain the executives necessary to achieve our business objectives. However, the HR Committee also believes termination payments should not be guaranteed. Accordingly, a termination payment will not be paid if a termination occurs after notice and lapse of the notice period to terminate the Executive Employment Agreement. Also, a termination payment will not be made if the executive officer resigns other than for good reason. Good reason under the employment contracts includes: (1) a material breach of the employment agreement by the Company; (2) failure to maintain or reelect the executive officer to his position; (3) a significant reduction of the executive officer’s duties, position or responsibilities; (4) a substantial reduction, without good business reasons, of the facilities and perquisites available to the executive officer; (5) a reduction by the Company of the executive officer’s monthly base salary; (6) failure of the Company to continue the executive officer’s participation in any bonus, incentive, profit sharing, performance, savings, retirement or pension policy, plan, program or arrangement on substantially the same or better basis relative to other participants; or (7) the relocation of the executive officer more than fifty miles from the location of the Company’s principal office.
Change of Control
Since it is in our best interest to retain executive officers during uncertain times who will act in the best interests of the stockholders without concern for personal outcome, our Executive Employment Agreements provide benefits in the event of loss of employment for employees in good standing due to a change of control. Change of control is defined as the acquisition of 50% or more of our voting stock, the cessation of the incumbent board of directors to constitute a majority of the board of directors, or the reorganization, merger, or sale or disposition of at least 50% of our assets where we are not the surviving entity. Change of control severance benefits apply to terminations taking place between 240 days before a change of control and 730 days after a change of control.
Entitlements based on Terms in
Executive Employment Agreements if
we terminate the employment without
cause or notice related to a Change of
Control
Mr.
Edmiston
Mr.
Haynes
Mr. Speirs
Mr.
Nesselrode
Mr. Head
A lump sum amount equal to a certain multiple of base salary
3 times
2 times
2 times
2 times
2 times
A lump sum amount equal to a certain multiple of the highest annual bonus over the past 3 years or target bonus, whichever is higher
3 times
2 times
2 times
2 times
2 times
An amount equal to a certain number of years times the maximum annual employer contributions made under out 401(k) plan
3 years
2 years
2 years
2 years
2 years
Continuation of accident, life, disability, dental and health benefits for a certain number of years
3 years
2 years
2 years
2 years
2 years
Excise tax reimbursement and gross up on the reimbursement
Yes
Yes
Yes
Yes
Yes
Vesting of all stock options
Yes
Yes
Yes
Yes
Yes
Vesting of all restricted stock awards
Yes
Yes
Yes
Yes
Yes
Reimbursement of Outplacement Services
Yes
Yes
Yes
Yes
Yes
Restrictions on ability to compete with the Company after termination of employment
2 years
2 years
2 years
2 years
2 years
The change of control benefits in the Executive Employment Agreements contain a double trigger in that both a change of control must occur and the executive officer must be terminated without cause or resign for good reason within a specified period of time after the change of control. The HR Committee believes that the double trigger avoids unnecessarily rewarding an executive officer when a change of control occurs and the executive officer’s status is not changed as a result. However, because of the significant uncertainty that can arise during a period of a potential or actual change of control, the Committee has provided greater benefits to the executive officer in the event of a termination resulting from a change of control. Change of control benefits are detailed in the “Potential Payments under Termination or Change of Control” table in the Compensation of Executive Officers section below.
HUMAN RESOURCES COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the Board’s HR Committee is or has been an officer or employee of the Company or has a relationship requiring disclosure under Item 404(a) of SEC Regulation S-K. No executive officer of the Company serves on the compensation committee or serves as a director of another entity where an executive officer of that entity also serves on the HR Committee or on the Board.
HUMAN RESOURCES COMMITTEE REPORT
The HR Committee has reviewed and discussed with management the Compensation Discussion and Analysis filed in this document. Based on such review and discussions, the HR Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.
R. E. Irelan, Committee Chairman
Igor Effimoff
J. Michael Stinson
COMPENSATION OF EXECUTIVE OFFICERS
Summary Compensation Table
The following table summarizes the compensation of the Company’s named executive officers for the three most recently completed fiscal years ended December 31, 2012, 2011 and 2010.
Notes:
(1) Harvest pays bonuses one year in arrears but reflects the bonus in the table above in the year to which it related. Harvest deferred the payment of bonuses to key employees for 2010 until later in 2011. These bonuses have been included in the above table as 2010 bonuses. Bonuses related to 2011 were paid February 24, 2012 and are reflected in the table above as 2011 bonuses. Bonuses related to 2012 were paid March 1, 2013 and are reflected in the table above as 2012 bonuses.
(2) Harvest uses the Black-Scholes option pricing model to determine the value of each option grant on the date of grant. Harvest does not advocate or necessarily agree that the Black-Scholes option pricing model can properly determine the value of an option. The 2012 calculations for the named executive officers are based on a weighted average expected life of five years, expected volatility of 67.32%, risk-free interest rate of 0.74%, expected dividend yield of 0% and expected annual forfeitures of 3% for stock options and 0% for restricted stock.
(3) In May 2012, Harvest issued stock appreciation rights (SAR) and restricted stock units (RSU) as long-term incentive compensation. These instruments can be settled in cash or equity. Currently, no plan has been approved by the shareholders for equity settlement and Harvest is recording the liability and expense associated with the awards based on the fair market value of the stock at $5.12 on May 17, 2012. The number of awards for each executive that equals the amount above is shown in the following table:
(4) Detail of all other compensation paid:
Grants of Plan-Based Awards
The following table shows information concerning options to purchase Common Stock granted to each of the named executive officers during 2012.
Notes:
(1) Options granted May 17, 2012 vest 1/3 each year over a three year period.
(2) Harvest granted options representing 436,298 shares to employees in 2012.
Outstanding Equity Awards at Fiscal Year End
The following table shows information concerning outstanding equity awards as of December 31, 2012 held by the named executive officers.
(1) The market value of shares is $8.840 per share, based upon the average of the high and low market prices on December 31, 2012.
(2) This stock unit is a right to receive, after vesting, a cash amount equal to the difference between the closing price of the stock on September 15, 2005 and the price of the stock on the date the payment is distributed. Vesting is 1/3 on the last to occur of September 15, 2006 and the date on which the average of the stock price for 10 consecutive trading days is greater than $25 per share. Vesting of 1/3 on September 2007 and 2008 is subject to the same $25 per share condition.
Options Exercised and Stock Vested
The following table provides information regarding the exercise of stock options during 2012 by the named executive officers.
Potential Payments under Termination or Change of Control
The tables below reflect the additional compensation paid to the named executive officers of the Company under the terms of their Executive Employment Agreements in the event of termination without cause or without proper notice, termination following change of control, or termination for disability or death. (See Compensation Discussion and Analysis - Employment Agreements and Change of Control above for a description of the terms of the Executive Employment Agreements.) The amounts shown in the tables assume that such termination was effective as of December 31, 2012, and thus include estimated amounts earned through that date that would be paid out to the named executive officers. The actual amounts can only be determined at the time of separation from the Company.
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
DIRECTOR COMPENSATION
Our philosophy in determining director compensation is to align compensation with the long-term interests of the stockholders, adequately compensate the directors for their time and effort and establish an overall compensation package that will attract and retain qualified directors. In determining overall director compensation, we seek to strike the right balance between the cash and stock components of director compensation. The Board’s policy is that the directors should hold equity ownership in the Company and that a portion of the director fees should consist of Company equity in the form of restricted stock and stock grants. The Board also believes that directors should develop a meaningful equity position over time and has adopted stock retention guidelines applicable to all directors. These guidelines state directors must retain (i) at least 50% of the shares of restricted stock granted to them for at least three years after the restriction lapses and (ii) at least 50% of the net shares of stock received through the exercise of an option or SAR must be retained by a director for at least three years after the exercise date.
Our retainer and meeting fee schedule remained the same in 2012 as it was in 2011, 2010 and 2009. Each non-employee director of the Company received cash compensation as follows:
•
An annual Board retainer of $40,000, plus travel and related expenses;
•
A meeting fee of $1,500 for each board or committee meeting attended;
•
An annual committee retainer of $20,000 for serving as committee chair of the Audit Committee, $15,000 for serving as committee chair of the Human Resources Committee and $10,000 for serving as committee chair of the Nominating and Corporate Governance Committee; and
•
A fee of $1,500 per day for attending business meetings on our behalf in the member’s capacity as a director that requires out of town travel or a substantial commitment of time.
Our director compensation includes additional compensation for the non-executive Chairman of the Board in recognition of the significant added responsibilities and time commitments of that position. In addition to his compensation as a director, he receives a retainer of $120,000 a year; this 2012 retainer remained the same as the retainer in 2011 and 2010.
Under the 2010 Plan, directors are eligible to receive restricted stock, RSUs, stock options and SAR grants. In May 2012, the Board approved a RSU award of $100,000 in value for each director.
The following table sets forth the cash and other compensation paid to the non-employee members of our Board of Directors in 2012.
(1) Includes $4,500 in business meeting fees and $6,000 for travel days.
(2) Includes $1,500 for travel days.
(3) Includes $4,500 in business meeting fees and $1,500 for travel days.
(4) Includes $1,500 in business meeting fees and $4,500 for travel days.
(5) Includes $3,000 in business meeting fees and $4,500 for travel days.
(6) Includes $1,500 for travel days.
(7) The amounts included in this column represent the aggregate grant date fair value of the grant of 19,500 deferred shares granted to each of our non-employee directors on May 17, 2012. As of December 31, 2012, each of the non-employee directors had aggregate outstanding deferred shares as follows: Mr. Chesebro’ - 19,500; Dr. Effimoff - 19,500; Mr. Hardee - 19,500; Mr. Irelan - 19,500; Mr. Murray - 19,500 and Mr. Stinson - 19,500.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
EQUITY COMPENSATION PLAN INFORMATION
As of December 31, 2012
A description of our equity compensation plans is included in this Annual Report on Form 10-K, Part IV, Item 15, Notes to the Consolidated Financial Statements, Note 9 - Stock-Based Compensation and Stock Purchase Plans.
(1) Options were issued to new hire employees as employment inducement grants under a NYSE exception. These options were granted from 2007 through 2012 between $5.85 and $10.25 and vest ratably over three years from the grant date. At December 31, 2012, a total of 125,000 options were issued and outstanding as inducement grants, which are included in the table above, and 106,667 of these options were exercisable. This compensation plan was not approved by security holders.
(2) A SAR is a right to receive on the Exercise Date, after vesting thereof, for each share of Company stock underlying the SAR with respect to which the SAR is exercised, an amount equal to the excess of (a) the Fair Market Value of one share of the Company stock on the Exercise Date over (b) 100 percent of the Fair Market Value of one share of the Stock determined as of the Grant Date (the “SAR Exercise Price”). The grant date for the 2009 SARs was June 18, 2009 and the SAR Exercise Price is $4.595 per share of Company stock. The 2009 SARs vest one-third each year beginning on June 18, 2012 and expire after seven years on June 18, 2016. The grant date for the 2012 SARs was May 17, 2012 and the SAR Exercise Price is $5.12 per share of Company stock. The 2012 SARs vest one-third each year beginning on May 17, 2013 and expire after five years on May 17, 2017. At the sole discretion of the company, a SAR may be settled in cash or with shares of the underlying Company stock from an approved plan that allows the payment of a SAR in the medium of Company stock. This compensation plan was not approved by security holders.
(3) This reflects the weighted average exercise of the stock options and SARs listed in column (a).
(4) Securities remaining available for future issuances from the following plans are:
In addition to the outstanding options and SARs listed above, there are a total of 284,750 shares of restricted stock awards that were granted under all plans that are outstanding as of December 31, 2012. Of these full value awards, 280,750 shares were granted under equity plans approved by security holders. There were 4,000 shares awarded as inducement grants and not approved by security holders.
A “ Stock Unit ” is a right to receive on the Payment Date, after vesting thereof, a cash amount equal to the Fair Market Value of one share of Company stock on the Payment Date. At December 31, 2012, the Company had 530,006 Stock Units outstanding. Stock Units were granted on June 18, 2009 and vest one-third each year beginning June 18, 2012. Stock Units were also granted to employees on May 17, 2012 and vest on May 17, 2015. Stock Units granted to directors on May 17, 2012 vest on May 17, 2013. At the sole discretion of the Company, a Stock Unit may be settled in cash or with shares of the underlying Company stock from an approved plan that allows the payment of the stock unit in the medium of Company stock. This compensation plan was not approved by security holders.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Directors and Named Executive Officers
The following table shows the amount of our common stock beneficially owned (unless otherwise indicated) by our directors and nominees for director, each named executive officer and our directors and named executive officers as a group. Except as otherwise indicated, all information is as of April 24, 2013.
The number of shares of our common stock beneficially owned by each director or named executive officer is determined under rules of the SEC, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares as to which the individual has the sole or shared voting power or investment power and also any shares which the individual has the right to acquire within 60 days after April 24, 2013 through the exercise of stock options or other rights. Unless otherwise indicated, each person has sole investment and voting power (or shares such powers with his spouse) with respect to the shares set forth in the following table.
* Represents less than one percent of the Company’s outstanding common stock.
(1) This number does not include common stock that our directors or named executive officers have a right to acquire within 60 days of April 24, 2013.
(2) Percentages are based upon 39,454,279 shares of common stock outstanding on April 24, 2013.
(3) Percentage should be calculated assuming that the vested options have been exercised by the individual for whom the percent is being calculated.
Certain Beneficial Owners
The following table shows the beneficial owners of more than five percent of the Company’s common stock as of April 24, 2013:
(1) The stockholder has sole voting and dispositive power over the shares indicated unless otherwise disclosed.
(2) The Company’s outstanding common shares as of April 24, 2013 were 39,454,279.
Item 13. Certain Relationships and Related Transactions, and Director Independence
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Our Code of Business Conduct and Ethics (the “Code”) applies to all of our directors, officers and employees. Under the Code, individuals subject to the Code and their family members must knowingly avoid owning any interest (other than nominal amounts of stock in publicly-traded companies) in any supplier or customer; consulting with, or being an employee of, any customer, lessor, lessee, contractor, supplier or competitor; purchasing from, or selling to us, assets, goods or services; or serving on the board of directors of any customer, lessor, lessee, contractor, supplier or competitor, except where full disclosure of all facts is made known to us in advance to permit us to protect our interests. Each year we require our executive officers to certify their compliance with the Code. Our Audit Committee has oversight compliance responsibilities for the Code. Exceptions to the Code are reported to the Audit Committee. Waivers of the Code for officers and directors may only be granted by the
Board and waivers for employees may only be granted by the CEO and reported to the Audit Committee. No waivers of the Code were granted in 2012. In addition to the Code, each year we require our directors and executive officers to disclose in writing certain transactions and relationships and this information is used in preparing the proxy statement and in making independence determinations for directors.
For the purposes of this Annual Report on Form 10-K, the Company has no transactions to describe pursuant to SEC Regulation S-K Item 404(a).
DIRECTOR INDEPENDENCE
Of our seven directors standing for re-election, six have been affirmatively determined by the Board to be independent, including our non-executive Chairman of the Board. The directors our Board has determined to be independent are Stephen D. Chesebro’, Dr. Igor Effimoff, H. H. Hardee, Robert E. Irelan, Patrick M. Murray and J. Michael Stinson. The Board’s determination of independence is based upon the standards set forth in our Guidelines for Corporate Governance, which may be found under the Corporate Governance section on our website at http://www.harvestnr.com. The Guidelines for Corporate Governance include the NYSE independence standards. In making its determination of independence, the Board took into account responses of the directors to questions concerning their employment history, compensation, affiliations and family and other relationships.
Item 14. Principal Accountant Fees and Services
During 2012, PricewaterhouseCoopers LLP served as our independent registered public accounting firm and provided certain tax and consulting services to us. Representatives of PricewaterhouseCoopers LLP are expected to attend the annual meeting of stockholders where they will be available to respond to questions and, if they desire, to make a statement.
Audit Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for professional services rendered by it for the audit of our annual financial statements and review of financial statements included in our quarterly reports and services that are normally provided by it in connection with statutory and regulatory filings or engagements in those years were $1,190,000 for the year ended December 31, 2011, and $3,327,212 for the year ended December 31, 2012.
Audit Related Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for assurance and related services by it that are reasonably related to the performance of the audit or review of our financial statements that are not included as “Audit Fees” above were $0 for the year ended December 31, 2011, and $0 for the year ended December 31, 2012.
Tax Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for professional services rendered by it for tax compliance, tax advice and tax planning were $34,870 for the year ended December 31, 2011, and $32,274 for the year ended December 31, 2012.
All Other Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for all other products and services provided by it were $0 for the year ended December 31, 2011, and $0 for the year ended December 31, 2012.
All of the foregoing fees were approved by the Audit Committee.
Audit Committee Pre-Approval Policies and Procedures. The Audit Committee’s Charter provides that our independent registered public accounting firm may provide only those services pre-approved by the Audit Committee, subject to de minimus exceptions for non-audit services described in the rules and regulations of the SEC, which are subsequently ratified by the Audit Committee prior to completion of the audit. The Audit Committee annually reviews and pre-approves the audit, review, attestation and permitted non-audit services to be provided during the next audit cycle by the independent registered public accounting firm. To the extent practicable, at the same meeting the Audit Committee also reviews and approves a budget for each of such services.
The Audit Committee may delegate to a member(s) the authority to grant pre-approvals under its policy with respect to audit and permitted non-audit services, provided that any such grant of pre-approval shall be reported to the full Audit Committee no later than its next scheduled meeting.
The Audit Committee has concluded that the provision of non-audit services is compatible with maintaining the registered public accounting firm’s independence.
PART IV
Item 15. Exhibits and Financial Statement Schedules
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
Separate financial statements of Petrodelta, S.A. required pursuant to Rule 3-09 of Regulation S-X are filed as Exhibit 99.1.
(b) 3. Exhibits:
 Identifies management contracts or compensating plans or arrangements required to be filed as an exhibit hereto pursuant to Item 15(a) and (b) of Form 10-K.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Harvest Natural Resources, Inc.
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)1 present fairly, in all material respects, the financial position of Harvest Natural Resources, Inc. and its subsidiaries at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule, Schedule II-Valuation and Qualifying Accounts, listed in the index appearing under Item 15(a)2 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because material weaknesses in internal control over financial reporting related to (1) a sufficient complement of accounting and financial reporting resources; (2) accounting for certain transactions for oil and gas properties; (3) accounting for income taxes; (4) appropriate segregation of duties related to certain system access rights and the recording and review of journal entries; (5) preparation and review of certain classification and disclosure matters impacting the financial statements and related notes; and (6) accounting for significant and complex debt and equity transactions existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses referred to above are described in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. We considered these material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the 2012 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management’s report referred to above. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has not generated revenue and has incurred recurring losses and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 3, the Company restated its 2011 and 2010 consolidated financial statements and financial statement schedule to correct errors.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with 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 (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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.
/s/PricewaterhouseCoopers LLP
Houston, Texas
May 2, 2013
S-1
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
S-2
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
See accompanying notes to consolidated financial statements.
S-3
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
See accompanying notes to consolidated financial statements.
S-4
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements.
S-5
Supplemental Schedule of Noncash Investing and Financing Activities:
During the year ended December 31, 2012, we settled 70,994 restricted stock units with Harvest common stock valued at $0.4 million. Also, some of our employees elected to pay withholding tax on restricted stock grants on a cashless basis which resulted in 7,789 shares being added to treasury stock at cost. During the year ended December 31, 2012, capital expenditures of $10.5 million were financed through current liabilities. See Note 3 - Summary of Significant Accounting Policies, Other Assets for a discussion of certain non-cash asset transactions and Note 6 - Long-Term Debt for a discussion of other non-cash equity transactions.
During the year ended December 31, 2011, we issued 0.2 million shares of restricted stock valued at $2.0 million. Also, some of our employees elected to pay withholding tax on restricted stock grants on a cashless basis which resulted in 45,532 shares being added to treasury stock at cost. During the year ended December 31, 2011, capital expenditures of $3.4 million were financed through current liabilities.
During the year ended December 31, 2010, we issued 0.3 million shares of restricted stock valued at $1.8 million. Also some of our employees elected to pay withholding tax on restricted stock grants on a cashless basis, which resulted in 26,260 shares being added to treasury stock at cost; and 1,000 shares held in treasury that had been reissued as restricted stock were forfeited and returned to treasury. During the year ended December 31, 2010, capital expenditures of $7.6 million were financed through current liabilities. During the year ended December 31, 2010, the fair value of our warrant derivative liability of $15.0 million was offset through long-term debt.
See accompanying notes to consolidated financial statements.
S-6
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1 - Organization
Harvest Natural Resources, Inc. (“Harvest”) is an independent energy company engaged in the acquisition, exploration, development, production and disposition of oil and natural gas properties since 1989, when it was incorporated under Delaware law.
We have acquired and developed significant interests in the Bolivarian Republic of Venezuela (“Venezuela”). Our Venezuelan interests are owned through Harvest-Vinccler Dutch Holding, B.V., a Dutch private company with limited liability (“Harvest Holding”). Our ownership of Harvest Holding is through HNR Energia, B.V. (“HNR Energia”) in which we have a direct controlling interest. Through HNR Energia, we indirectly own 80 percent of Harvest Holding and our partner, Oil & Gas Technology Consultants (Netherlands) Coöperatie U.A., a controlled affiliate of Venezolana de Inversiones y Construcciones Clerico, C.A. (“Vinccler”), indirectly owns the remaining 20 percent interest of Harvest Holding. Harvest Holding owns, indirectly through wholly owned subsidiaries, a 40 percent of Petrodelta, S.A. (“Petrodelta”). As we indirectly own 80 percent of Harvest Holding, we indirectly own a net 32 percent interest in Petrodelta, and Vinccler indirectly owns eight percent. Corporación Venezolana del Petroleo S.A. (“CVP”) owns the remaining 60 percent of Petrodelta. Petroleos de Venezuela S.A. (“PDVSA”) owns 100 percent of CVP. Harvest Holding has a direct controlling interest in Harvest Vinccler S.C.A. (“Harvest Vinccler”). Harvest Vinccler’s main business purposes are to assist us in the management of Petrodelta and in negotiations with PDVSA. We do not have a business relationship with Vinccler outside of Venezuela.
In addition to our interests in Venezuela, we hold exploration acreage in four projects:
•
Mainly onshore in West Sulawesi in the Republic of Indonesia (“Indonesia”) through the Budong-Budong Production Sharing Contract (“Budong PSC”) (see Note 14 - Indonesia),
•
Offshore of the Republic of Gabon (“Gabon”) through the Dussafu Marin Permit (“Dussafu PSC”) (see Note 15 - Gabon),
•
Onshore in the Sultanate of Oman (“Oman”) through the Oman Exploration and Production Sharing Agreement (“EPSA”) Al Ghubar / Qarn Alam license (“Block 64 EPSA”) (see Note 16 - Oman), and
•
Offshore of the People’s Republic of China (“China”) through the Wab-21 Petroleum Contract (see Note 17 - China).
Note 2 - Liquidity and Going Concern
Historically, our primary ongoing source of cash has been dividends from Petrodelta and the sale of oil and gas properties. See Note 5 - Dispositions - Discontinued Operations. Currently, our source of cash is expected to be generated by accessing debt and/or equity markets, and/or farm-downs.
Our primary ongoing use of cash has been to fund oil and gas exploration projects, debt, interest, and general and administrative costs. We require capital principally to fund the exploration and development of new oil and gas properties. As is common in the oil and gas industry, we have various contractual commitments pertaining to exploration, development and production activities. See Note 14 - Indonesia and Note 15 - Gabon for our contractual commitments.
S-7
The environments in which we operate are often difficult and the ability to operate successfully depends on a number of factors including our ability to control the pace of development, our ability to apply “best practices” in drilling and development, and the fostering of productive and transparent relationships with local partners, the local community and governmental authorities. Financial risks include our ability to control costs and attract financing for our projects. In addition, often the legal systems of certain countries are not mature and their reliability can be uncertain. This may affect our ability to enforce contracts and achieve certainty in our rights to develop and operate oil and natural gas projects, as well as our ability to obtain adequate compensation for any resulting losses. Our strategy depends on our ability to have significant influence over operations and financial control.
Our operations are subject to various risks inherent in foreign operations. These risks may include, among other things, loss of revenue, property and equipment as a result of hazards such as expropriation, nationalization, war, insurrection, civil unrest, strikes and other political risks, increases in taxes and governmental royalties, being subject to foreign laws, legal systems and the exclusive jurisdiction of foreign courts or tribunals, renegotiation of contracts with governmental entities, changes in laws and policies, including taxes, governing operations of foreign-based companies, currency restrictions and exchange rate fluctuations and other uncertainties arising out of foreign government sovereignty over our international operations. Our international operations may also be adversely affected by the U.S. Foreign Corrupt Practices Act and similar worldwide anti-corruption laws, laws and policies of the United States affecting foreign policy, foreign trade, taxation and the possible inability to subject foreign persons to the jurisdiction of the courts in the United States.
There are also a number of variables and risks related to our minority equity investment in Petrodelta that could significantly utilize our cash balances, and affect our capital resources and liquidity. Petrodelta’s capital commitments are determined by its business plan, and Petrodelta’s capital commitments are expected to be funded by internally generated cash flow. The total capital required to develop the fields in Venezuela may exceed Petrodelta’s available cash and financing capabilities, and there may be operational or contractual consequences due to this inability. Petrodelta’s ability to fully develop the fields in Venezuela will require a significant investment. Due to PDVSA’s liquidity constraints, PDVSA has not been providing the necessary monetary support and contractual adherence required by Petrodelta. If we are called upon to fund our share of Petrodelta’s operations, our failure to do so could be considered a default under the Conversion Contract and cause the forfeiture of some or all our shares in Petrodelta.
Petrodelta currently represents our only source of earnings. Petrodelta also has a material impact on our results of operations for any quarter or annual reporting period. See Note 13 - Investment in Equity Affiliate - Petrodelta, S.A. Petrodelta operates under a business plan, the success of which relies heavily on the market price of oil. To the extent that market prices of oil decline, the business plan, and thus our equity investment and/or operations and/or profitability, could be adversely affected.
Operations in Venezuela are subject to various risks inherent in foreign operations. It is possible the legal or fiscal framework for Petrodelta could change and the Venezuela government may not honor its commitments. Our ability to implement or influence Petrodelta’s business plan, assure quality control and set the timing and pace of development could also be adversely impacted. No assurance can be provided that events beyond our control will not adversely affect the value of our minority investment in Petrodelta.
Between Petrodelta’s formation in October 2007 and June 2010, Petrodelta declared and paid dividends of $105.5 million to HNR Finance, B.V. (“HNR Finance”), a wholly owned subsidiary of Harvest Holding ($84.4 million net to our 32 percent interest). See Note 18 - Related Party Transactions for a discussion of our obligations to our non-controlling interest holder, Vinccler, for any dividend received from Petrodelta. As discussed below, on November 12, 2010, Petrodelta’s board of directors declared a dividend of $30.6 million; however, such dividend has not been received. There is uncertainty with respect to the timing of the receipt of such dividend or whether future dividends will be declared and/or paid. We have and will continue to monitor our investment in Petrodelta. Should the dividend receivable not be collected, or facts and circumstances surrounding our investment change, our results of operations and our investment in Petrodelta could be adversely impacted.
We have incurred losses from continuing operations since 2007 and negative cash flows since 2009 and have utilized the proceeds from the sale of property and debt to fund our operations. For the year ended December 31, 2012, we incurred a net loss attributable to Harvest of approximately $12.2 million and negative cash flows from operations of approximately $26.4 million. At December 31, 2012, we had retained earnings of approximately $181.4 million and working capital of approximately $40.5 million. We currently do not have any revenue or operating cash inflow and, as indicated above, historically our main source of cash has been dividends
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from Petrodelta. On November 12, 2010, Petrodelta’s board of directors declared a dividend of $30.6 million, $12.2 million net to HNR Finance ($9.8 million net to our 32 percent interest). The dividend was ratified by Petrodelta’s shareholders on March 14, 2011. Due to Petrodelta’s liquidity constraints caused by PDVSA’s insufficient monetary support and contractual adherence, this dividend has not yet been received, although it is due and payable. Our other main source of cash is the sale of assets. As discussed in Note 5 - Dispositions, on June 21, 2012, we announced entering into an agreement for the sale of our investment in Petrodelta. However, the buyer’s sole shareholder did not approve the transaction, and on February 19, 2013, we exercised our right to terminate the agreement.
We expect that for 2013 we will not generate revenue, will continue to generate losses from operations, and our cash flows will not be sufficient to cover our operating expense; therefore, expected continued losses from operations and use of cash will be funded through debt or equity financings, farm-downs, delay of the discretionary portion of our capital spending to future periods and/or operating cost reductions. To meet our capital needs, we are considering multiple alternatives, including, but not limited to, additional debt and/or equity financing, farm-down, delay of the discretionary portion of our capital spending to future periods and/or operating cost reductions. Our ability to continue as a going concern also depends upon the success of our planned exploration and development activities. There can be no guarantee of future capital acquisition, fundraising or explorations success or that we will realize the value of our unevaluated exploratory well costs. We believe that we will continue to be successful in securing any funds necessary to continue as a going concern. However, our current cash position and our ability to access additional capital may limit our available opportunities or not provide sufficient cash for operations.
Failure to generate sufficient cash flow, raise additional capital through debt or equity financings, farm-downs, and/or further reduce operating costs could have a material adverse effect on our ability to meet our short- and long-term liquidity needs and achieve our intended long-term business objectives.
While we believe the issuance of additional equity securities, short- or long-term debt financing, farm-downs, delay of the discretionary portion of our capital spending to future periods and/or operating cost reductions could be put into place which would not jeopardize our operations and future growth plans, these circumstances raise substantial doubt about our ability to continue to operate as a going concern.
The audit opinion on our financial statements as of and for the year ended December 31, 2012 includes an explanatory paragraph expressing substantial doubt regarding our ability to continue as a going concern. Our financial statements have been prepared under the assumption that we will continue as a going concern, which contemplates that we will continue in operation for the foreseeable future and will be able to realize assets and settle liabilities and commitments in the normal course of business. The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or amounts and classification of liabilities that could result should we be unable to continue as a going concern.
Note 3 - Summary of Significant Accounting Policies
Restatement of Prior Period Financial Statements
In connection with the preparation of our Annual Report on Form 10-K for the year ended December 31, 2012, we concluded that there were errors in previously filed financial statements. In the course of our review, management determined that (a) certain warrants issued in 2010 in connection with our $60 million term loan facility (the “Warrants”) were improperly valued at inception and improperly classified as equity instruments rather than liability instruments. As a result of the improper classification of the Warrants, (b) the debt discount and associated interest expense related to the amortization of the debt discount was understated for all periods in which the associated debt was outstanding, and (c) the consolidated statement of operations and comprehensive income (loss) for each reporting period was misstated by the omission of the changes in fair value of the Warrants as a liability instrument. Additionally, (d) certain exploration overhead was incorrectly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed, and (e) certain leasehold maintenance and other costs were improperly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed. Finally, (f) advances to equity affiliate were improperly classified as an operating activity rather than an investing activity and (g) certain costs were improperly classified as an investing activity rather than an operating activity on the consolidated statement of cash flows. Such errors impacted annual periods ended December 31, 2010 and 2011 and quarterly periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012, and September 30, 2012.
As a result of the errors related to the Warrants described above, loss on extinguishment of debt was understated for the year ended December 31, 2011 and the quarters ended June 30, 2011, September 30, 2011 and December 31, 2011.
Additionally, an error was identified in the calculation of earnings (loss) per diluted share for the year ended December 31, 2011 and the three and six months ended June 30, 2011, and an additional error was identified related to the improper expensing of costs associated with debt conversions that should have been recorded to equity for the quarters ended March 31, 2012 and September 30, 2012.
We have restated our segment footnote information to reflect the applicable errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense. Such errors impacted annual periods ended December 31, 2010 and 2011 and quarterly periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012 and September 30, 2012. We also restated our financial statement schedule to reflect adjustments to the balance sheet related to income taxes for the years ended December 31, 2010 and 2011.
In assessing the severity of the errors, management determined that the errors were material to the consolidated financial statements for the years ended December 31, 2011 and 2010 and quarterly information for all quarters in 2011 and the first, second and third quarters of 2012. In addition to the errors described above, we made corrections for previously identified immaterial errors and errors affecting classification within the consolidated statement of operations and comprehensive income (loss) related to impairment of oil and gas properties and income taxes and the consolidated balance sheets related to income taxes.
The audited financial statements, related notes and analyses for the years ended December 31, 2011 and 2010 have been retrospectively restated in this Annual Report on Form 10-K for the year ended December 31, 2012. We will amend our Quarterly Reports on Form 10-Q/A for each of the quarterly periods shortly after the filing of this Annual Report on Form 10-K.
The following tables set forth the effect of the adjustments described above on the consolidated statements of operations and comprehensive income (loss), the consolidated statements of cash flows and the consolidated statements of stockholders’ equity for the years ended December 31, 2011 and 2010, and the consolidated balance sheet as of December 31, 2011.
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Consolidated Statements of Operations and Comprehensive Income (Loss)
(a) For 2011, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $2,210 thousand offset by a reclassification from exploration expense to impairment of oil and gas properties of $3,335 thousand for amounts that were erroneously classified as exploration expense. For 2010, relates to lease maintenance costs that were erroneously capitalized as oil and gas properties rather than as exploration expense.
(b) Represents change in fair value of the Warrants for the period. Such Warrants were previously erroneously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(c) The fair value of the Warrants was not appropriately determined at inception because certain features of the Warrants were not originally considered in the fair value calculation. The corrected fair value of the Warrants at inception exceeds the original valuation by $3,878 thousand. As a result of this change in the fair value of the Warrants, the original discount allocated to the debt was understated by approximately $3,878 thousand; therefore, the additional amortization of the discount on debt, which is a component of interest expense, was understated for each period the debt was outstanding. For 2011, income tax expense of $237 thousand was improperly classified as interest expense.
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(d) As noted in (c) above, the correction in the fair value of the Warrants and its classification as a liability resulted in an increased discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(e) In addition to the impact on EPS related to the adjustments described in (a) through (d) above and (f) and (g) below, diluted EPS has been adjusted to reflect an error in the calculation of the weighted average common shares outstanding for dilutive EPS as of December 31, 2011. The weighted average common shares utilized for the calculation of diluted EPS was erroneously 39,339 thousand rather than 34,117 thousand.
(f) Reclassification of impairment of oil and gas properties expense in 2011 of $3,335 thousand that was previously erroneously presented as exploration expense.
(g) Represents income tax improperly classified as interest expense.
Consolidated Balance Sheets
(a) Relates to a deferred tax asset that was erroneously reported gross of the related liability.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Relates to the reclassification of the Warrants out of additional paid in capital to warrant derivative liabilities. The fair value of the Warrants was not appropriately determined at inception because certain features of the Warrants were not originally considered in the fair value calculation. Thus, the correction of the error to record the Warrants as a liability does not agree to the correction of the error removing the Warrants from equity. Additionally, the Warrants were not properly marked to market at the end of each period. The warrant derivative liability was valued at $15,000 thousand at inception with subsequent reductions in fair value of $344 thousand in 2010 and $9,786 thousand in 2011.
(d) Relates to the reversal of the amount recorded to equity at inception for the Warrants of $11,122 thousand and the reversal of the amount removed from additional paid in capital of $2,730 thousand when a portion of the Warrants were redeemed by the Company. In May 2011, additional paid in capital was debited for $2,730 thousand for the reversal of the original fair value of such warrants which was an error as they did not qualify for equity classification.
(e) Relates to (a) net increase in expense in 2010 and 2011 related to exploration expense of $2,523 thousand (inclusive of the reclassification of exploration expense to impairment of oil and gas properties of $3,335 thousand), (b) net increase in unrealized gain on warrant derivatives of $10,130 thousand for cumulative 2010 and 2011, (c) net increase in interest expense of $2,921 thousand cumulative for 2010 and 2011, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011 (e) net increase in income tax expense of $237 thousand for income taxes improperly classified as interest expense, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(f) Relates to reclassification of the Warrants as described in (d) above plus the impact of retained earnings described in (e) above.
(g) Represents other current liabilities that were improperly classified as interest payable and income taxes payable.
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Consolidated Statements of Cash Flows
(a) For 2011, relates to the $2,288 thousand of lease maintenance costs, exploration overhead and $900 thousand of certain investment costs that were improperly classified as an investing activity rather than an operating activity. In addition, Advances to Equity Affiliates of $(682) thousand were previously erroneously classified as an operating activity rather than an investing activity.
(b) For 2010, relates to $167 thousand of lease maintenance costs and $(558) thousand of certain investment costs that were improperly classified as an investing activity rather than an operating activity. In addition, Advances to Equity Affiliates of $3,221 thousand were improperly classified as an operating activity rather than an investing activity.
In addition to the above, we have restated the Consolidated Statements of Stockholder’s Equity to reflect the reclassification of the Warrants from equity to warrant derivative liability and to restate the January 1, 2010 beginning balances to reflect cumulative adjustments related to the previously described errors that affect periods prior to the year ended December 31, 2010 as follows:
(a) Relates to lease maintenance costs that were erroneously capitalized as oil and gas properties rather than expensed prior to January 1, 2010 (the “Beginning Retained Earnings Adjustment”).
(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability.
(b) The adjustment to retained earnings relates to (a) lease maintenance costs of $313 thousand that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense, (b) the reduction in the fair value of the Warrants for the year ended December 31, 2010 of $344 thousand, additional amortization of debt of $1,098 thousand resulting from the increased discount allocated to the debt, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized as oil and gas properties rather than expensed to exploration expense prior to January 1, 2010.
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(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the reversal of the original fair value of certain Warrants that did not qualify for equity classification.
(b) The adjustment to retained earnings relates to (a) net increase in 2010 and 2011 expense related to exploration expense of $2,523 thousand that was erroneously capitalized as oil and gas properties rather than expensed as exploration expense (includes consideration of reclassification between exploration expense and impairment of oil and gas properties), (b) net increase in unrealized gain on warrant derivatives of $10,130 thousand for cumulative 2010 and 2011, (c) net increase in interest expense of $2,921 thousand cumulative for 2010 and 2011, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011, (e) net increase in income tax expense of $237 thousand for income taxes improperly classified as interest expense, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
In addition to the above, we have restated Operating Segments to reflect the errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense.
(a) Relates to reclassification of noncontrolling interest from United States segment to Venezuela segment and elimination of intrasegment revenue erroneously reported gross of intrasegment expense.
(b) For 2011, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $1,505 thousand and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense of $1,383 thousand. For 2010, relates to elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(c) For 2011, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $415 thousand and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense of $1,830 thousand. For 2010, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $313 thousand and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense of $786 thousand.
(d) Relates to elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(e) Relates to the impact of (a) through (d) above.
(a) Relates to elimination of intrasegment receivables erroneously reported gross of related intrasegment payable.
Principles of Consolidation
The consolidated financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. Third-party interests in our majority-owned subsidiaries are presented as noncontrolling interests.
Presentation of Comprehensive Income (Loss)
We adopted ASU No. 2011-05 (ASU 2011-05), which is included in ASC 220, “Comprehensive Income”, effective January 1, 2012 and have elected to utilize the “single continuous statement” for presentation of all nonowner changes in stockholders’ equity.
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Reporting and Functional Currency
The United States Dollar (“U.S. Dollar”) is the reporting and functional currency for all of our controlled subsidiaries and Petrodelta. Amounts denominated in non-U.S. Dollar currencies are re-measured into U.S. Dollars, and all currency gains or losses are recorded in the consolidated statements of operations and comprehensive income (loss). There are many factors that affect foreign exchange rates and the resulting exchange gains and losses, many of which are beyond our influence.
See Note 12 - Venezuela for a discussion of currency exchange rates and currency exchange risk on Harvest Vinccler’s and Petrodelta’s businesses.
Cash and Cash Equivalents
Cash equivalents include money market funds and short term certificates of deposit with original maturity dates of less than three months.
Restricted Cash
Restricted cash is classified as current or non-current based on the terms of the agreement. Restricted cash at December 31, 2012 represents cash held in a U.S. bank used as collateral for a standby letter of credit issued in support of a performance bond for a joint study. Restricted cash at December 31, 2011 represents cash held in a U.S. bank used as collateral for a standby letter of credit issued as a payment guarantee for electric wireline services to be provided during the drilling of the two exploratory wells on Block 64 EPSA. The restricted cash was returned to us on April 18, 2012.
Financial Instruments
Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, accounts receivable, dividend receivable, notes payable and derivative financial instruments. We maintain cash and cash equivalents in bank deposit accounts with commercial banks with high credit ratings, which, at times may exceed the federally insured limits. We have not experienced any losses from such investments. Concentrations of credit risk with respect to accounts receivable are limited due the nature of our receivables, which include primarily income tax receivables. In the normal course of business, collateral is not required for financial instruments with credit risk.
Notes Receivable
Notes receivable bear interest and can have due dates that are less than one year or more than one year. Amounts outstanding under the notes bear interest at a rate based on the current prime rate and are recorded at face value. Interest income is recognized over the life of the note.
Each note is analyzed to determine if it is impaired pursuant to ASU 2010-20, which is included in ASC 310, “Receivables”. A note is impaired if it is probable that we will not collect all principal and interest contractually due. We do not accrue interest when a note is considered impaired. All cash receipts on impaired notes are applied to reduce the accrued interest on the note until the interest is made current and, thereafter, applied to reduce the principal amount of such notes.
Other Assets
Other assets consist of business development acquisition costs associated with new business development projects, prepaid expenses which are expected to be realized in the next 12 to 24 months deferred financing costs and a long-term receivable for value added tax (“VAT”) credits related to the Budong PSC. New business development acquisition costs are reclassified to oil and gas properties or expensed depending on management’s assessment of the project under ASC 932-360-35-19 “Sufficient Progress Assessment”. Deferred financing costs relate to specific financing and are amortized over the life of the financing to which the costs relate. See Note 6 - Long-Term Debt. The VAT receivable is reimbursed through the sale of hydrocarbons. See Note 14 - Indonesia for development plans for the Budong PSC.
At December 31, 2012, other assets included $0.2 million of long-term prepaid expenses, $3.2 million of deferred financing costs and $3.5 million of long-term VAT receivable. At December 31, 2011, other assets consisted of $0.4 million of new business development costs, $1.0 million of deferred financing costs and $3.3 million of long-term VAT receivable.
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Other Assets at December 30, 2012 also includes a blocked payment of $0.7 million (2011: $0.7 million) net to our 66.667 percent interest related to our drilling operations in Gabon in accordance with the U.S. sanctions against Libya as set forth in Executive Order 13566 of February 25, 2011, and administered by the United States Treasury Department’s Office of Foreign Assets Control (“OFAC”). See Note 7 - Commitments and Contingencies.
Investment in Equity Affiliates
We evaluate our investments in unconsolidated companies under ASC 323, “Investments - Equity Method and Joint Ventures.” Investments in which we have significant influence are accounted for under the equity method of accounting. Under the equity method, Investment in Equity Affiliates is increased by additional investments and earnings and decreased by dividends and losses.
We review our Investment in Equity Affiliates for impairment whenever events and circumstances indicate a loss in investment value is other than a temporary decline. At December 31, 2012, we reviewed our investment in Petrodelta under the terms of the share purchase agreement (see Note 6 - Dispositions, Share Purchase Agreement (“SPA”)). The SPA purchase price, subject to adjustment as described in the SPA, exceeded the carrying value of our equity investment, the dividend receivable and advances to equity affiliate. As such, we concluded that there was no impairment to our equity investment as of December 31, 2012.
There are many factors to consider when evaluating an equity investment for possible impairment. Currency devaluations, inflationary economies, and cash flow analysis are some of the factors we consider in our evaluation for possible impairment. At December 31, 2012, there were no events that would indicate that our equity investment in Petrodelta had sustained a loss in value that is other than temporary.
The SPA was terminated on February 19, 2013 and a devaluation of the Bolivar occurred on February 8, 2013. We do not believe either of these events impact our conclusion regarding the value of our equity investment at December 31, 2012.
We measure and disclose our noncontrolling interests in accordance with the provisions of ASC 810 “Consolidation”. Our noncontrolling interest relates to Vinccler’s indirectly owned 20 percent interest in Harvest Holding (see Note 1 - Organization).
Oil and Gas Properties
The major components of property and equipment at December 31 are as follows (in thousands):
Property and equipment are stated at cost less accumulated depletion, depreciation and amortization (“DD&A”). Costs of improvements that appreciably improve the efficiency or productive capacity of existing properties or extend their lives are capitalized. Maintenance and repairs are expensed as incurred. Upon retirement or sale, the cost of property and equipment, net of the related accumulated DD&A, is removed and, if appropriate, gains or losses are recognized in investment earnings and other. We did not record any depletion expense in the years ended December 31, 2012, 2011, or 2010.
We follow the successful efforts method of accounting for our oil and gas properties. Under this method, exploration costs such as exploratory geological and geophysical costs, delay rentals and exploration overhead are charged against earnings as incurred. Costs of drilling exploratory wells are capitalized pending determination of whether proved reserves can be attributed to the area as a result of drilling the well. If management determines that proved reserves, as that term is defined in Securities and Exchange Commission (“SEC”) regulations, have not been
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discovered, capitalized costs associated with the drilling of the exploratory well are charged to expense. Costs of drilling successful exploratory wells, all development wells, and related production equipment and facilities are capitalized and depleted or depreciated using the unit-of-production method as oil and gas is produced. At December 31, 2012, we expensed to dry hole costs $0.7 million related to the drilling of Karama-1 (“KD-1”) and first sidetrack, KD-1ST, on the Budong PSC and $4.9 million related to the drilling of Al Ghubar North-A (“AGN-1”) on Block 64 EPSA. At December 31, 2011, we expensed to dry hole costs $14.0 million related to the drilling of Lariang-1 (“LG-1”) on the Budong PSC, $26.0 million related to the drilling of KD-1 and KD-1ST on the Budong PSC, $6.9 million related to the drilling of Mafraq South-A (“MFS-1”) on Block 64 EPSA, and $2.8 million related to the drilling of AGN-1 on Block 64 EPSA. See Note 14 - Indonesia and Note 16 - Oman.
Leasehold acquisition costs are initially capitalized. Acquisition costs of unproved leaseholds are assessed for impairment during the holding period. Costs of maintaining and retaining unproved leaseholds, as well as impairment of unsuccessful leases, are included in exploration expense. Impairment is based on specific identification of the lease. Costs of expired or abandoned leases are charged to exploration expense, while costs of productive leases are transferred to proved oil and gas properties.
Proved oil and gas properties are reviewed for impairment at a level for which identifiable cash flows are independent of cash flows of other assets when facts and circumstances indicate that their carrying amounts may not be recoverable. In performing this review, future net cash flows are determined based on estimated future oil and gas sales revenues less future expenditures necessary to develop and produce the reserves. If the sum of these undiscounted estimated future net cash flows is less than the carrying amount of the property, an impairment loss is recognized for the excess of the property’s carrying amount over its estimated fair value, which is generally based on discounted future net cash flows. We did not have any proved oil and gas properties in 2012, 2011 or 2010.
Costs of drilling and equipping successful exploratory wells, development wells, asset retirement liabilities and costs to construct or acquire offshore platforms and other facilities, are depleted using the unit-of-production method based on total estimated proved developed reserves. Costs of acquiring proved properties, including leasehold acquisition costs transferred from unproved leaseholds, are depleted using the unit-of-production method based on total estimated proved reserves. All other properties are stated at historical acquisition cost, net of allowance for impairment, and depreciated using the straight-line method over the useful lives of the assets.
Unproved property costs, excluding oilfield inventories, consist of (in millions):
At December 31, 2012, we impaired the carrying value of Block 64 EPSA, $6.4 million, and WAB -21, $2.9 million. At December 31, 2011, we impaired the carrying value of West Bay, $3.3 million.
Other Administrative Property
Furniture, fixtures and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are recorded at cost and amortized using the straight-line method over the life of the applicable lease. For the year ended December 31, 2012, depreciation expense was $0.4 million (2011: $0.5 million, 2010: $0.5 million).
Reserves
We measure and disclose our oil and gas reserves in accordance with the provisions of the SEC’s Modernization of Oil and Gas Reporting and ASC 932, “Extractive Activities - Oil and Gas” (“ASC 932”). All of our reserves are owned through our equity investment in Petrodelta. We do not have any wholly owned reserves at December 31, 2012.
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Capitalized Interest
We capitalize interest costs for qualifying oil and gas properties. The capitalization period begins when expenditures are incurred on qualified properties, activities begin which are necessary to prepare the property for production and interest costs have been incurred. The capitalization period continues as long as these events occur. The average additions for the period are used in the interest capitalization calculation. During the year ended December 31, 2012, we capitalized interest costs for qualifying oil and gas property additions of $3.0 million (2011: $2.3 million, 2010: $1.8 million).
Derivative Financial Instruments
Under ASC 480 “Distinguishing Liabilities from Equity”, certain of our financial instruments with anti-dilution protection features do not meet the conditions to obtain equity classification, as there are conditions which may require settlement by transferring assets, and are required to be carried as derivative liabilities, at fair value, with changes in fair value reflected in our consolidated statements of operations and comprehensive income (loss). See Note 10 - Warrant Derivative Liabilities for additional disclosures. In the occurrence of a fundamental change, we are required to repurchase the Warrants at the higher of (1) the fair market value of the warrant and (2) a valuation based on a computation of the option value of the Warrant using the Black-Scholes calculation method using the assumptions described in the Warrant Agreement. A fundamental change is defined as “the occurrence of one of the following events: a) a person or group becomes the direct or indirect owner of more than 50% of the voting power of the outstanding common stock, b) a merger event or similar transaction in which the majority owners before the transaction fail to own a majority of the voting power of the Company after the transaction, and c) approval of a plan of liquidation or dissolution of the Company or sale of all or substantially all of the Company’s assets.”
Fair Value Measurements
We measure and disclose our fair values in accordance with the provisions of ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy assigns the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 measurements are inputs that are observable for assets or liabilities, either directly or indirectly, other than quoted prices included within Level 1. We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable.
Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques (such the Monte Carlo model) are highly volatile and sensitive to changes in the trading market price of our common stock. Since derivative financial instruments are initially and subsequently carried at fair value, our (income) loss will reflect the volatility in these estimate and assumption changes.
Inherent in the Monte Carlo valuation model are assumptions related to expected stock price volatility, expected life, risk-free interest rate and dividend yield. We estimate the volatility of our common stock based on historical volatility that matched the expected remaining life of the warrants. The risk-free interest rate is based on the U.S. Treasury yield curve as of the valuation dates for a maturity similar to the expected remaining life of the warrants. The expected life of the warrants is assumed to be equivalent to their remaining contractual term. The dividend rate is based on the historical rate, which we anticipate to remain at zero.
As part of our overall valuation process, management employs processes to evaluate and validate the methodologies, techniques and inputs, including review and approval of valuation judgments, methods, models, process controls, and results. These processes are designed to help ensure that the fair value measurements and disclosures are appropriate, consistently applied, and reliable.
The Monte Carlo model is used on the warrants to appropriately value the potential future exercise price adjustments triggered by the anti-dilution provisions. See Note 10 - Warrant Derivative Liability. This requires Level 3 inputs which are based on our estimates of the probability and timing of potential future financings and fundamental transactions. The assumptions we used are summarized in the following tables for warrants that were outstanding as of any of the balance sheet dates presented on our consolidated balance sheets:
The following tables set forth by level within the fair value hierarchy our financial liabilities that were accounted for at fair value as of December 31, 2012 and 2011. As required by ASC 820, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value liabilities and their placement within the fair value hierarchy levels.
We record the net change in the fair value of the derivative positions listed above in unrealized gain (loss) on warrant derivative liabilities in our consolidated statements of operations and comprehensive income (loss). During the year ended December 31, 2012, an unrealized loss of $0.6 million was recorded to reflect the change in fair value of the warrants (2011: $9.8 million unrealized gain, 2010: $0.3 million unrealized gain).
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The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of ASC 825, Financial Instruments. The estimated fair value amounts have been determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The following table presents the estimated fair values of our fixed interest rate, long-term debt instrument (Level 3) as of December 31, 2012.
The fair value of our fixed interest debt instruments (Level 3) was calculated using a pricing model which incorporates transaction details such as contractual terms, maturity and, in certain instances, timing and amount of future cash flows, as well as assumptions related to liquidity and credit valuation adjustments of marketplace participants.
Changes in Level 3 Instruments Measured at Fair Value on a Recurring Basis
The following table provides a reconciliation of financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
During the year ended December 31, 2012, there were no transfers between Level 1, Level 2 and Level 3 liabilities.
Share-Based Compensation
We use a fair value based method of accounting for stock-based compensation. We utilize the Black-Scholes option pricing model to measure the fair value of stock options and stock appreciation rights (“SARs”). Restricted stock and restricted stock units (“RSUs”) are measured at their intrinsic values. See Note 9 - Stock-Based Compensations and Stock Purchase Plans.
Income Taxes
Deferred income taxes reflect the net tax effects, calculated at currently enacted rates, of (a) future deductible/taxable amounts attributable to events that have been recognized on a cumulative basis in the financial statements or income tax returns, and (b) operating loss and tax credit carryforwards. A valuation allowance for deferred tax assets is recorded when it is more likely than not that the benefit from the deferred tax asset will not be realized.
We classify interest related to income tax liabilities as interest expense, and if applicable, penalties are recognized as a component of interest expense.
We do not provide deferred income taxes on undistributed earnings of our foreign subsidiaries for possible future remittances as all such earnings are permanently reinvested as part of our ongoing business.
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New Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2012-02, which is included in ASC 350, “Intangibles - Goodwill and Other”. This update gives an entity the option first to assess qualitative factors in assessing whether an asset is impaired. ASU No. 2012-02 is effective for annual and interim impairment test performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of ASU No. 2012-02 did not have a material impact on our consolidated financial position, results of operation or cash flows.
In January 2013, FASB issued ASU No. 2013-01, which is included in ASC 210, “Balance Sheet”, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” (“ASU No. 2013-01”). This update clarifies that the scope of ASU 2011-11: “Disclosures about Offsetting Assets and Liabilities” applies only to derivatives accounted for under ASC 815 “Derivatives and Hedging”, included bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities lending transactions that are either offset in accordance with ASC 210-20-45 or ASC 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. ASU No. 2013-01 is effective for fiscal years and interim periods within those years, beginning on or after January 1, 2013. Entities should provide the required disclosures retrospectively for all comparative periods presented. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial position, results of operation or cash flows.
In February 2013, FASB issued ASU No. 2013-02, which is included in ASC 220, “Comprehensive Income”, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU NO. 2013-02”). This update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under USGAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under USGAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under USGAAP that provide additional detail about those amounts. The amendments of ASU No. 2013-02 do not change the current requirements for reporting net income or other comprehensive income in financial statements. ASU No. 2013-02 is effective for fiscal years and interim periods within those years, beginning on or after December 15, 2012. Early adoption is permitted. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial position, results of operation or cash flows.
In February 2013, FASB issued ASU No. 2013-04, which is included in ASC 405, “Liabilities”, “Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date”. This update provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation with the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing guidance in USGAAP. Examples of obligations within the scope to ASU No. 2013-04 include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. ASU No. 2013-04 is effective for fiscal years and interim periods within those years beginning after December 5, 2013. Entities should provide the required disclosures retrospectively for all comparative periods presented. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial position, results of operation or cash flows.
In March 2013, FASB issued ASU No. 2013-05, which is included in ASC 830, “Foreign Currency Matters”, “Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU 2013-05”). This update resolves the diversity in practice regarding the release into net income of the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. ASU No. 2013-05 is effective for fiscal years and interim periods within those years beginning after December 5, 2013. ASU No. 2013-05 is not expected to have a material impact on our consolidated financial position, results of operation or cash flows.
Use of Estimates
The preparation of financial statements in conformity with USGAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved oil and natural gas reserve volumes and future development costs. Actual results could differ from those estimates.
Note 4 - Earnings Per Share
Basic earnings per common share (“EPS”) are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock.
(a) Includes net income attributable to noncontrolling interest.
The year ended December 31, 2012 per share calculations above exclude 3.9 million options and 2.4 million warrants because they were anti-dilutive. The year ended December 31, 2011 per share calculations above exclude 3.7 million options and 1.6 million warrants because they were anti-dilutive. The year ended December 31, 2010 per share calculations above exclude 2.9 million options and 1.6 million warrants because they were anti-dilutive.
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Note 5 - Dispositions
Share Purchase Agreement (“SPA”)
On June 21, 2012, we announced that we and our wholly owned subsidiary HNR Energia had entered into a SPA with PT Pertamina (Persero), a state-owned limited liability company existing under the laws of Indonesia (“Buyer”) under which HNR Energia agreed to sell, indirectly through subsidiaries, all of its interests in Venezuela for a cash purchase price of $725.0 million, subject to adjustment as described in the SPA.
The closing of the transaction was subject to receipt of three approvals, in addition to satisfaction of other conditions standard in transactions of this type: (a) approval by the Ministerio del Poder Popular de Petroleo y Mineria representing the Government of the Bolivarian Republic of Venezuela (which indirectly owns the other 60 percent interest in Petrodelta); (b) approval by the Government of the Republic of Indonesia in its capacity as Buyer’s sole shareholder; and (c) approval by the holders of a majority of Harvest’s common stock.
After receiving notice from Buyer that Buyer’s sole shareholder, the Government of Indonesia, had decided not to approve the transaction described in the SPA, on February 19, 2013, HNR Energia exercised its right to terminate the agreement in accordance with its terms.
Discontinued Operations
On May 17, 2011, we closed the transaction to sell the Antelope Project. The sale had an effective date of March 1, 2011. We received cash proceeds of approximately $217.8 million which reflects increases to the purchase price for customary adjustments and deductions for transaction related costs. We do not have any continuing involvement with the Antelope Project. The related gain on the sale was reported in discontinued operations in the second quarter of 2011.
During the year ended December 31, 2012, we incurred $0.1 million of expense related to settlement of royalty payments to the Mineral Management Services, write-offs of $5.2 million of accounts and note receivable and $3.6 million of accounts payable, carry obligation related to the settlement of all outstanding claims with a private third party on the Antelope Project. The note receivable related to a prospect leasing cost financing arrangement. The note receivable plus accrued interest was approximately $3.3 million at December 31, 2011, and was secured by a portion of the production from the Bar F #1-20-3-2 in Utah.
Revenue and net loss on the disposition of the Antelope Project are shown in the table below:
Note 6 - Long-Term Debt
Long-term debt consists of the following (in thousands):
On October 11, 2012, we closed the sale of $79.8 million aggregate principal amount of 11 percent senior unsecured notes due October 11, 2014. Under the terms of the notes, interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1, beginning January 1, 2013. The purchase price of the notes was paid in
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cash, except for approximately $10.5 million in principal amount, which was exchanged by a single purchaser in exchange for approximately $6.0 million in face value of that purchaser’s existing 8.25 percent unsecured senior convertible notes issued by Harvest in 2010. The 11 percent senior unsecured notes are general unsecured obligations, ranking equally in right of payment with all our future senior unsecured indebtedness. The senior unsecured notes are effectively subordinated to our secured indebtedness and are structurally subordinated to indebtedness and other liabilities of our subsidiaries. The net cash proceeds of the offering were approximately $63.5 million after deducting the issuance discount (approximately $2.8 million), placement fees, and other transaction costs (approximately $3.0 million).
The 11 percent senior unsecured notes were issued at a price of 96 percent of principal amount, or $3.2 million of original issue discount (“OID”). The OID is recorded as a discount on debt. Warrants to purchase up to 0.8 million share of our common stock with an exercise price of $10.00 per share were issued in connection with the 11 percent senior unsecured notes. See Note 9 - Stock-Based Compensation and Stock Purchase Plans, Common Stock Warrants. The fair value of the warrants, $2.8 million, is classified as Discount on Debt with a corresponding credit to additional paid in capital on our consolidated balance sheet at December 31, 2012. The OID is being amortized over the life of the debt. The discount on debt is amortized over the life of the debt.
If the event that a sale of assets (farm-outs are not included in the definition of a sale of assets in the indenture) for more than $5.0 million in the aggregate occurs, we are required to offer to all noteholders of our 11 percent senior unsecured notes to purchase the maximum principal amount of our 11 percent senior unsecured notes that may be purchased out of the sale proceeds at an offer price in cash in an amount equal to 105.5 percent of the principal amount plus accrued and unpaid interest, if any. In the event of a change in control or a sale of Petrodelta, the noteholders of our 11 percent senior unsecured notes have the right to require us to repurchase all or any part of the 11 percent senior unsecured notes at a repurchase price equal to 101 percent in the case of a change in control or 105.5 percent in the case of a sale of Petrodelta plus accrued interest. We assessed the prepayment requirements and concluded they qualified as an embedded derivative. We considered the probabilities of these events occurring and determined that the derivative had an immaterial value at December 31, 2012.
The indenture relating to the notes includes various additional covenants, including a covenant that we file annual reports on Form 10-K with the Securities and Exchange Commission, post the report on our web site and provide the report to the note holders within the time periods specified in the Commission’s rules and regulations. Because we did not timely file our annual report for the year ended December 31, 2012, we are in breach of this covenant. The indenture states that failure to comply with this covenant will be an event of default if the breach continues for a period of 60 days. Therefore, our failure to timely file our annual report for the year ended December 31, 2012, is not currently an event of default for purposes of the indenture, and if we are able to file our annual report within that 60-day period, there will be no event of default as a result of our late filing.
Financing costs associated with the 11 percent senior unsecured notes are being amortized over the life of the notes and are recorded in other assets. The balance for financing costs was $3.2 million at December 31, 2012.
On February 17, 2010, we closed an offering of $32.0 million in aggregate principal amount of our 8.25 percent senior convertible notes. Under the terms of the notes, interest was payable semi-annually in arrears on March 1 and September 1 of each year, beginning September 1, 2010. The senior convertible notes matured on March 1, 2013 unless earlier redeemed, repurchased or converted. The notes were convertible into shares of our common stock at a conversion rate of 175.2234 shares of common stock per $1,000 principal amount of senior convertible notes, equivalent to a conversion price of approximately $5.71 per share of common stock. The 8.25 percent senior convertible notes were general unsecured obligations, ranking equally with all of our other unsecured senior indebtedness, if any, and senior in right of payment to any of our subordinated indebtedness, if any.
Non-cash payment of debt during the year ended December 31, 2011 was $0.5 million of senior convertible notes converted into 0.1 million share of common stock at a conversion rate of $5.71 per share. Non-cash payment of debt during the year ended December 31, 2012 was $25.5 million of the senior convertible notes exchanged for 4.6 million shares of common stock at an effective exchange price of $5.59 per share. The difference between the exchange price and the market price on the date of the transaction is recorded as debt conversion expense on our consolidated statements of operations and comprehensive income (loss). The remaining balance of the senior convertible notes, $6.0 million, was repaid by way of a non-cash exchange for approximately $10.5 million of the 11 percent senior unsecured notes, the value of which was agreed to by us and the noteholder that the noteholder would have otherwise attained had the noteholder converted the note into shares of common stock. The difference between the value of the senior convertible notes exchanged and the senior unsecured notes received is recorded as a loss on extinguishment of debt on our consolidated statements of operations and comprehensive income (loss).
Financing costs associated with the 8.25 percent senior convertible notes were amortized over the life of the notes and were recorded in other assets. In connection with the exchange of convertible notes into our common stock, we reclassified $0.6 million of deferred financing costs to additional paid in capital. Financing costs for the convertible notes were fully amortized or reclassified at December 31, 2012 (2011: $1.0 million).
On October 29, 2010, we closed a $60.0 million term loan facility with MSD Energy Investments Private II, LLC (“MSD Energy”), an affiliate of MSD Capital, L.P., as the sole lender under the term loan facility. Under the terms of the term loan facility, interest was paid on a monthly basis at the initial rate of 10 percent and had a maturity of October 28, 2012. The initial rate of interest was scheduled to increase to 15 percent on July 28, 2011, the Bridge Date. Financing costs associated with the term loan facility were being amortized over the remaining life of the loan and were recorded in other assets. See Note 9 - Stock-Based Compensation and Stock Purchase Plans - Common Stock Warrants for a discussion of the warrants that were issued in connection with the $60.0 million term loan facility.
In May 2011, we prepaid our $60 million term loan facility. The early repayment resulted in a loss on extinguishment of debt of $13.1 million (Restated). The loss on extinguishment of debt includes the write off of the discount on debt ($10.6 million), a prepayment premium of 3.5 percent of the amount outstanding ($2.1 million), and expensing of financing costs related to the term loan facility ($0.4 million).
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The principal payment requirements for our long-term debt outstanding at December 31, 2012 are as follows (in thousands):
Note 7 - Commitments and Contingencies
We have employment contracts with five executive officers which provide for annual base salaries, eligibility for bonus compensation and various benefits. The contracts provide for a lump sum payment as a multiple of base salary in the event of termination of employment without cause. In addition, these contracts provide for payments as a multiple of base salary and bonus, excise tax reimbursement, outplacement services and a continuation of benefits in the event of termination without cause following a change in control. By providing one year notice, these agreements may be terminated by either party on or after May 31, 2013.
We have regional/technical offices in the United Kingdom and Singapore, and field offices in Jakarta, Indonesia; Port Gentil, Gabon; and Muscat, Oman to support field operations in those areas. At December 31, 2012, we had the following lease commitments for office space:
We have various contractual commitments pertaining to exploration, development and production activities. We entered the third exploration phase of the Dussafu PSC on May 28, 2012. The third exploration phase of the Dussafu PSC has a $7.0 million ($4.7 million net to our 66.667 percent interest) work commitment over a four year period. This commitment was fulfilled with the drilling of DTM-1. In January 2013, the Budong PSC partners were granted a four year extension of the initial six year exploration term of the Budong PSC to January 15, 2017. The extension of the initial exploration term includes an exploration well, which if not drilled by January 2016, results in the termination of the Budong PSC. Also, if this exploration well is not drilled within 18 months of the date of the Government of Indonesia approval of this transaction, we will be required to pay our partner in the Budong PSC $3.2 million. See Note 14 - Indonesia. These work commitments are non-discretionary; however, we do have the ability to control the pace of expenditures.
The following related class action lawsuits were filed on the dates specified in the United States District Court, Southern District of Texas: John Phillips v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (March 22, 2013); Sang Kim v. Harvest Natural Resources, Inc., James A. Edmiston, Stephen C. Haynes, Stephen D. Chesebro’, Igor Effimoff, H. H. Hardee, Robert E. Irelan, Patrick M. Murray and J. Michael Stinson (April 3, 2013); Chris Kean v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 11, 2013); Prastitis v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 17, 2013); Alan Myers v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 22, 2013); and Edward W. Walbridge and the Edward W. Walbridge Trust v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 26, 2013). The complaints allege that the Company made certain false or misleading public statements and demand that the defendants pay unspecified damages to the class action plaintiffs based on stock price declines. On April 18, 2013, the second, third and fourth listed actions were consolidated into the Phillips case. The Company and the other named defendants intend to vigorously defend the consolidated and other listed lawsuits.
On March 25, 2013, the Securities and Exchange Commission, notified the Company that it is conducting an inquiry related to certain matters disclosed in the Company’s Form 12B-25 announcing that it would be unable to file on a timely basis its 2012 Annual Report on Form 10-K, including certain errors in the Company’s financial statements and weaknesses in the Company’s internal controls. The Company is engaged in discussions with the Commission concerning these matters.
In June 2012, the operator of the Budong PSC received notice of a claim related to the ownership of part of the land comprising the Karama-1 (“KD-1”) drilling site. The claim asserts that the land on which the drill site is located is partly owned by the claimant. The operator purchased the site from local landowners in January 2010, and the purchase was approved by BPMIGAS, Indonesia’s oil and gas regulatory authority. The claimant is seeking compensation of 16 billion Indonesia Rupiah (approximately $1.7 million, $1.2 million net to our 71.61 percent cost sharing interest) for land that was purchased at a cost of $4,100 in January 2010. On or about March 8, 2013, the operator learned that the court has ruled to dismiss the claim because the claim had not been filed against the proper parties to the claim. The claimant can appeal the dismissal once the ruling has been issued in writing.
In May 2012, Newfield Production Company (“Newfield”) filed notice pursuant to the Purchase and Sale Agreement between Harvest (US) Holdings, Inc. (“Harvest US”), a wholly owned subsidiary of Harvest, and Newfield dated March 21, 2011 (the “PSA”) of a potential environmental claim involving certain wells drilled on the Antelope Project. The claim asserts that locations constructed by Harvest US were built on, within, or otherwise impact or potentially impact wetlands and other water bodies. The notice asserts that to the extent of potential penalties or other obligations that might result from potential violations that Harvest US indemnifies Newfield pursuant to the PSA. In June 2012, we provided Newfield with notice pursuant to the PSA (1) denying that Newfield has any right to indemnification from us, (2) alleging that any potential environmental claim related to Newfield’s notice would be an assumed liability under the PSA and (3) asserting that Newfield indemnify us pursuant to the PSA. We dispute Newfield’s claims and plan to vigorously defend against them. We are unable to estimate the amount or range of any possible loss.
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On May 31, 2011, the United Kingdom branch of our subsidiary, Harvest Natural Resources, Inc. (UK), initiated a wire transfer of approximately $1.1 million ($0.7 million net to our 66.667 percent interest) intending to pay Libya Oil Gabon S.A. (“LOGSA”) for fuel that LOGSA supplied to our subsidiary in the Netherlands, Harvest Dussafu, B.V., for the company’s drilling operations in Gabon. On June 1, 2011, our bank notified us that it had been required to block the payment in accordance with the U.S. sanctions against Libya as set forth in Executive Order 13566 of February 25, 2011, and administered by OFAC, because the payee, LOGSA, may be a blocked party under the sanctions. The bank further advised us that it could not release the funds to the payee or return the funds to us unless we obtain authorization from OFAC. On October 26, 2011, we filed an application with OFAC for return of the blocked funds to us. Unless that application is approved, the funds will remain in the blocked account, and we can give no assurance when, or if, OFAC will permit the funds to be released. As of May 2, 2013, our October 26, 2011 application for the return of the blocked funds remains pending with OFAC.
Robert C. Bonnet and Bobby Bonnet Land Services vs. Harvest (US) Holdings, Inc., Branta Exploration & Production, LLC, Ute Energy LLC, Cameron Cuch, Paula Black, Johnna Blackhair, and Elton Blackhair in the United States District Court for the District of Utah. This suit was served in April 2010 on Harvest and Elton Blackhair, a Harvest employee, alleging that the defendants, among other things, intentionally interfered with Plaintiffs’ employment agreement with the Ute Indian Tribe - Energy & Minerals Department and intentionally interfered with Plaintiffs’ prospective economic relationships. Plaintiffs seek actual damages, punitive damages, costs and attorney’s fees. We dispute Plaintiffs’ claims and plan to vigorously defend against them. We are unable to estimate the amount or range of any possible loss.
Uracoa Municipality Tax Assessments. Our Venezuelan subsidiary, Harvest Vinccler, has received nine assessments from a tax inspector for the Uracoa municipality in which part of the Uracoa, Tucupita and Bombal fields are located as follows:
•
Three claims were filed in July 2004 and allege a failure to withhold for technical service payments and a failure to pay taxes on the capital fee reimbursement and related interest paid by PDVSA under the Operating Service Agreement (“OSA”). Harvest Vinccler has filed a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss one of the claims and has protested with the municipality the remaining claims.
•
Two claims were filed in July 2006 alleging the failure to pay taxes at a new rate set by the municipality. Harvest Vinccler has filed a protest with the Tax Court in Barcelona, Venezuela, on these claims.
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Two claims were filed in August 2006 alleging a failure to pay taxes on estimated revenues for the second quarter of 2006 and a withholding error with respect to certain vendor payments. Harvest Vinccler has filed a protest with the Tax Court in Barcelona, Venezuela, on one claim and filed a protest with the municipality on the other claim.
•
Two claims were filed in March 2007 alleging a failure to pay taxes on estimated revenues for the third and fourth quarters of 2006. Harvest Vinccler has filed a protest with the municipality on these claims.
Harvest Vinccler disputes the Uracoa tax assessments and believes it has a substantial basis for its positions. Harvest Vinccler is unable to estimate the amount or range of any possible loss. As a result of the SENIAT’s, the Venezuelan income tax authority, interpretation of the tax code as it applies to operating service agreements, Harvest Vinccler has filed claims in the Tax Court in Caracas against the Uracoa Municipality for the refund of all municipal taxes paid since 1997.
Libertador Municipality Tax Assessments. Harvest Vinccler has received five assessments from a tax inspector for the Libertador municipality in which part of the Uracoa, Tucupita and Bombal fields are located as follows:
•
One claim was filed in April 2005 alleging the failure to pay taxes at a new rate set by the municipality. Harvest Vinccler has filed a protest with the Mayor’s Office and a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss the claim. On April 10, 2008, the Tax Court
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suspended the case pending a response from the Mayor’s Office to the protest. If the municipality’s response is to confirm the assessment, Harvest Vinccler will defer to the competent Tax Court to enjoin and dismiss the claim.
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Two claims were filed in June 2007. One claim relates to the period 2003 through 2006 and seeks to impose a tax on interest paid by PDVSA under the OSA. The second claim alleges a failure to pay taxes on estimated revenues for the third and fourth quarters of 2006. Harvest Vinccler has filed a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss both claims.
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Two claims were filed in July 2007 seeking to impose penalties on tax assessments filed and settled in 2004. Harvest Vinccler has filed a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss both claims.
Harvest Vinccler disputes the Libertador allegations set forth in the assessments and believes it has a substantial basis for its position. Harvest Vinccler is unable to estimate the amount or range of any possible loss. As a result of the SENIAT’s interpretation of the tax code as it applies to operating service agreements, Harvest Vinccler has filed claims in the Tax Court in Caracas against the Libertador Municipality for the refund of all municipal taxes paid since 2002.
On May 4, 2012, Harvest Vinccler learned that the Political Administrative Chamber of the Supreme Court of Justice has issued a decision dismissing one of Harvest Vinccler’s claims against the Libertador Municipality. Harvest Vinccler continues to believe that it has sufficient arguments to maintain its position in accordance with the Venezuelan Constitution. Harvest Vinccler plans to present a request of Constitutional Revision to the Constitutional Chamber of the Supreme Court of Justice once it is notified officially of the decision. As of May 2, 2013, Harvest Vinccler has not received official notification of the decision. Harvest Vinccler is unable to predict the impact of this decision on the remaining outstanding municipality claims and assessments.
We are a defendant in or otherwise involved in other litigation incidental to our business. In the opinion of management, there is no such litigation which will have a material adverse impact on our financial condition, results of operations and cash flows.
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Note 8 - Taxes
Taxes on Income
The tax effects of significant items comprising our net deferred income taxes as of December 31, 2012, are as follows:
Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets (“DTAs”). A significant piece of objective negative evidence evaluated was the cumulative losses incurred in our foreign operating entities over the three-year period ended December 31, 2012. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth. We have therefore placed a valuation allowance (“VA”) on all of our foreign DTAs with the exception of $0.8 million related to NOL carryforwards in Venezuela which would be realized upon settlement of uncertain tax positions.
Management also reviewed the earnings history of our U.S. operations and determined that, with the exception of 2010 and 2011 when we had domestic production from our Utah assets and subsequently sold those assets, we have a history of domestic losses and are not currently involved in any domestic exploration and production activity. We have therefore placed a VA on our domestic DTAs, with the exception of $22 thousand that we expect to be realized by our UK branch.
The components of loss from continuing operations before income taxes are as follows:
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The provision (benefit) for income taxes on continuing operations consisted of the following at December 31:
A comparison of the income tax expense (benefit) on continuing operations at the federal statutory rate to our provision for income taxes is as follows:
Rate differentials for foreign income result from tax rates different from the U.S. tax rate being applied in foreign jurisdictions.
We do not provide deferred income taxes on undistributed earnings of our foreign subsidiaries for possible future remittances as all such earnings are permanently reinvested as part of our ongoing business. Any dividends that are repatriated in the future would come out future earnings from our foreign subsidiaries. At December 31, 2012, we have the following net operating losses available for carryforward (in thousands):
If the U.S. operating loss carryforwards are ultimately realized, approximately $1.5 million will be credited to additional paid in capital for tax benefits associated with deductions for income tax purposes related to stock options and convertible debt.
Accumulated Undistributed Earnings of Foreign Subsidiaries
As of December 31, 2012, the book-tax outside basis difference in our foreign subsidiary that has been indefinitely reinvested was approximately $331 million. No U.S. taxes have been recorded on these earnings. In general, it is our practice and intention to reinvest the earnings of our non-U.S. subsidiaries in those operations. All of our current exploration activity is outside of the U.S. We currently intend to utilize our unremitted foreign earnings to fund international projects, including the development of our properties in Gabon, Indonesia and South America.
Under ASC 740-30-25-17, no deferred tax liability must be recorded if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings or that the earnings will be remitted in a tax-free manner. Management must consider numerous factors in determining timing and amounts of possible future distribution of these earnings to the parent company and whether a U.S. deferred tax liability should be recorded for these earnings. These factors include the future operating and capital requirements of both the parent company and the subsidiaries, remittance restrictions imposed by foreign governments or financial agreements and tax consequences of the remittance, including possible application of U.S. foreign tax credits and limitations on foreign tax credits that may be imposed by the Internal Revenue Service (“IRS”) or IRS regulations.
If we were to make a distribution of our foreign earnings in the form of dividends, we would likely be subject to U.S. income taxes. Pursuant to ASC 740-30-50-2, we have estimated that the potential U.S. tax cost if we were to repatriate all of our currently unremitted foreign earnings through a dividend would be approximately $113 million based upon our foreign tax credit position in the U.S.
Accounting for Uncertainty in Income Taxes
The FASB issued ASC 740-10 (prior authoritative literature: Financial Interpretation No. [“FIN”] 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 [“FIN 48”]) to create
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a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.
We or one of our subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local tax examinations by tax authorities for years before 2008. Our primary income tax jurisdictions and their respective open audit years are:
A reconciliation of the beginning amount, and current year additions, of unrecognized tax benefits follows:
If the above tax benefits were recognized, the full amount would affect the effective tax rate. We have accrued interest of $0.1 million, and penalty of $0.3 million, a deduction for which has been recorded in pretax income. We believe that it is likely that $5.0 million of the uncertain tax position will be resolved within the next twelve months, and the amount of unrecognized tax benefits will significantly decrease.
Note 9 - Stock-Based Compensation and Stock Purchase Plans
Total share-based compensation expense, which includes stock options, restricted stock, stock appreciation rights (“SARs”), and restricted stock units (“RSUs”), totaled $5.2 million for the year ended December 31, 2012 (2011: $4.8 million, 2010: $5.7 million). All awards utilize the straight line method of amortization over vesting terms. RSUs and SARs can be cash settled and are accounted for as liability instruments.
The cash flows resulting from tax deductions in excess of the compensation cost recognized for share-based awards (excess tax benefits) are classified as financing cash flows. The actual tax benefit realized from share-based awards during the year ended December 31, 2011 was $2.5 million. We did not realize tax benefits from share-based awards during the years ended December 31, 2012 or 2010.
Long Term Incentive Plans
As of December 31, 2012, we had several long term incentive plans under which stock options, restricted stock, SARs and RSUs can be granted to eligible participants including employees, non-employee directors and consultants of our Company or subsidiaries:
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2010 Long Term Incentive Plan (“2010 Plan”) - Provides for the issuance of up to 1,700,000 shares of our common stock in satisfaction of stock options, SARs, restricted stock, RSUs and other stock-based awards. No more than 500,000 shares may be granted as restricted stock and no individual may be granted more than 1,000,000 stock options or SARs. In the event of a change in control, all outstanding stock options and SARs become immediately exercisable to the extent permitted by the plan, and any restrictions on restricted stock and RSUs lapse.
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2006 Long Term Incentive Plan (“2006 Plan”) - Provides for the issuance of up to 1,825,000 shares of our common stock in satisfaction of stock options, SARs and restricted stock. No more than 325,000 shares may be granted as restricted stock, and no individual may be granted more than 900,000 options or SARs and not more than 175,000 share of restricted stock during any period of three consecutive calendar years. The 2006 Plan also permits the granting of performance awards to eligible employees and consultants. In the event of a change in control, all outstanding stock options and SARs become immediately exercisable to the extent permitted by the plan, and any restrictions on restricted stock lapse.
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2004 Long Term Incentive Plan (“2004 Plan”) - Provides for the issuance of up to 1,750,000 shares of our common stock in satisfaction of stock options, SARs and restricted stock. No more than 438,000 shares may be granted as restricted stock, and no individual may be granted more than 438,000 options and not more than 110,000 share of restricted stock over the life of the plan. The 2004 Plan also permits the granting of performance awards to eligible employees and consultants. In the event of a change in control, all outstanding stock options and SARs become immediately exercisable to the extent permitted by the plan, and any restrictions on restricted stock lapse.
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2001 Long Term Stock Incentive Plan (“2001 Plan”) - Provides for the issuance of up to 1,697,000 shares of our common stock in the form of Incentive Stock Options and Non-Qualified Stock Options. No officer may be granted more than 500,000 stock options during any one fiscal year, as adjusted for any changes in capitalization, such as stock splits. In the event of a change in control, all outstanding options become immediately exercisable to the extent permitted by the plan.
Stock Options
Stock options granted under the plans must be no less than the fair market value of our common stock on the date of grant. Stock options granted under the plans generally are exercisable in varying cumulative periodic installments after one year. Stock options granted under the plans expire five to ten years from the date of grant. Stock options to purchase 85,006 common shares remained available for grant as of December 31, 2012 (2011: 507,298). Of the common shares available for grant as of December 31, 2012, all of these shares are also available for issuance in the form of restricted shares.
The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option-pricing model which uses assumptions for the risk-free interest rate, volatility, dividend yield and the expected term of the options. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for a period equal to the expected term of the option. Expected volatility is based on historical volatilities of our stock. We do not assume any dividend yield since we do not pay dividends. The expected term of options granted is the weighted average life of stock options and represents the period of time that options are expected to be outstanding.
We also consider an estimated forfeiture rate for these stock option awards, and we recognize compensation cost only for those shares that are expected to vest, on a straight-line basis over the requisite service period of the award, which is generally the vesting term of three to five years. The forfeiture rate is based on historical experience.
Stock option transactions under our various stock-based employee compensation plans are presented below:
Of the options outstanding, 2.5 million were exercisable at weighted-average exercise price of $10.12 as of December 31, 2012 (2011: 2.2 million at $10.15; 2010: 1.8 million at $10.27).
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During the year ended December 31, 2012, we awarded stock options vesting over three years to purchase 451,298 of our common shares to our employees and executive officers (2011: 498,500 stock options; 2010: 477,000 stock options).
The value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
(1) Expected volatilities are based on historical volatilities of our stock.
A summary of our unvested stock option awards as of December 31, 2012, and the changes during the year then ended is presented below:
The total intrinsic value of stock options exercised during the year ended December 31, 2012 was $0.3 million (2011: $1.4 million; 2010: $2.5 million). The total fair value of stock options that vested during the year ended December 31, 2012, was $1.9 million (2011: $2.7 million; 2010: $2.6 million).
As of December 31, 2012, there was $2.4 million of total future compensation cost related to unvested stock option awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 2.6 years.
Restricted Stock
Restricted stock is issued on the grant date, but cannot be sold or transferred. Restricted stock granted to directors vest one year after date of grant. Restricted stock granted to employees vest at the third year after date of grant. Vesting of the restricted stock is dependent upon the employee’s continued service to Harvest.
A summary of our restricted stock awards as of December 31, 2012, and the changes during the year then ended is presented below:
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During 2012, we awarded 2,000 shares of restricted stock to new hire employees as employment inducement grants under a New York Stock Exchange (“NYSE”) exception (2011: 181,050 shares to employees and directors). These awards had an aggregate fair value at their date of grant of $11,700 (2011: $2.0 million). The restricted stock is schedule to vest at the third year after date of grant for employees and one year after date of grant for directors. The value of the restricted stock that vested during the year ended December 31, 2012 was $0.8 million (2011: $3.4 million; 2010: $1.4 million). The weighted average grant date fair value of awards granted in 2011 was $11.21 and 2010 was $7.10.
As of December 31, 2012 there was $0.8 million of total future compensation cost related to unvested restricted stock awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 1.2 years.
Stock Appreciation Rights (“SARs”)
All SAR awards granted to date have been granted outside of active long-term incentive plans and are held by Harvest employees. SARs granted in 2009 vest ratably over three years beginning with the third year of grant. SARs granted in 2012 vest ratably over three years beginning in the first year of grant. Vesting of SARs is dependent upon the employee’s continued service to Harvest. SAR awards are settled either in cash or Harvest common stock if available through an equity compensation plan. For recording of compensation, we assume the SAR award will be cash-settled and record compensation expense based on the fair value of the SAR awards at the end of each period.
SAR award transactions under our employee compensation plans are presented below:
Of the SAR awards outstanding, 74,997 were exercisable at weighted-average exercise price of $4.60 as of December 31, 2012 (2011: 83,000 at $4.60; 2010: none).
During the year ended December 31, 2012, we awarded 707,202 SARs vesting over three years to our employees and executive officers (2011: none; 2010: none).
The value of each SAR award is estimated on the date of grant using the Black-Scholes option pricing model using the assumptions discussed above.
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A summary of our unvested SAR awards as of December 31, 2012, and the changes during the year then ended is presented below:
The total intrinsic value of SAR awards exercised during the year ended December 31, 2012 was $0.3 million. No SAR awards were exercised during the years ended December 31, 2011 or 2010. The total fair value of SAR awards that vested during the year ended December 31, 2012, was $0.3 million (2011: $0.2 million; 2010: none).
As of December 31, 2012, there was $3.7 million of total future compensation cost related to unvested SAR awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 2.3 years.
Restricted Stock Units (“RSUs”)
All RSU awards granted to date have been granted outside of active long-term incentive plans, are held by Harvest employees and directors, and are settled either in cash or Harvest common stock if available through an equity compensation plan. RSU awards granted in 2009 vest ratably over three years beginning with the third year of grant. RSU awards granted in 2012 to employees vest at the third year after date of grant. RSU awards granted in 2012 to directors vest one year after date of grant. Vesting of the RSU awards is dependent upon the employee’s and director’s continued service to Harvest.
A summary of our RSU awards as of December 31, 2012, and the changes during the year then ended is presented below:
During 2012, we awarded 388,000 RSUs to employees (2011: none, 2010: none). These RSU awards had an aggregate fair value at their date of grant of $2.0 million (2011: none, 2010: none). The 70,994 RSU awards which vested in 2012 were settled with Harvest common stock. The value of the RSU awards that vested during the year ended December 31, 2012 was $0.4 million (2011: $0.6 million; 2010: none).
As of December 31, 2012 there was $2.7 million of total future compensation cost related to unvested RSU awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 2.0 years.
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Common Stock Warrants
In connection with a $60 million term loan facility issued in November 2010, we issued (1) 1.2 million warrants exercisable at any time on or after the closing date of the term loan facility for a period of five years from the closing date on a cashless exercise basis at $15 per share until July 28, 2011, the Bridge Date, at which time the exercise price per share would be repriced to equal the lower of $15 or 120 percent of the average closing bid price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date (“Tranche A”); (2) 0.4 million warrants exercisable at any time on or after the closing date of the term loan facility for a period of five years from the closing date on a cashless exercise basis at $20 per share until the Bridge Date, at which time the exercise price per share would be repriced to equal the lower of $15 or 120 percent of the average closing bid price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date (“Tranche B”); and (3) 4.4 million warrants exercisable at any time on or after the Bridge Date for a period of five years from the Bridge Date on a cashless exercise basis at the lower of $15 per share or 120 percent of the average closing price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date (“Tranche C”) (“collectively “the Warrants”). Tranche C was redeemable by Harvest for $0.01 per share at any time prior to the Bridge Date in conjunction with the repayment of the loan prior to the Bridge Date.
On May 17, 2011, in connection with the payment of the term loan facility, we redeemed all of Tranche C at $0.01 per share. The cost to redeem Tranche C ($44,000) was expensed to loss on extinguishment of debt in the six months ended June 30, 2011.
On July 28, 2011, the Bridge Date, Tranche A and Tranche B were repriced to $14.78 per warrant which is the lower of $15 or 120 percent of the average closing bid price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date.
The Warrants include anti-dilution provisions which adjust the number of warrants and the exercise price per warrant based on the issuance of additional shares. The induced conversions related to the $32 million senior convertible notes triggered the anti-dilution provision which resulted in the issuance of 118,327 additional warrants in the year ended December 31, 2012 (2011: 2,007 additional warrants). In addition, the exercise price per share for all Warrants was repriced to $13.75 per warrant. The Warrants are classified as a liability on our consolidated balance sheets and marked to market. See Note 3 - Summary of Significant Accounting Policies, Restatement of Prior Period Financial Statements.
In the occurrence of a fundamental change, we are required to repurchase the Warrants at the higher of (1) the fair market value of the warrant and (2) a valuation based on a computation of the option value of the Warrant using the Black-Scholes calculation method using the assumptions described in the Warrant Agreement. A fundamental change is defined as “the occurrence of one of the following events: a) a person or group becomes the direct or indirect owner of more than 50% of the voting power of the outstanding common stock, b) a merger event or similar transaction in which the majority owners before the transaction fail to own a majority of the voting power of the Company after the transaction, and c) approval of a plan of liquidation or dissolution of the Company or sale of all or substantially all of the Company’s assets.”
In connection with the 11 percent senior unsecured notes issued October 11, 2012, we issued warrants to purchase up to 0.7 million share of our common stock with an exercise price of $10.00 per share. The warrants can be exercised at any time up until the three-year anniversary of the closing. The Black-Scholes option pricing model was used in pricing the warrants. The fair value of the warrants, $2.8 million, is classified as a discount on debt with a corresponding credit to additional paid in capital on our consolidated balance sheet at December 31, 2012.
The dates the warrants were issued, the expiration dates, the exercise prices and the number of warrants issued and outstanding at December 31, 2012 were:
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Note 10 - Warrant Derivative Liabilities
As of December 31, 2012, warrant derivative financial instruments consisted of 1,720,334 warrants (2011: 1,602,007 warrants) issued under the warrant agreements dated November 2010 in connection with a $60 million term loan facility (see Note 9 - Stock-Based Compensation and Stock Purchase Plans, Common Stock Warrants). The fair value of the warrants as of December 31, 2012 was $3.18 per warrant (2011: $3.04 per warrant).
These warrant agreements include provisions wherein we may be required to settle the warrant agreement by transferring assets. Consequently, under ASC 480-10-25-8, these warrants must be treated as a derivative liability, bifurcated from the host instrument, and recorded at fair value at each reporting date. In the occurrence of a fundamental change, we are required to repurchase the Warrants at the higher of (1) the fair market value of the warrant and (2) a valuation based on a computation of the option value of the Warrant using the Black-Scholes calculation method using the assumptions described in the Warrant Agreement. A fundamental change is defined as “the occurrence of one of the following events: a) a person or group becomes the direct or indirect owner of more than 50% of the voting power of the outstanding common stock, b) a merger event or similar transaction in which the majority owners before the transaction fail to own a majority of the voting power of the Company after the transaction, and c) approval of a plan of liquidation or dissolution of the Company or sale of all or substantially all of the Company’s assets.”
All our warrant derivative contracts are recorded at fair value and are located in the balance sheet as warrant derivative liability. The following table summarizes the effect on our income (loss) associated with changes in the fair values of our derivative financial instruments:
Note 11 - Operating Segments
We regularly allocate resources to and assess the performance of our operations by segments that are organized by unique geographic and operating characteristics. The segments are organized in order to manage
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regional business, currency and tax related risks and opportunities. Operations included under the heading “United States” include corporate management, cash management, business development and financing activities performed in the United States and other countries, which do not meet the requirements for separate disclosure. All intersegment revenues, other income and equity earnings, expenses and receivables are eliminated in order to reconcile to consolidated totals. Corporate general and administrative and interest expenses are included in the United States segment and are not allocated to other operating segments.
(a) Includes net income attributable to noncontrolling interest.
Note 12 - Venezuela
Harvest Vinccler’s and Petrodelta’s functional and reporting currency is the U.S. Dollar. They do not have currency exchange risk other than the official prevailing exchange rate that applies to their operating costs denominated in Venezuela Bolivars (“Bolivars”) (4.30 Bolivars per U.S. Dollar). However, during the year ended December 31, 2012, Harvest Vinccler exchanged approximately $1.5 million (2011: $1.2 million) through the Sistema de Transacciones con Títulos en Moneda Extranjera (“SITME”) and received an average exchange rate of 5.16 Bolivars (2011: 5.19 Bolivars) per U.S. Dollar. Petrodelta does not have, and has not had, any Bolivars pending government approval for settlement for U.S. Dollars at the official exchange rate or the SITME exchange rate.
The monetary assets that are exposed to exchange rate fluctuations are cash, accounts receivable, and other current assets. The monetary liabilities that are exposed to exchange rate fluctuations are accounts payable, accruals and other current liabilities. All monetary assets and liabilities incurred at the official Bolivar exchange rate are settled at the official Bolivar exchange rate. At December 31, 2012, the balances in Harvest Vinccler’s Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 6.2 million Bolivars and 5.7 million Bolivars, respectively. At December 31, 2012, the balances in Petrodelta’s Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 277.2 million Bolivars and 2,646.2 million Bolivars, respectively.
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On February 8, 2013, the Venezuelan government published in the Official Gazette the Exchange Agreement No. 14 which establishes new exchange rates for the Bolivar/U.S. Dollar currencies that became effective February 9, 2013. The exchange rate established in the Agreement is 6.30 Bolivars per U.S. Dollar. The Exchange Agreement also announced the elimination of SITME effective February 8, 2013. All exchanges of Bolivars must now transact through the Central Bank. As a result of the February 2013 devaluation, Harvest Vinccler estimates the impact of the devaluation to be approximately $0.1 million gain on revaluation of its assets and liabilities, and Petrodelta estimates the impact of the devaluation to be approximately $54.8 million gain on revaluation of its assets and liabilities.
On May 7, 2012, the Organic Law on Employment, Male and Female Workers (“Labor Law”) was published in the Official Gazette, the official government publication where laws, decrees, resolutions, instructions, and other regulations of general interest issued by the central government of Venezuela are published in order to make those acts valid and official. The Labor Law’s purpose is to regulate the relations between workers and employers. In August 2012, the labor contract between PDVSA and the labor union was signed. The new labor contract awarded salary increases to both union and non-union labor retroactive to December 2011. The new labor contract increased the effect of the Labor Law on Petrodelta by increasing the salaries on which the Labor Law benefits are calculated. Per the actuarial study that PDVSA commissioned, the effect of the Labor Law on Petrodelta’s business was $3.8 million ($1.2 million net to our 32 percent interest) for the year ended December 31, 2012. The Labor Law had no impact to Harvest Vinccler.
Note 13 - Investment in Equity Affiliates - Petrodelta, S.A.
See Note 5 - Dispositions, Share Purchase Agreement (“SPA”).
On October 25, 2007, the Venezuelan Presidential Decree which formally transferred to Petrodelta the rights to the Petrodelta Fields subject to the conditions of the Conversion Contract was published in the Official Gazette. Petrodelta is governed by its own charter and bylaws and will engage in the exploration, production, gathering, transportation and storage of hydrocarbons from the Petrodelta Fields for a maximum of 20 years from that date. Petrodelta operates a portfolio of properties in eastern Venezuela including large proven oil fields as well as properties with substantial opportunities for both development and exploration. Petrodelta is to undertake its operations in accordance with Petrodelta’s business plan as set forth in its conversion contract. Under its conversion contract, work programs and annual budgets adopted by Petrodelta must be consistent with Petrodelta’s business plan. Petrodelta’s business plan may be modified by a favorable decision of the shareholders owning at least 75 percent of the shares of Petrodelta.
The sale of oil and gas by Petrodelta to the Venezuelan government is pursuant to a Contract for Sale and Purchase of Hydrocarbons with PDVSA Petroleo S.A. (“PPSA”) signed on January 17, 2008. The form of the agreement is set forth in the Conversion Contract. Crude oil delivered from the Petrodelta Fields to PPSA is priced with reference to Merey 16 published prices, weighted for different markets, and adjusted for variations in gravity and sulphur content, commercialization costs and distortions that may occur given the reference price and prevailing market conditions. Merey 16 published prices are quoted and sold in U.S. Dollars. Natural gas delivered from the Petrodelta Fields to PPSA is priced at $1.54 per thousand cubic feet. Natural gas deliveries are paid in Bolivars, but the pricing for natural gas is referenced to the U.S. Dollar. PPSA is obligated to make payment to Petrodelta of each invoice within 60 days of the end of the invoiced production month by wire transfer, in U.S. Dollars in the case of payment for crude oil and natural gas liquids delivered, and in Bolivars in the case of payment for natural gas delivered, in immediately available funds to the bank accounts designated by Petrodelta. Major contracts for capital expenditures and lease operating expenditures are denominated in U.S. Dollars. Any dividend paid by Petrodelta will be made in U.S. Dollars.
When the Sales Contract was executed, Petrodelta was producing only one type of crude, Merey 16. Beginning in October 2011, the Ministry of the People’s Power for Petroleum and Mining (“MENPET”) determined that Petrodelta’s production flowing through the COMOR transfer point was a heavier type of crude, Boscan. Since Petrodelta was producing only Merey 16 when the Sales Contract was executed, the Boscan gravity and sulphur correction factors and crude pricing formula are not included in the Sales Contract. However, under the Sales Contract, PPSA is obligated to receive all of Petrodelta’s production. All production deliveries for all of Petrodelta’s fields have been certified by MENPET and acknowledged by PPSA. All pricing factors to be used in the Merey 16 and Boscan pricing formulas have been provided by and certified by MENPET to Petrodelta.
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Since the Sales Contract provides for only one crude pricing formula, the Sales Contract had to be amended to include the Boscan pricing formula to allow Petrodelta to invoice PPSA for El Salto crude oil deliveries. From October 1, 2011 through June 30, 2012, Petrodelta used the Boscan pricing formula as published in the Official Gazette on January 11, 2007 to record revenue from El Salto deliveries. Petrodelta subsequently received from PDVSA Trade and Supply a draft amendment to the Sales Contract. The pricing formula in the draft amendment was used to record revenue for El Salto field deliveries from July 1, 2012 through December 31, 2012, and revenue for El Salto deliveries for October 1, 2011 through June 30, 2012 was revised to reflect the pricing formula in the draft amendment. The only item included in the draft amendment is the Boscan pricing formula to be used in invoicing El Salto crude oil deliveries. All other terms and conditions of the Sales Contract remain in force. On January 28, 2013, Petrodelta’s board of directors endorsed the amendment to the Sales Contract. The amendment has to be approved by CVP’s board of directors and HNR Finance’s board of directors. Once these approvals are received, the amendment to the Sales Contract will be executed and PPSA will be invoiced for the deliveries.
At December 31, 2012, El Salto deliveries, net of royalties, covering the delivery months of October 2011 through December 2012 totaled approximately 4.0 MBls (1.3 MBls net to our 32 percent interest). The draft amendment to the Sales Contract pricing formula for Boscan based upon the deliveries and factors certified by MENPET, results in revenue for these deliveries of $352.7 million ($112.9 million net to our 32 percent interest). As of December 31, 2012, these deliveries for El Salto remain uninvoiced to PPSA.
As discussed in previous filings, PDVSA has failed to pay on a timely basis certain amounts owed to contractors that PDVSA has contracted to do work for Petrodelta. PDVSA purchases all of Petrodelta’s oil production. PDVSA and its affiliates have reported shortfalls in meeting their cash requirements for operations and planned capital expenditures, and PDVSA has fallen behind in certain of its payment obligations to its contractors, including contractors engaged by PDVSA to provide services to Petrodelta. In addition, PDVSA has fallen behind in certain of its payment obligations to Petrodelta, which payments Petrodelta would otherwise use to pay its contractors, including Harvest Vinccler. As a result, Petrodelta has experienced, and is continuing to experience, difficulty in retaining contractors who provide services for Petrodelta’s operations. We cannot provide any assurance as to whether or when PDVSA will become current on its payment obligations. Inability to retain contractors or to pay them on a timely basis is having an adverse effect on Petrodelta’s operations and on Petrodelta’s ability to carry out its business plan.
Harvest Vinccler has advanced certain costs on behalf of Petrodelta. These costs include consultants in engineering, drilling, operations, seismic interpretation, and employee salaries and related benefits for Harvest Vinccler employees seconded into Petrodelta. Currently, we have three employees seconded into Petrodelta. Costs advanced are invoiced on a monthly basis to Petrodelta. Harvest Vinccler is considered a contractor to Petrodelta, and as such, Harvest Vinccler is also experiencing the slow payment of invoices. During the year ended December 31, 2012, Harvest Vinccler advanced to Petrodelta $0.5 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advance. Petrodelta and Petrodelta’s board have not indicated that the advances are not payable, nor that they will not be paid. At December 31, 2012, we reclassified $2.1 million of the Advances to Affiliate to a long-term receivable due to slow payment and age of the advances. During the year ended December 31, 2011, we advanced Petrodelta $0.8 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advances. Although payment is slow and the balance is increasing, payments continue to be received.
In April 2011, the Venezuelan government published in the Official Gazette the Law Creating a Special Contribution on Extraordinary Prices and Exorbitant Prices in the International Hydrocarbons Market (“Windfall Profits Tax”). Windfall Profits Tax is deductible for Venezuelan income tax purposes. In February 2013, the Venezuelan government published in the Official Gazette an amendment to the Windfall Profits Tax. The amended Windfall Profits Tax establishes new levels for contribution of extraordinary prices (under $80 per barrel) and exorbitant prices (over $100 per barrel), and levels in-between, to the Venezuelan government. During the year ended December 31, 2012, Petrodelta recorded $291.4 million for Windfall Profits Tax (2011: $237.6 million).
One section of the Windfall Profits Tax states that royalties paid to Venezuela are capped at $70 per barrel, but the cap on royalties has not been defined as being applicable to in-cash, in-kind, or both. Per instructions received from PDVSA, Petrodelta reports royalties, whether paid in-cash or in-kind, at $70 per barrel (royalty barrels x $70). The difference between the $70 royalty cap and the current oil price is to be reflected on the income statement as a reduction in oil sales. For the year ended December 31, 2012, the reduction to oil sales due to the $70 cap applied to all royalty barrels was $113.7 million ($36.4 million net to our 32 percent interest) (2011: $85.0 million [$27.2 million net to our 32 percent interest]).
Per our interpretation of the Windfall Profits Tax, the $70 cap on royalty barrels should only be applied to the 3.33 percent royalty which Petrodelta pays in cash. We have applied the $70 cap to only the 3.33 percent royalty
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paid in cash and the current oil sales price to the 30 percent royalty paid in-kind for the year months ended December 31, 2012. With assistance from Petrodelta, we have recalculated Petrodelta’s oil sales and royalties to apply the current oil price to its total barrels produced and to the 30 percent royalty paid in-kind and applied the $70 cap to the 3.33 percent royalty paid in cash for the year ended December 31, 2012. For the year ended December 31, 2012, net oil sales (oil sales less royalties) are slightly higher, $11.4 million ($3.6 million net to our 32 percent interest) (2011: $8.5 million [$2.7 net to our 32 percent interest]) under this method than the method advised by PDVSA and the method of applying the current oil price to total barrels produced and to total royalty barrels. We have reported revenues and royalties for Petrodelta under this method.
On November 12, 2010, Petrodelta’s board of directors declared a dividend of $30.6 million, $12.2 million net to HNR Finance ($9.8 million net to our 32 percent interest). Petrodelta shareholder approval of the dividend was received on March 14, 2011. Due to Petrodelta’s liquidity constraints caused by PDVSA’s insufficient monetary support and contractual adherence, as of May 2, 2012, this dividend has not been received, although it is due and payable. Petrodelta’s board of directors declared this dividend and has never indicated that the dividend is not payable, nor that it will not be paid. The dividend receivable is classified as a long-term receivable at December 31, 2012 due to the uncertainty in the timing of payment. There is uncertainty with respect to the timing of the receipt of this dividend and whether future dividends will be declared or paid. We have and will continue to monitor our investment in Petrodelta. Should the dividend receivable not be collected or facts and circumstances surrounding our investment change, our results of operations and investment in Petrodelta could be adversely impacted.
The Organic Law on Sports, Physical Activity and Physical Education (“Sports Law”) was published in the Official Gazette on August 23, 2011. The purpose of the Sports Law is to establish the public service nature of physical education and the promotion, organization and administration of sports and physical activity. Funding of the Sports Law is by contributions made by companies or other public or private organizations that perform economic activities for profit in Venezuela. The contribution is one percent of annual net or accounting profit and is not deductible for income tax purposes. Per the Sports Law, contributions are to be calculated on an after-tax basis. However, in March 2012, CVP has instructed Petrodelta to calculate the contribution on a before-tax basis contrary to the Sports Law. For the year ended December 31, 2012, this method of calculation overstates the liability for the Sports Law contribution by $2.5 million ($0.8 million net to our 32 percent interest). We have adjusted for the overaccrual of the Sports Law in the December 31, 2012 Net Income from Equity Affiliate.
Petrodelta’s reporting and functional currency is the U.S. Dollar. HNR Finance owns a 40 percent interest in Petrodelta. Petrodelta’s financial information is prepared in accordance with International Financial Reporting Standards (“IFRS”) which we have adjusted to conform to USGAAP. The two major differences between IFRS and USGAAP, for which we adjust, are deferred taxes and depletion expense.
•
Deferred tax. IFRS allows the inclusion of monetary temporary differences impacted by inflationary adjustments. USGAAP does not. Net Income Equity Affiliate is increased or decreased by the deferred tax benefit created by the monetary temporary differences impacted by inflationary adjustments.
•
Depletion expense. Oil and gas reserves used by Petrodelta in calculating depletion expense under IFRS are provided by MENPET. MENPET reserves are not prepared using the guidance on extractive activities for oil and gas (ASC 932). At least annually, we prepare reserve reports for Petrodelta using ASC 932. Petrodelta depletion is recalculated using the USGAAP compliant reserves.
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All amounts through Net Income Equity Affiliate represent 100 percent of Petrodelta. Summary financial information has been presented below at December 31, 2012 and 2011, and for the years ended December 31, 2012, 2011 and 2010:
Fusion Geophysical, LLC (“Fusion”)
On January 28, 2011, Fusion Geophysical, LLC’s (“Fusion”) 69 percent owned subsidiary, FusionGeo, Inc., was acquired by a private purchaser pursuant to an Agreement and Plan of Merger. We received $1.4 million for our equity investment.
At December 31, 2009, we fully impaired the carrying value of our equity investment in Fusion. Accordingly, we did not record net losses incurred by Fusion in the year ended December 31, 2011 of $0.2 million ($0.1 million net to our 49 percent interest) or (2010: $2.4 million [$1.2 million net to our 49 percent interest]) as doing so would have caused our equity investment to go into a negative position.
Note 14 - Indonesia
In 2007, we entered into a Farmout Agreement to acquire a 47 percent interest in the Budong PSC located mostly onshore West Sulawesi, Indonesia. In April 2008, the Government of Indonesia approved the assignment to
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us of the 47 percent interest in the Budong PSC. Our partner is the operator through the exploration phase as required by the terms of the Budong PSC, and we have an option to become operator, if approved by the Government of Indonesia and SKK Migas in any subsequent development and production phase.
We acquired our original 47 percent interest in the Budong PSC by committing to fund the first phase of the exploration program up to a cap of $17.2 million, including the acquisition of 2-D seismic and drilling of the first two exploration wells under a Farmout Agreement with our partner in the Budong PSC. Prior to drilling the first exploration well, our partner had a one-time option to increase the level of the carried interest to a maximum of $20.0 million. On September 15, 2010, our partner exercised their option to increase the carry obligation by $2.7 million to a total of $19.9 million. The additional carry increased our ownership by 7.4 percent to 54.4 percent. On March 3, 2011, the Government of Indonesia approved this change in ownership interest.
On January 5, 2011, we exercised our first refusal right to a proposed transfer of interest by the operator to a third party, which allowed us to acquire an additional 10 percent ownership in the Budong PSC at a cost of $3.7 million payable ten business days after completion of the first exploration well. The $3.7 million was paid on April 18, 2011. Closing of this acquisition increased our participating ownership interest in the Budong PSC to 64.4 percent with our cost sharing interest becoming 64.51 percent until first commercial production. On August 11, 2011, the Government of Indonesia approved this change in ownership interest.
The initial exploration term of the Budong PSC was due to expire on January 15, 2013. In September 2012, the operator of the Budong PSC, on behalf of us and the other co-venturer, submitted a request to BPMIGAS under the terms of the Budong PSC for a four-year extension of the initial six-year exploration term of the Budong PSC. In January 2013, we received written approval from SKK Migas of the four-year extension of the initial six-year exploration term.
In November 2012, the Indonesia constitutional court declared BPMIGAS, Indonesia’s oil and gas regulatory authority, to be unconstitutional. In January 2013, SKK Migas, the Special Task Force for oil and gas upstream sector, was formed to replace BPMIGAS.
In December 2012, we signed a farmout agreement with the operator of the Budong PSC to acquire an additional 7.1 percent participating interest and to become operator of the Budong PSC. We assumed the role of interim operator effective January 16, 2013. Closing of this acquisition will increase our participating ownership interest in the Budong PSC to 71.5 percent with our cost sharing interest becoming 72 percent until first commercial production. The consideration for this transaction is that we will fund 100 percent of the costs of the first exploration well of the four-year extension to the Budong PSC. If the exploration well is not drilled within 18 months of the date of approval from the Government of Indonesia of this transaction, our partner has the right to give notice that the consideration be paid in cash, or $3.2 million. The acquisition of the additional participating interest and the transfer of operatorship are dependent on approval by the Government of Indonesia.
We have satisfied all work commitments for the current exploration phase of the Budong PSC. However, the extension of the initial exploration term includes an exploration well, which if not drilled by January 2016, results in the termination of the Budong PSC.
During the initial exploration period, the Budong PSC covered 1.35 million acres. The Budong PSC includes a ten-year exploration period and a 20-year development phase. Pursuant to the terms of the Budong PSC, at the end of the first three-year exploration phase, 45 percent of the original area was to be relinquished to SKK Migas. In January 2010, 35 percent of the original area was relinquished and ten percent of the required relinquishment was deferred until 2011. In January 2011, the deferred ten percent of the original total contract area was relinquished to SKK Migas. The Budong PSC currently covers 0.75 million acres. However, pursuant to the request for extension of the initial exploration term, the contract area held by the Budong PSC at the beginning of the extension period should be reduced, per the terms of the Budong PSC, from the current 55 percent to 20 percent of the original contract area. If the full amount of the required relinquishment is required, 0.3 million acres would remain in the Budong PSC contract area. In January 2013, our partner, on our behalf, submitted a relinquishment proposal of 10 percent to SKK Migas. The retained area will contain all the areas of geological interest to the Budong PSC partners.
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Operational activities during 2012 focused on a review of geological and geophysical data obtained from the drilling of LG-1 and KD-1 wells to upgrade the prospectivity of the block and to define a prospect for potential drilling in 2013. We have completed remapping of both the Lariang and Karama Basins with eight leads in the Lariang Basin and five leads in the Karama Basin having been identified. The identification of these leads is the basis for the four-year extension request of the first six-year exploration term.
The Budong PSC represents $5.3 million of unproved oil and gas properties on our December 31, 2012 balance sheet (2011: $5.3 million).
Note 15 - Gabon
We are the operator of the Dussafu PSC with a 66.667 percent ownership interest. Located offshore Gabon, adjacent to the border with the Republic of Congo, the Dussafu PSC covers an area of 680,000 acres with water depths up to 1,650 feet.
The Dussafu PSC partners and the Republic of Gabon, represented by the Ministry of Mines, Energy, Petroleum and Hydraulic Resources, entered into the third exploration phase of the Dussafu PSC with an effective date of May 28, 2012. The Direction Generale Des Hydrocarbures (“DGH”) agreed to lengthen the third exploration phase to four years until May 27, 2016. The third exploration phase of the Dussafu PSC has a $7.0 million ($4.7 million net to our 66.667 percent interest) work commitment over a four year period. This commitment was fulfilled with the drilling of DTM-1.
Operational activities during the year ended December 31, 2012 included completion of the processing of 545 square kilometers of seismic which was acquired in the fourth quarter of 2011 and well planning. The 3-D Pre-Stack Time Migration (“PSTM”) was completed in July 2012.
Well planning progressed to drill an exploration well in the fourth quarter of 2012 on the Tortue prospect. DTM-1 well was spud November 19, 2012. DTM-1 was drilled with the Scarabeo 3 semi-submersible drilling unit. On January 4, 2013, we announced that DTM-1 had reached the Dental Formation and discovered oil in both the Gamba and Dentale formations. Additional technical evaluation is on-going and is expected to take several months.
See Note 7 - Commitments and Contingencies for a discussion of legal matters related to our Gabon operations.
The Dussafu PSC represents $76.4 million of unproved oil and gas properties on our December 31, 2012 balance sheet (2011: $48.9 million).
Note 16 - Oman
In 2009, we signed an EPSA with Oman for Block 64 EPSA. We have an 80 percent working interest and our partner, Oman Oil Company, has a 20 percent carried interest in Block 64 EPSA during the initial period. Block 64 EPSA was a block designated for exploration and production of non-associated gas and condensate, which the Oman Ministry of Oil and Gas carved out of the Block 6 Concession operated by Petroleum Development of Oman (“PDO”). PDO has continued to produce oil from several shallow oil fields within Block 64 EPSA area.
All work commitments for the First Phase exploration period on Block 64 EPSA have been completed. Operational activities during 2012 include post well evaluation and review of geological and geophysical data obtained from the drilling of the MFS-1and AGN-1 wells. On March 12, 2013, we elected to not request an extension of the First Phase or enter the Second Phase of Block 64 EPSA and Block 64 will be relinquished effective June 30, 2013. The carrying value of Block 64 EPSA of $6.4 million was written off to impairment expense at December 31, 2012. During the first half of 2013, we will terminate operations and close the field office.
Block 64 EPSA represented $5.3 million of unproved oil and gas properties on our December 31, 2011 balance sheet.
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Note 17 - China
In December 1996, we acquired a petroleum contract with China National Offshore Oil Corporation (“CNOOC”) for the WAB-21 area. The WAB-21 petroleum contract covers 6.2 million acres in the South China Sea, with an option for an additional 1.25 million acres under certain circumstances, and lies within an area which is the subject of a border dispute between China and Socialist Republic of Vietnam (“Vietnam”). Vietnam has executed an agreement on a portion of the same offshore acreage with another company. The border dispute has lasted for many years, and there has been limited exploration and no development activity in the WAB-21 area due to the dispute. Due to the border dispute between China and Vietnam, we have been unable to pursue an exploration program during Phase One of the contract. As a result, we have obtained license extensions, with the current extension in effect until May 31, 2013. The Joint Management Committee has approved an extension of the license until May 31, 2015. We are meeting with CNOOC in April 2013 to discuss the ratification of the extension. Regular meetings are held with CNOOC with contingent work programs being planned and annual budgets being set. While no assurance can be given, we believe we will continue to receive contract extensions so long as the border disputes persist. Even though there continues to be increasing activity on the Vietnamese blocks which we believe confirms our view of WAB-21’s prospectivity, we impaired the carrying value of WAB-21 of $2.9 million at December 31, 2012 due to our continued inability to pursue an exploration program. However, we continue to seek permission to acquire regional 2-D seismic and localized 3-D seismic.
WAB-21 represented $2.9 million of unproved oil and gas properties on our December 31, 2011 balance sheet.
Note 18 - Related Party Transactions
Dividends declared and paid by Petrodelta are paid to HNR Finance. HNR Finance must declare a dividend in order for the partners, Harvest and Vinccler, to receive their respective shares of Petrodelta’s dividend. Between 2008 and 2010, Petrodelta declared three dividends, totaling $105.5 million, which have been received by HNR Finance and one dividend, totaling $12.2 million, which has not yet been received by HNR Finance. HNR Finance declared a dividend in 2008 in the amount of $72.5 million. HNR Finance has not declared a dividend for the remaining $33.0 million. At December 31, 2012, Vinccler’s share of the undistributed dividends is $9.0 million.
Note 19 - Subsequent Events
On February 20, 2013, we announced that the SPA had been termination as a result of the Government of Indonesia voting not to approve the transaction. See Note 5 - Dispositions, Share Purchase Agreement (“SPA”).
On March 25, 2013, SKK Migas approved the transfer of operatorship of the Budong PSC to us.
On April 9, 2013, the Government of Indonesia approved the acquisition of the additional 7.1 percent participating interest in the Budong PSC.
We conducted our subsequent events review up through the date of the issuance of this Annual Report on Form 10-K.
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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
Quarterly Financial Data (unaudited)
Summarized quarterly financial data is as follows:
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As noted above, the amounts per quarter were restated. Presented below are restated quarterly financial statements for each of the three quarters of 2012 and all quarters of 2011.
During 2012, we identified accounting errors subsequent to filing our Quarterly Reports on Form 10-Q for the periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012 and September 30, 2012. As discussed in Note 3, in the course of management’s ongoing review and analysis and management’s review of the design and operating effectiveness of internal control over financial reporting, we concluded that there were errors in previously filed financial statements. In the course of our review, management determined that (a) certain warrants issued in 2010 in connection with our $60 million term loan facility (the “Warrants”) were improperly valued at inception and improperly classified as equity instruments rather than liability instruments. As a result of the improper classification of the Warrants, (b) the debt discount and associated interest expense related to the amortization of the debt discount was understated for all periods in which the associated debt was outstanding, and (c) the consolidated statement of operations and comprehensive income (loss) for each reporting period was misstated by the omission of the changes in fair value of the Warrants as a liability instrument. Additionally, (d) certain exploration overhead was incorrectly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed, and (e) certain leasehold maintenance and other costs were improperly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed. Finally, (f) advances to equity affiliate were improperly classified as an operating activity rather than an investing activity and (g) certain costs were improperly classified as an investing activity rather than an operating activity on the consolidated statement of cash flows. As a result of the errors related to the Warrants described above, loss on extinguishment of debt was understated for the quarters ended June 30, 2011, September 30, 2011 and December 31, 2011. Additionally, an error was identified in the calculation of earnings (loss) per diluted share for the three and six months ended June 30, 2011, and an additional error was identified related to the improper expensing of costs associated with debt conversions that should have been recorded to equity for the quarters ended March 31, 2012 and September 30, 2012.
We have restated our segment footnote information to reflect the applicable errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense. Such errors impacted the quarterly periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012, and September 30, 2012.
In assessing the severity of the corrections, management determined that the errors were material to the consolidated financial statements as of and for the quarters ended March 31, 2011 June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012 and September 30, 2012. In addition to the errors described above, we have also made corrections for previously identified immaterial errors and errors affecting classification within the consolidated statement of operations and comprehensive income (loss) related to impairment of oil and gas properties and income taxes and the consolidated balance sheets related to income taxes. Management concluded that we should restate our financial statements included in our Quarterly Report on Form 10-Q for the periods ending March 31, 2012, June 30, 2012, and September 30, 2012, and recommended that the Audit Committee authorize such restatement.
Set forth below is a summary of the nature of the errors. Correction explanations are provided following each of the financial statements affected.
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CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2012, June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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2012 Consolidated Balance Sheet Corrections:
(a) Represents a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Income tax effect of the adjustments and income taxes improperly classified as interest payable in 2011.
(d) Represents the fair value of the Warrants at the reporting date.
(e) For the three months ended March 31, 2012 and six months ended June 30, 2012, the adjustment to additional paid-in capital relates to (a) the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification and (b) deferred financing costs of $439 thousand that were erroneously expensed rather than capitalized to additional paid-in capital. For the nine months ended September 30, 2012, the adjustment to additional paid-in capital relates to (a) the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification and (b) deferred financing costs of $265 thousand that were erroneously expensed rather than capitalized to additional paid-in capital.
(f) Relates to the improper expensing of costs associated with debt conversion.
(g) Relates to a deferred tax asset that was erroneously reported gross of the related liability.
(h) Represents other current liabilities that were improperly classified as interest payable and income taxes payable.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2012, June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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YTD 2012 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(b) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(c) Relates to the improper expensing of accrued interest associated with debt conversions.
(d) Relates to the improper expensing of costs associated with debt conversions.
(e) Represents a previously identified immaterial error.
(f) Income tax effects of adjustments.
(g) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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Quarter 2012 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(b) Represents changes in fair value of the Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(c) Relates to the improper expensing of deferred financing costs associated with the debt conversions.
(d) Income tax effect of adjustments.
(e) Represents a previously identified immaterial error.
(f) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
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CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(dollars in millions, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2012, June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
2012 Consolidated Statements of Cash Flows Corrections:
(a) Relates to certain costs improperly classified as an investing activity rather than an operating activity.
(b) Relates to the improper classification of Advances to Equity Affiliate as an operating activity rather than an investing activity.
(c) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Relates to the improper expensing of deferred financing costs associated with the debt conversions that should have been recorded to equity.
(e) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(f) Represents a previously identified immaterial error.
(g) Income tax effects of the adjustments.
(h) Relates to the previously identified improper expensing of costs associated with debt conversion.
(i) Relates to the improper expensing of accrued interest associated with the debt conversions that should have been recorded to equity.
In addition to the above, we have restated the Consolidated Statements of Stockholder’s Equity for the nine months ended September 30, 2012 to reflect the reclassification of the Warrants from equity to warrant derivative liability and to restate the January 1, 2011 beginning balances to reflect cumulative adjustments related to the previously described errors as follows:
(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability.
(b) The adjustment to retained earnings relates to (a) lease maintenance costs of $313 thousand that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense, (b) the reduction in the fair value of the Warrants for the year ended December 31, 2010 of $344 thousand, additional amortization of debt of $1,098 thousand resulting from the increased discount allocated to the debt, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification.
(b) The adjustment to retained earnings relates to (a) net increase in 2010 and 2011 expense related to exploration expense of $2,523 thousand that was erroneously capitalized as oil and gas properties rather than expensed as exploration expense (includes consideration of reclassification between exploration expense and impairment of oil and gas properties), (b) net increase in unrealized gain on warrant derivatives of $10,130 thousand for cumulative 2010 and 2011, (c) net increase in interest expense of $2,921 thousand cumulative for 2010 and 2011, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011, (e) net increase in income tax expense of $237 thousand for income taxes improperly classified as interest expense, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(a) The adjustment to additional paid-in capital relates to (a) the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification and (b) deferred financing costs of $265 thousand that were erroneously expensed rather than capitalized to additional paid-in capital.
(b) The adjustment to retained earnings relates to (a) net increase in 2010, 2011 and nine months 2012 expense related to exploration expense of $3,823 thousand that was erroneously capitalized as oil and gas properties rather than expensed as exploration expense (includes consideration of reclassification between exploration expense and impairment of oil and gas properties), (b) net increase in unrealized gain on warrant derivatives of $9,170 thousand for cumulative 2010, 2011 and nine months 2012, (c) net increase in interest expense of $2,619 thousand cumulative for 2010, 2011, and nine months 2012, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011, (e) increase in net income from equity affiliate of $373 thousand less noncontrolling interest of $75 thousand due to a previously identified immaterial error, (f) net increase in income tax expense of $238 thousand for income taxes improperly classified as interest expense, (g) net decrease in debt conversion expense of $12 thousand for the improper expensing of deferred financing costs associated with the debt conversions that should have been recorded in equity, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(c) The adjustment to noncontrolling interest relates to the net increase in net income from equity affiliated due to a previously identified immaterial error.
In addition to the above, we have restated Operating Segments to reflect the errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense.
(a) Represents a previously identified immaterial error.
(b) Relates to elimination of intrasegment receivables erroneously reported gross of related intrasegment payable.
(c) Relates to elimination of intrasegment receivables erroneously reported gross of related intrasegment payable and a deferred tax asset that was erroneously reported gross of the related liability.
(a) Represents a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Represents change in the fair value of the Warrants for the reporting period and improper expensing of debt conversion costs and lease maintenance costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
(a) Represents a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Represents change in the fair value of the Warrants for the reporting period and improper expensing of debt conversion costs and lease maintenance costs that were erroneously capitalized as oil and gas properties rather than expensed to exploration expense.
(d) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2011, June 30, 2011 and September 30, 2011 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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YTD 2011 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense. This amount was offset by a reclassification from exploration expense to impairment of oil and gas properties of $3,335 thousand in the six months ended June 30, 2011 and nine months ended September 30, 2011, respectively, for amounts that were erroneously classified as exploration expense.
(b) Represents the reclassification from exploration expense to impairment of oil and gas properties for amounts that were erroneously classified as exploration expense.
(c) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(d) As a result of the change in the fair value of the Warrants, the original discount allocated to the debt was understated; therefore, the additional amortization of the discount on debt, which is a component of interest expense, was understated for each period the debt was outstanding and income tax improperly classified as interest expense.
(e) The correction in the fair value of the Warrants and its classification as a liability resulted in an increase discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(f) Relates to income tax improperly classified as interest expense.
(g) Relates to previously identified immaterial error.
(h) Diluted EPS has been adjusted to reflect an error in the calculation of the weighted average common shares outstanding for dilutive EPS for the six months ended June 30, 2011. The weighted average common shares utilized for the calculation of diluted EPS was erroneously 40,027 thousand rather than 33,992 thousand.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2011, June 30, 2011 and September 30, 2011 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
Quarter 2011 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense. For the three months ended June 30, 2011, this amount was offset by a reclassification from exploration expense to impairment of oil and gas properties of $3,335 thousand for amounts that were erroneously classified as exploration expense.
(b) Represents the reclassification from exploration expense to impairment of oil and gas properties for amounts that were erroneously classified as exploration expense.
(c) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(d) As a result of the change in fair value of the Warrants, the original discount allocated to the debt was understated; therefore, the additional amortization of the discount on debt, which is a component of interest expense, was understated for each period the debt was outstanding.
(e) The correction in the fair value of the Warrants and its classification as a liability resulted in an increase discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(f) Income tax effects of the adjustments.
(g) Relates to previously identified immaterial error.
(h) Diluted EPS has been adjusted to reflect an error in the calculation of the weighted average common shares outstanding for dilutive EPS for the three months ended June 30, 2011. The weighted average common shares utilized for the calculation of diluted EPS was erroneously 40,260 thousand rather than 34,039 thousand.
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CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2011, June 30, 2011 and September 30, 2011 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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2011 Consolidated Statements of Cash Flows Corrections:
(a) Represents the reclassification from impairment of long-lived assets to impairment of oil and gas properties for amounts that were erroneously classified as impairment of long-lived assets.
(b) As a result of the change in the fair value of the Warrants, the original discount allocated to the debt was understated; therefore, the additional amortization of the discount on debt was understated for each period the debt was outstanding.
(c) The correction in the fair value of the Warrants and its classification as a liability resulted in an increased discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(d) Relates to previously identified immaterial error.
(e) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(f) Relates to certain costs improperly classified as an investing activity rather than an operating activity.
(g) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(h) Relates to the improper classification of Advances to Equity Affiliate as an operating activity rather than an investing activity.
(i) Relates to income tax payable improperly classified as interest payable.
(j) Income tax effect of the adjustments and income tax payable improperly classified as interest payable.
In addition to the above, we have restated Operating Segments to reflect the errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenues erroneously reported gross of related intrasegment expense.
(a) Relates to a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(c) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Represents (a) change in fair value of the Warrants for the reporting period, (b) understatement of interest expense and debt discount which resulted from the improper classification of the Warrants, (c) lease maintenance costs erroneously capitalized as oil and gas properties rather than expensed to exploration expense, and (d) for the periods ended June 30, 2011 and September 30, 2011, changes in the loss on extinguishment of debt due to the correction in discount on debt related to the improper classification of the Warrants.
(a) Relates to a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(c) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Represents (a) changes in fair value of the Warrants for the reporting period, (b) understatement of interest expense and debt discount which resulted from the improper classification of the Warrants, (c) lease maintenance costs erroneously capitalized as oil and gas properties rather than expensed to exploration expense, and (d) for the periods ended June 30, 2011 and September 30, 2011, changes in the loss on extinguishment of debt due to the correction in discount on debt related to the improper classification of the Warrants.
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Supplemental Information on Oil and Natural Gas Producing Activities (unaudited)
The following tables summarize our proved reserves, drilling and production activity, and financial operating data at the end of each year. Tables I through III provide historical cost information pertaining to costs incurred in exploration, property acquisitions and development; capitalized costs; and results of operations. Tables IV through VI present information on our estimated proved reserve quantities, standardized measure of estimated discounted future net cash flows related to proved reserves, and changes in estimated discounted future net cash flows.
TABLE I - Total costs incurred in oil and natural gas acquisition, exploration and development activities (in thousands):
* See Note 3 - Summary of Significant Accounting Policies - Restatement of Prior Period Financial Statements for additional information.
TABLE II - Capitalized costs related to oil and natural gas producing activities (in thousands):
(a) Drilling activities were completed in September 2011 for Dussafu Ruche Marin-1 (“DRM-1”) exploratory well on the Dussafu PSC. DRM-1 well costs of $39.2 million were suspended pending further exploration and development activities. Exploration activities continued in 2012 with the acquisition of additional seismic and the spud of our second exploration well, DTM-1, on November 19, 2012.
* See Note 3 - Summary of Significant Accounting Policies - Restatement of Prior Period Financial Statements for additional information.
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We regularly evaluate our unproved properties to determine whether impairment has occurred. We have excluded from amortization our interest in unproved properties and the cost of uncompleted exploratory activities. The principal portion of such costs is expected to be included in amortizable costs during the next two to three years.
Unproved property costs at December 31, 2012 relates to two on-going projects. Costs incurred by year are as follows (in thousands):
* See Note 3 - Summary of Significant Accounting Policies - Restatement of Prior Period Financial Statements for additional information.
TABLE III - Results of operations for oil and natural gas producing activities (in thousands):
TABLE IV - Quantities of Oil and Natural Gas Reserves
Estimating oil and gas reserves is a very complex process requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. This data may change substantially over time as a result of numerous factors such as production history, additional development activity and continual reassessment of the viability of production under various economic and political conditions. Consequently, material upward or downward revisions to existing reserve estimates may occur from time to time; although, every reasonable efforts is made to ensure that reported results are the most accurate assessment available. We ensure that the data provided to our external independent experts, and their interpretation of that data, corresponds with our development plans and management’s assessment of each reservoir. The significance of subjective decisions required and variances in available data make estimates generally less precise than other estimates presented in connection with financial statement disclosures.
We measure and disclose our oil and gas reserves in accordance with the provisions of the SEC’s Modernization of Oil and Gas Reporting and ASC 932, “Extractive Activities - Oil and Gas” (“ASC 932”).
The process for preparation of our oil and gas reserves estimates is completed in accordance with our prescribed internal control procedures, which include verification of data provided for, management reviews and review of the independent third party reserves report. The technical employee responsible for overseeing the
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process for preparation of the reserves estimates has a Bachelor of Arts in Engineering Science, a Master of Science in Petroleum Engineering, has more than 25 years of experience in reservoir engineering and is a member of the Society of Petroleum Engineers.
All reserve information in this report is based on estimates prepared by Ryder Scott Company L.P. (“Ryder Scott”), independent petroleum engineers. The technical personnel responsible for preparing the reserve estimates at Ryder Scott meet the requirements regarding qualifications, independence, objectivity and confidentiality set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers. Ryder Scott is an independent firm of petroleum engineers, geologists, geophysicists and petrophysicists; they do not own an interest in our properties and are not employed on a contingent fee basis.
See the following section Additional Supplemental Information on Oil and Natural Gas Producing Activities (unaudited) for Venezuela Equity Affiliate as of December 31, 2012, 2011 and 2010, TABLE IV - Quantities of Oil and Natural Gas Reserves for Petrodelta’s reserves.
The table shown below represents our interests in the United States. On May 17, 2011, we closed the transaction to sell our Antelope Project. The sale had an effective date of March 1, 2011. We received cash proceeds of approximately $217.8 million which reflected increases to the purchase price for customary adjustments and deductions for transaction related costs. We do not have any continuing involvement with the Antelope Project. The related gain on the sale was reported in discontinued operations in the second quarter of 2011. The Antelope Project has been classified as discontinued operations.
TABLE V - Standardized Measure of Discounted Future Net Cash Flows Related to Proved Oil and Natural Gas Reserve Quantities
The standardized measure of discounted future net cash flows is presented in accordance with the provisions of the accounting standard on disclosures about oil and gas producing activities. In preparing this data, assumptions and estimates have been used, and we caution against viewing this information as a forecast of future economic conditions.
Future cash inflows are estimated by applying the average price during the 12-month period, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, adjusted for fixed and determinable escalations provided by the contract, to the estimated future production of year-end proved reserves. Future cash inflows are reduced by estimated future production and development costs to
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determine pre-tax cash inflows. Future income taxes are estimated by applying the year-end statutory tax rates to the future pre-tax cash inflows, less the tax basis of the properties involved, and adjusted for permanent differences and tax credits and allowances. The resultant future net cash inflows are discounted using a ten percent discount rate.
The table shown below represents our net interest at December 31, 2011 and 2010.
TABLE VI - Changes in the Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves:
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Additional Supplemental Information on Oil and Natural Gas Producing Activities (unaudited) for Petrodelta S.A.
The following tables summarize the proved reserves, drilling and production activity, and financial operating data at the end of each year for our net 32 percent interest in Petrodelta. Tables I through III provide historical cost information pertaining to costs incurred in exploration, property acquisitions and development; capitalized costs; and results of operations. Tables IV through VI present information on our estimated proved reserve quantities, standardized measure of estimated discounted future net cash flows related to proved reserves, and changes in estimated discounted future net cash flows.
Petrodelta (32 percent ownership) is accounted for under the equity method, and has been included at its ownership interest in the consolidated financial statements and the following Tables based on a year ending December 31 and, accordingly, results of operations for oil and natural gas producing activities in Venezuela reflect the year ended December 31, 2012, 2011 and 2010.
TABLE I - Total costs incurred in oil and natural gas acquisition, exploration and development activities (in thousands):
TABLE II - Capitalized costs related to oil and natural gas producing activities (in thousands):
TABLE III - Results of operations for oil and natural gas producing activities (in thousands):
(1) Expenses include operating expenses, production taxes and Windfall Profits Tax. Net to our 32 percent interest, Windfall Profits Tax for December 31, 2012 was $93.2 million (2011: $76.0 million, 2010: $4.5 million).
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TABLE IV - Quantities of Oil and Natural Gas Reserves
We measure and disclose our oil and gas reserves in accordance with the provisions of the SEC’s Modernization of Oil and Gas Reporting and ASC 932, “Extractive Activities - Oil and Gas” (“ASC 932”).
Petrodelta is producing from, and continuing to develop, the Petrodelta Fields. Petrodelta has both developed and undeveloped oil and gas reserves identified in all six fields. Petrodelta produces the fields in accordance with a business plan originally defined by its Conversion Contract executed in late 2007. Proved Undeveloped (“PUD”) oil and gas reserves are drilled in accordance with Petrodelta’s business plan, but can be revised where drilling results indicate a change is warranted.
During 2012, Petrodelta drilled and completed 12 production wells. Six of the wells were previously identified Proved Undeveloped (“PUD”) locations and six wells were previously classified Probable, Possible or undefined locations. In 2012, an additional ten PUD locations were identified through drilling activity; however, ten PUD locations which are scheduled to be drilled five years after the wells were originally identified have been reclassified as Probable reserves. At December 31, 2012, Petrodelta had a total of 157 PUD (22.9 MMBOE) locations identified. Since the implementation of its 2007 business plan, Petrodelta has drilled 67 gross production wells (2008 nine wells [1.4 MMBOE], 2009 15 wells [2.0 MMBOE], 2010 16 wells [2.0 MMBOE], 2011 15 wells [2.1 MMBOE], and 2012 12 wells [2.2 MMBOE]) which have moved to the proved developed producing (“PDP”) category. Of these 67 locations drilled since 2008, 33 (5.9 MMBOE) represent the movements of PUD locations to PDP locations. The other 34 new producing wells (3.8 MMBOE) were previously classified Probable, Possible or un-defined.
Petrodelta has a track record of identifying, executing and converting its PUD locations to PDP locations in accordance with the business plan defined by the conversion contract executed in 2007 and subsequent updates. However, the timing and pace of the development is controlled by the majority owner, PDVSA through CVP, although we have substantial negative control provisions as a noncontrolling interest shareholder. In 2010, Petrodelta submitted a revised business plan to PDVSA which substantially increases the total projected drilling activity and production volumes compared to the 2007 business plan, but which is otherwise consistent with the 2007 business plan. The 2010 business plan, as approved by PDVSA, contemplates sustained drilling activities through the year 2024 to fully develop the El Salto and Temblador fields. As a noncontrolling interest shareholder in Petrodelta, HNR Finance has limited ability to control the development plans that are periodically prepared and/or approved by the Venezuelan government. Since this constraint represents a hindrance to development not experienced by typical operations, the PUD locations which are now scheduled to be drilled five years after they were originally identified have been reclassified as Probable reserves.
Proved undeveloped reserves of 22.9 MMBOE from 157 gross PUD locations are all scheduled to be drilled within the period from 2013 to 2016 and within five years from when these locations were first identified.
All above MMBOE represent our net 32 percent interest, net of a 33.33 percent royalty.
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The tables shown below represent HNR Finance’s 40 percent ownership interest and our net 32 percent ownership interest, both net of a 33.33 percent royalty, in Venezuela in each of the years.
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TABLE V - Standardized Measure of Discounted Future Net Cash Flows Related to Proved Oil and Natural Gas Reserve Quantities
The standardized measure of discounted future net cash flows is presented in accordance with the provisions of the accounting standard on disclosures about oil and gas producing activities. In preparing this data, assumptions and estimates have been used, and we caution against viewing this information as a forecast of future economic conditions.
Future cash inflows are estimated by an applying the average price during the 12-month period, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, adjusted for fixed and determinable escalations provided by the contract, to the estimated future production of year-end proved reserves. Our average prices used were $89.77 per barrel for oil for the El Salto field and $100.41 per barrel
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for the other fields, and $1.54 per Mcf for gas. Future cash inflows were reduced by estimated future production and development costs to determine pre-tax cash inflows. Future income taxes were estimated by applying the year-end statutory tax rates to the future pre-tax cash inflows, less the tax basis of the properties involved, and adjusted for permanent differences and tax credits and allowances. The resultant future net cash inflows are discounted using a ten percent discount rate.
The table shown below represents HNR Finance’s net interest in Petrodelta.
(1) Future production costs include operating costs, production taxes and Windfall Profits Tax. For 2012, Windfall Profits Tax equates to $1.5 million, or 74 percent, of the $2.0 million of discounted future production costs.
(2) Future production costs include operating costs, production taxes and Windfall Profits Tax. For 2011, Windfall Profits Tax equates to $1.6 million, or 68 percent, of the $2.4 million of discounted future production costs.
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TABLE VI - Changes in the Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves (in thousands):
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on the 2nd of May 2013, on behalf of the registrant and in the capacities indicated:
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SCHEDULE Valuation and Qualifying Accounts SCHEDULE II
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts
(in thousands)
* Amounts charged to other accounts include net operating losses and income tax credits.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from adverse changes in oil and natural gas prices and foreign exchange risk, as discussed below.
Oil Prices
Oil and natural gas prices historically have been volatile, and this volatility is expected to continue. Prevailing prices for such commodities are subject to wide fluctuation in response to relatively minor changes in supply and demand and a variety of additional factors beyond our control. Being primarily a crude oil producer, we are more significantly impacted by changes in crude oil prices than by changes in natural gas prices. As an independent oil producer, our revenue, other income and profitability, reserve values, access to capital and future rate of growth are substantially dependent upon the prevailing prices of crude oil and natural gas.
We currently do not have any oil production that is hedged. While hedging limits the downside risk of adverse price movements, it may also limit future revenues from favorable price movements.
Interest Rates
Total long-term debt at December 31, 2012 consisted of $75.0 million of fixed-rate senior unsecured notes maturing in 2014. A hypothetical 10 percent adverse change in the prime rate would not have a material effect on our results of operations for the year ended December 31, 2012.
Foreign Exchange
The Bolivar is not readily convertible into the U.S. Dollar. We have not utilized currency hedging programs to mitigate any risks associated with operations in Venezuela, and, therefore, our financial results are subject to favorable or unfavorable fluctuations in exchange rates and inflation in that country. Venezuela has imposed currency exchange controls. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Effects of Changing Prices, Foreign Exchange Rates and Inflation above.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this item is included herein on pages S-1 through S-68.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We have established disclosure controls and procedures that are designed to ensure the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Management of the Company, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures. Based on their evaluation as of December 31, 2012, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective because of the material weaknesses in our internal control over financial reporting described below. Notwithstanding this determination, our management concluded that the consolidated financial statements (as restated for 2010 and 2011) in this Annual Report on Form 10-K fairly present, in all material respects, our financial position and results of operations and cash flows as of the dates and for the periods presented, in conformity with accounting principles generally accepted in the United States of America (“USGAAP”).
Management’s Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f). Internal control over financial reporting is defined as a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officer’s, or persons performing similar functions, and effected by the Company’s board of directors, management, and other personnel, to provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures which (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company, (b) 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 are being made only in accordance with authorizations of management and the board of directors, and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of The Treadway Commission. Based on our evaluation under the Internal Control Integrated Framework, our management concluded that our internal control over financial reporting was not effective as of December 31, 2012 as a result of material weaknesses described below.
Sufficient Complement of Accounting and Financial Reporting Resources
In certain areas, we did not maintain a sufficient complement of resources with an appropriate level of accounting knowledge, experience and training commensurate with our financial reporting requirements. This limited our ability, in certain areas, to ensure the necessary consistent communication, reinforcement, and application of accounting policies to make appropriate accounting and disclosure decisions. This material weakness contributed to the material weaknesses set forth below.
Accounting for Certain Transactions for Oil and Gas Properties
We did not maintain effective internal control over the accuracy, valuation and application of USGAAP related to capitalization, classification, and impairment of certain costs related to oil and gas properties. Specifically, effective controls were not designed or effectively operating to review the nature and classification of costs to be capitalized to oil and gas properties which impacts the accurate calculation of oil and gas property impairments. This control deficiency resulted in the misstatement of oil and gas properties, exploration expense, and related financial statement disclosures.
Accounting for Income Taxes
We did not maintain effective controls over the completeness, accuracy, presentation and disclosure of our accounting for income taxes, including income tax expense and income tax assets and liabilities. Specifically, we did not maintain effective controls to (1) document our analysis, considerations and evaluation of relevant facts related to our accounting judgments for income taxes, (2) account for uncertain tax positions, and (3) ensure appropriate recording and presentation of our net operating losses and associated valuation allowance and related footnote disclosures. This control deficiency resulted in the misstatement of income tax expense, deferred tax assets, our valuation allowance, related financial statement disclosures, and our financial statement schedule.
Financial Reporting Process
We did not maintain effective internal control over certain of our financial close and reporting processes because of the following material weaknesses:
(a) We did not maintain effective controls over segregation of duties related to certain system access rights and the recording and review of journal entries for validity, accuracy, and completeness for substantially all significant accounts. Specifically, certain individuals have incompatible access rights within key IT systems and certain accounting personnel have the ability to prepare and post journal entries without an independent review that is designed with sufficient rigor and precision to prevent or detect an error.
(b) We did not maintain effective controls over the preparation and review of certain classification and disclosure matters impacting the financial statements and related notes. Specifically, controls are not designed and operating effectively to accumulate and review all information required to ensure complete, accurate, and proper presentation of the statement of cash flows and financial statement disclosures. This control deficiency resulted in the misstatement of cash provided by or used in investing and operating activities and related financial statement disclosures and the misstatement of segment information.
(c) We did not maintain effective controls over significant and complex debt and equity transactions. Specifically, controls were not designed and operating effectively to ensure completeness and accuracy over the identification, evaluation, analysis and recording of significant and complex debt and equity transactions and the associated financial statement impact. This control deficiency resulted in the misstatement of debt, additional paid-in capital, debt conversion expense, interest expense, unrealized gain (loss) on warrant derivatives, loss on extinguishment of debt and related financial statement disclosures.
Additionally, each of the control deficiencies described above could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements and financial statement schedule that would not be prevented or detected. Certain of these material weaknesses resulted in errors which required the restatement of our annual consolidated financial statements for the years ended December 31, 2010 and 2011 and the unaudited interim consolidated financial statements for all quarters in 2011 and the first three quarters of 2012 and also resulted in recorded audit adjustments for the fourth quarter and annual period ended December 31, 2012.
The effectiveness of our internal control over financial reporting as of December 31, 2012 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Remediation Plan. In response to the identified material weaknesses, our management, with oversight from our Audit Committee will dedicate appropriate resources to remediate the material weaknesses described above. Until the remediation steps set forth below are fully implemented, the material weaknesses described above will continue to exist.
Management is taking the following actions to remediate the material weakness related to oil and gas properties described above:
•
Formalize policies and procedures for the appropriate recording of oil and gas property transactions.
•
Train the accounting staff on the above policies and procedures.
•
Establish timely independent review and approval of oil and gas property transactions and schedules.
•
Redesign the controls for the evaluation, analysis, recording and review of oil and gas property transactions.
Management is taking the following actions to remediate the material weakness related to income tax accounting described above:
•
Formalize the policies and procedures for appropriate recording of income taxes.
•
Maintain and update memorandum to reflect the current status of income tax accounting positions and the relevant analysis, considerations and conclusions.
•
Redesign the controls for income taxes to ensure the level of precision and operating effectiveness required by management.
•
Redesign the controls for income taxes to ensure appropriate presentation and disclosure of the associated footnotes and financial statement schedule.
•
Supplement existing resources with additional personnel and additional training.
Management is taking the following actions to remediate the material weaknesses related to our Financial Reporting Process and complement of accounting and financial reporting resources:
•
Implement a sufficiently-designed control that is intended to ensure functions are appropriately segregated and that all journal entries are reviewed by an appropriate person.
•
Modify the system access of individuals with incompatible responsibilities and/or design compensating controls that operate at the appropriate level of precision to address the associated conflict.
•
Redesign the controls for the preparation, execution and review of the cash flow statement and financial statement disclosures.
•
Redesign certain entity-level monitoring controls and certain transaction level controls in order to achieve the level of precision and operating effectiveness required by management.
•
Redesign the controls over significant and complex debt and equity transactions to ensure appropriate identification, evaluation, analysis and recording of such transactions.
•
Supplement our accounting department with additional personnel and provide additional training to our personnel regarding the application of USGAAP.
Inherent Limitations of Internal Controls. Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Changes in Internal Control over Financial Reporting. There have been no changes in internal control over financial reporting during the quarter ended December 31, 2012 that have materially affected or are reasonably likely to materially affect that Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
DIRECTORS
There are currently seven members of our Board of Directors (the “Board”), each of whom has been nominated for reelection to the Board this year and will stand for election at our annual meeting. Information regarding the business experience of each nominee is provided below. All directors are elected annually to serve until the next annual meeting and until their respective successors are elected.
When considering whether directors and nominees have the experience, qualifications, attributes and skills, taken as a whole, to enable the Board to satisfy its oversight responsibilities effectively in light of the Company’s business and structure, the Nominating and Corporate Governance Committee, which is a Committee of the Board responsible for recommending director candidates to be nominated by the Board, and the Board focused primarily on the information discussed in each of the directors’ individual biographies set forth below.
In particular, with regard to Messrs. Chesebro’, Edmiston, Irelan and Stinson and Dr. Effimoff, the Nominating and Corporate Governance Committee considered their strong backgrounds in the oil and gas sector, believing that their individual experiences at management levels with large multinational corporations engaged in oil and gas exploration and production are invaluable in evaluating the performance of management and other aspects of the Company. The Nominating and Corporate Governance Committee considered Mr. Murray’s individual experiences at management levels with large multinational corporations engaged in oil and gas services as a valuable complement to the experiences of the other directors. Additionally, the Nominating and Corporate Governance Committee considered the engineering education and experiences of Messrs. Chesebro’, Edmiston, Stinson and Irelan and Dr. Effimoff important to understand the goals and challenges of the Company and to effectively advise the direction of the Company in the oil and gas industry. With respect to Messrs. Hardee and Murray, the Nominating and Corporate Governance Committee considered their significant experience, expertise and background with regard to financials and financial and accounting matters and business management. The Nominating and Corporate Governance Committee also considered the broad perspective brought by Mr. Hardee’s and Dr. Effimoff’s experiences in consulting to clients and, with respect to Messrs. Hardee and Murray, serving in directorships in many diverse industries. The Nominating and Corporate Governance Committee also considered the many years of experience with the Company and in the industry represented by Mr. Edmiston, our Chief Executive Officer (“CEO”). Additionally, with respect to Messrs. Chesebro’, Edmiston, Irelan, Murray and Stinson and Dr. Effimoff, the Nominating and Corporate Governance Committee considered their experience in international business vital to the Company’s global strategy. With respect to Mr. Stinson, the Nominating and Corporate Governance Committee believes that his experience in governmental relations on an international level provides valuable insight to assist management in establishing and maintaining their relationships with foreign governments, which is a primary focus of the Company.
Stephen D. Chesebro’
Appointed Director in October 2000
Age
Mr. Chesebro’ has served as the Chairman of the Board of Harvest since 2001. From December 1998 until he retired in 1999, he served as President and Chief exploration and production company that was formerly a business unit of Pennzoil Company. From February 1997 to December 1997, Mr. Chesebro’ served as Group Vice President - Oil and Gas and from December 1997 until December 1998 he served as
President and Chief Operating Officer of Pennzoil Company, an integrated oil and gas company. From 1993 to 1996, Mr. Chesebro’ was Chairman and Chief Executive Officer of Tenneco Energy. Tenneco Energy was part of Tenneco, Inc., a worldwide corporation that owned diversified holdings in six major industries. Mr. Chesebro’ is an advisory director to Preng & Associates, an executive search consulting firm. In 1964, Mr. Chesebro’ graduated from the Colorado School of Mines. He was awarded the school’s Distinguished Achievement Medal in 1991 and received his honorary doctorate from the institution in 1998. He currently serves on the school’s visiting committee for petroleum engineering and is a member of the Colorado School of Mines Foundation Board of Governors. In 1994, Mr. Chesebro’ was the first American awarded the H. E. Jones London Medal by the Institution of Gas Engineers, a British professional association. Since December 2005, he has served as the President of the Chesebro’ Foundation, Inc., a private charitable foundation incorporated in Delaware.
James A. Edmiston
Elected Director in May 2005
Age
Mr. Edmiston was elected President and Chief Executive Officer of Harvest on October 1, 2005. He joined the Company as Executive Vice President and Chief Operating Officer on September 1, 2004. Prior to joining Harvest, Mr. Edmiston was with Conoco and ConocoPhillips for 22 years in various management positions including President, Dubai Petroleum Company (2002-2004), a ConocoPhillips affiliate company in the United Arab Emirates, and General Manager, Petrozuata, C.A., in Puerto La Cruz, Venezuela (1999-2001). Prior to 1999, Mr. Edmiston also served as Vice President and General Manager of Conoco Russia and then as Asset Manager of Conoco’s South Texas Lobo Trend gas operations. Mr. Edmiston earned a Bachelor of Science degree in Petroleum Engineering from Texas Tech University and a Masters of Business Administration from the Fuqua School of Business at Duke University. Mr. Edmiston was inducted into the Petroleum Engineering Academy and was recognized as a Distinguished Engineer by Texas Tech College of Engineering in 2009. Mr. Edmiston is a Member of the Society of Petroleum Engineers.
Dr. Igor Effimoff
Appointed Director in February 2008
Age
Dr. Igor Effimoff is founder and principal of a firm which provides upstream and midstream consulting services since 2005. From 2002 until 2005 he was Chief Operating Officer for Teton Petroleum
Company. Between 1996 and 2001, he was President of Pennzoil Caspian Corporation, managing their interests in the Caspian Region. Between 1994 and 1996 he was the Chief Executive Officer of Larmag Energy, NV, a privately held Dutch oil and gas production company with its primary assets in the Caspian Sea. He has served in senior executive roles with Ashland Exploration Inc., Zilkha Energy Company and Kriti Exploration, Inc. Dr. Effimoff has authored numerous technical and business articles. He is a member of American Association of Petroleum Geology, the Society of Petroleum Engineers, the Society of Exploration Geophysicists and the Geological Society of America. Dr. Effimoff served on the audit and compensation committees of TrueStar Petroleum Corporation in 2007. He currently serves on the board of IPC Oil and Gas Holdings Ltd. He has a Doctorate in Geology from the University of Cincinnati and completed the Harvard Advanced Management Program.
H. H. Hardee
Appointed Director in October 2000
Age 58
Mr. Hardee is a Senior Vice President-Financial Advisor with RBC Wealth Management, since 1994. From 1991 through 1994, Mr. Hardee was a Senior Vice President with Kidder Peabody. From 1977 through 1991, Mr. Hardee was a Senior Vice President at Rotan Mosle/Paine Webber Inc. Mr. Hardee was named as one of America’s best financial advisors for 2009, 2010, 2011 and 2012 by Barron’s financial newspaper and by Reuters AdvicePoint. Furthermore, Mr. Hardee has been recognized by NABCAP, the National Association of Board Certified Advisory Practices, as a Premier Wealth Advisor. He currently advises/manages over $400 million in assets. Mr. Hardee’s expertise is advising high net worth individuals and small to mid-sized corporations. Mr. Hardee is a former director of the Bank of Almeda and Gamma Biologicals. He is also a former limited partner and advisory director of the Houston Rockets of the National Basketball Association. Mr. Hardee has a finance degree from the McCombs School of Business at the University of Texas. He has earned an Accredited Wealth Management designation through the Estate and Wealth Strategies Institute of Michigan State University. Mr. Hardee is a National Association of Corporate Directors (“NACD”) Board Leadership Fellow. He has demonstrated his commitment to boardroom excellence by completing NACD’s comprehensive program of study for corporate directors. He supplements his skill sets through ongoing engagement with the director community and access to leading practices.
Robert E. Irelan
Appointed Director in February 2008
Age 66
Mr. Irelan has over 37 years of experience in the oil and gas industry. He retired from Occidental Petroleum as Executive Vice President of Worldwide Operations in April 2004, having started there in 1998. Prior to Occidental Petroleum, Mr. Irelan held various positions at Conoco, Inc. from 1967 until 1998. Upon his retirement he opened his own company, Naleri Investments LLC. He also partnered in several entrepreneurial ventures including Rapid Retail Solutions LLC, BISS Product Development LLC and All About Baby LLC. Mr. Irelan earned his Professional Engineering degree in Petroleum Engineering from Colorado School of Mines. He also has advanced studies in Mineral Economics. He was awarded the Distinguished Achievement Award from the school in 1998.
Patrick M. Murray
Appointed Director in October 2000
Age
In 2007, Mr. Murray retired from Dresser, Inc. He had been the Chairman of the Board and Chief Executive Officer since 2004. Dresser, Inc. is an energy infrastructure and oilfield products and services company. From 2000 until becoming Chairman of the Board, Mr. Murray served as President and Chief Executive Officer of Dresser, Inc. Mr. Murray was President of Halliburton Company’s Dresser Equipment Group, Inc., Vice President, Strategic Initiatives of Dresser Industries, Inc. and Vice President, Operations of Dresser, Inc. from 1996 to 2000. Mr. Murray has also served as the President of Sperry-Sun Drilling Services from 1988 through 1996. Mr. Murray joined NL Industries in 1973 as a Systems Application Consultant and served in a variety of increasingly senior management positions. Mr. Murray currently serves on the board and audit committee of Precision Drilling Corporation, a publicly-held contract drilling company. Mr. Murray is also on the board of the World Affairs Council of Dallas Fort Worth. He is on the board of advisors for White Deer Energy, the Maguire Energy Institute at the Edwin L. Cox School of Business, Southern Methodist University and a member of the Board of Regents of Seton Hall University. Mr. Murray holds a Bachelor of Science degree in Accounting and a Master of Business Administration from Seton Hall University. He served for two years in the U.S. Army as a commissioned officer.
J. Michael Stinson
Appointed Director in November 2005
Age
From September 2006 to December 2011, Mr. Stinson was Chairman of TORP Terminal LP, the U.S. unit of a Norwegian LNG technology company. From 2004 until November of 2009, he served as a director of Enventure Global Technology, Inc., an oil equipment company, most recently as the Chairman of its Audit and Finance Committee. From January 2005 until November 2009, he was Chairman of the Board of Paulsson Geophysical Services, Inc., a vertical seismic profiling technology company. From February through August 2004, Mr. Stinson served with the U.S. Department of Defense and the Coalition Provisional Authority as Senior Advisor to the Iraqi Ministry of Oil. From 1965 to 2003, Mr. Stinson was with Conoco and ConocoPhillips in a number of assignments in operations and management. His last position at ConocoPhillips was as Senior Vice President, Government Affairs in which he was responsible for government relations with particular emphasis on developing and facilitating international business development opportunities in various countries. Previous positions included Senior Vice President - Business Development, Vice President - Exploration and Production, Chairman and Managing Director of Conoco (UK) Limited, Vice President/General Manager of International Production for Europe, Africa and the Far East and President and Managing Director of Conoco Norway, Inc. Mr. Stinson earned a Bachelor of Science degree in Industrial Engineering from Texas Tech University and a Master of Business Administration from Arizona State University. He is a member of the Society of Petroleum Engineers and the American Association of Petroleum Geologists.
EXECUTIVE OFFICERS
The following table provides information regarding each of our executive officers.
* See Mr. Edmiston’s biography under the section entitled “Directors” above.
Stephen C. Haynes has served as our Vice President, Chief Financial Officer and Treasurer since May 19, 2008. Mr. Haynes performed various financial consulting engagements from January 1, 2008 until his
appointment with Harvest. Previously, he served as Chief Financial Officer for Cygnus Oil and Gas Corporation for the period February 1, 2006 through December 31, 2007. Before joining Cygnus, Mr. Haynes was the Corporate Controller with Carrizo Oil and Gas for the period January 1, 2005 through January 31, 2006. Mr. Haynes served as an independent consultant from March 2001 through end of 2004. From March 1990 through December 2000, Mr. Haynes served in a series of increasing responsibilities in international managerial and executive positions with British Gas, culminating in his appointments as Vice President-Finance of Atlantic LNG, a joint venture of British Gas and several industry partners in Trinidad and Tobago. Mr. Haynes is a Certified Public Accountant, holds a Master of Business Administration degree with a concentration in Finance from the University of Houston and a Bachelor of Business Administration degree in Accounting from Sam Houston State University. He also attended the Executive Development Program at Harvard University.
Keith L. Head has served as our Vice President, General Counsel and Corporate Secretary since May 7, 2007. He joined Texas Eastern upon graduation from law school and remained with the same organization through mergers with Panhandle Eastern, Duke Energy Corporation and Cinergy Corp. Mr. Head held various business development positions with Duke Energy Corporation from 1995 to 2001. His corporate development work included the identification, evaluation and negotiation of acquisitions in Latin America, North America and the United Kingdom. Mr. Head was Senior Vice President and General Counsel at Duke Energy North America from 2001 to 2004 and Associate General Counsel of Duke Energy Corporation from 2004 through December 2006. After leaving Duke Energy, Mr. Head joined Harvest in May 2007. He currently serves on two non-profit boards: MentorCONNECT and the Texas Accountants and Lawyers for the Arts. He is also a board member of the Houston chapter of The General Counsel Forum. Mr. Head holds a Bachelor of Science degree in Business Administration from the University of North Carolina. He received both a Juris Doctorate and Master of Business Administration from the University of Texas in 1983.
Karl L. Nesselrode has served as Vice President, Engineering and Business Development of the Company since November 17, 2003. From August 9, 2007 to August 2, 2010, he accepted a long-term secondment to Petrodelta as its Operations and Technical Manager while remaining an officer of Harvest. From February 2002 until November 2003, Mr. Nesselrode was President of Reserve Insights, LLC, a strategy and management consulting company for oil and gas. He was employed with Anadarko Petroleum Corporation as Manager Minerals and Special Projects from July 2000 to February 2002. Mr. Nesselrode served in various managerial positions with Union Pacific Resources Company from August 1979 to July 2000. Mr. Nesselrode earned a Bachelor of Science in Petroleum Engineering from the University of Tulsa in 1979 and completed the Harvard Business School Program for Management Development in 1995.
Robert Speirs has served as Senior Vice President, Eastern Operations since July of 2011. Prior to his promotion, his title had been Vice President, Eastern Operations since December 6, 2007. He joined Harvest in June 2006 as President and General Manager, Russia. Previously Mr. Speirs was President of Marathon Petroleum Russia and General Director of their wholly-owned subsidiary, KhantyMansciskNefte Gas Geologia from March 2004 through May 2006. Prior to joining Marathon, Mr. Speirs was Executive Vice President of YUKOS EP responsible for engineering and construction from June 2001. During both these periods, Mr. Speirs spent considerable time in West Siberia where he oversaw substantial increases in production at both companies. From November 1997 until March 2001, Mr. Speirs resided in Jakarta where he served as President of Premier Oil Indonesia. During this period, Premier was active in all phases of the Upstream business, culminating in the commissioning of the West Natuna Gas Project. Prior to 1997, Mr. Speirs was with Conoco for 21 years in various leadership positions in the US, UK, Russia, Indonesia, Singapore and Dubai, UAE. Mr. Speirs earned a Bachelor of Science degree with Honors in Engineering Science from the University of Edinburgh. He also attended the Executive Management Program at INSEAD.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act (“Section 16(a)”) requires our directors, executive officers and beneficial holders of more than 10% of our common stock to file reports with the SEC regarding their ownership and changes in ownership of our stock. Based solely upon our review of SEC Forms 3, 4 and 5 and any amendments thereto furnished to us, to our knowledge, during fiscal year 2012, our officers, directors and 10% stockholders complied with all Section 16(a) filing requirements. In making this statement, we have relied upon the written representations of our directors and officers.
CODE OF BUSINESS CONDUCT AND ETHICS
The Board has adopted a Code of Business Conduct and Ethics, which applies to all of our directors, officers and employees. The Board last amended the Code of Business Conduct and Ethics in December 2010. The Board has not granted any waivers to the Code of Business Conduct and Ethics.
The Code of Business Conduct and Ethics is accessible on our website under the Corporate Governance section at http://www.harvestnr.com. Any amendments to or waivers of the Code of Conduct and Business Ethics will also be posted on our website.
AUDIT COMMITTEE
The Board has a standing Audit Committee. The Audit Committee assists the Board in its oversight of: our accounting and financial reporting policies and practices; the integrity of our financial statements; the independent registered public accounting firm’s qualifications, independence and objectivity; the performance of our internal audit function and our independent registered public accounting firm; and our compliance with legal and regulatory requirements. The Audit Committee acts as a liaison between our independent registered public accounting firm and the Board, and it has the sole authority to appoint or replace the independent registered public accounting firm and to approve any non-audit relationship with the independent registered public accounting firm. Our internal auditor and the independent registered public accounting firm report directly to the Audit Committee.
Dr. Effimoff and Messrs. Hardee, Murray and Stinson are members of the Audit Committee. The Board has determined that each member of the Audit Committee meets the independence standards of the SEC’s requirements, the rules of the NYSE and the Company Guidelines for Corporate Governance, which is an internal policy that requires independent directors comprise a majority of the Board and that the Chairman of the Board be elected from the independent directors. No member of the Audit Committee serves on the audit committee of more than three public companies. The Board has further determined that each member of the Audit Committee is financially literate and that Mr. Murray qualifies as an audit committee financial expert, as defined in Item 407(d)(5) of SEC Regulation S-K. Information on the relevant experience of Mr. Murray is set forth above under the section entitled “Directors.”
Item 11.
Item 11. Executive Compensation
COMPENSATION DISCUSSION AND ANALYSIS
Introduction
Harvest’s Compensation Discussion and Analysis describes the Company’s compensation program for the executive officers identified in the Summary Compensation Table. Throughout this proxy statement we refer to these individuals as “named executive officers.” They are James A. Edmiston, President and CEO; Stephen C. Haynes, Vice President, Chief Financial Officer and Treasurer; Robert Speirs, Senior Vice President - Eastern Operations; Karl L. Nesselrode, Vice President - Engineering & Business Development; and Keith L. Head, Vice President - General Counsel and Corporate Secretary.
Summary of Executive Compensation Decisions Made in 2012/2013
During 2012, our executive compensation decisions included:
•
Base salary increases of 1.8% for the CEO and averaging 3.3% for the other named executive officers were effective in March 2012;
•
In addition to individual performance objectives, the Human Resources Committee, which is a Committee of the Board that is responsible for establishing and recommending to the Board all elements of executive and Board compensation (the “HR Committee”), established Company annual incentive performance measures as follows:
•
Total Shareholder Return (weight 60%)
•
Reserve Additions/Production (weight 30%)
•
Social Responsibility and Governance (including safety) (weight 10%)
•
Annual cash incentive awards were paid in February 2013. The CEO received 137% of his target incentive and the other named executive officers also received an average of 137% of their target incentives. This reflects an increase in the annual incentive target for the named executives to 60% of base salary. Since 2008, we have been consistently low for this benchmark. This increase was approved at the February 2013 HR Committee meeting and effective for the 2012 incentive awards.
•
Long-term incentive awards were paid with approximately 30% restricted stock and 70% stock options valued at the closing stock price on May 17, 2012.
During 2013, our executive compensation decisions included:
•
Base salary increases of 3.5% for the CEO and averaging 3.5% for the other named executive officers were effective in March 2013.
Company Overview and Compensation Objectives
As a Company, our focus is on acquiring exploration, development, and producing properties in proven and active hydrocarbon systems. We operate from our Houston, Texas headquarters with regional/technical offices in the United Kingdom and Singapore and field offices in Jakarta, Indonesia; Port Gentil, Gabon; and Muscat, Oman.
In 2012, we achieved the following results:
•
Increased gross production in Venezuela to 13.2 million barrels of oil or an average of 36,979 barrels of oil per day, an increase of 14.7% over 2011;
•
Agreed third production phase with the Republic of Gabon to four years until May 2016.
•
Completed drilling of the Dussafu Tortue well in the fourth quarter of 2012 and announced an oil discovery of approximately 42 feet of pay in the Gamba formation and 123 feet of pay in the Dentale formation.
•
Received a four-year extension by the Indonesian government until January 2017 for the Budong Budong Block and agreed with our partner to assume operatorship of the block.
•
Maintained proved and probable (2P) reserve level from 2011, net of 2012 production.
•
Signed Sales Purchase Agreement with Pertamina, National Oil Company of Indonesia, which set the benchmark price for our Venezuelan Assets.
The following graphs highlight the Company results for 2012:
Note: Annual Net Production and Net Proved and Probable Reserves for 2010 include production and reserves from the Utah asset which were sold in 2011. (MBOE = Thousand Barrels of Oil Equivalent)
The HR Committee has the discretion to exercise their judgment in weighing the achievement of specific performance measures. For 2012, it considered total shareholder return, reserves, social responsibility/governance and safety as well as strategic individual objectives for the named executive officers. Total shareholder return (“TSR”) was up 22.9% in 2012 and the Company remained in the top quartile of its Peer Group over a three-year period from 2010-2012. Proved and probable reserves were down slightly by 4% from the prior year. We calculate TSR as year-end share price minus beginning year share price divided by beginning year share price. Annual net production in 2012 was up 14% over the prior year. Companywide health and safety programs were implemented in 2012. There were no Foreign Corrupt Practices Act (“FCPA”) incidents in 2012. Ethics and compliance guidelines were revised in 2012, and there was one contractor lost time accident in 2012. Given the operational and technical challenges faced by the Company, the Committee determined that the management team effectively managed the exploration assets we controlled and operated during the year.
Compensation Philosophy
Our compensation philosophy is to offer a competitive total compensation package to enable us to attract, motivate and retain key executives. Our compensation objectives include:
•
Offering total compensation that is competitive with the select peer group of globally-focused oil and gas companies with which we compete for executive talent;
•
Providing annual cash incentive awards that take into account performance factors weighted by both corporate and individual goals;
•
Aligning the interest of executive officers and directors with stockholder value creation by providing significant equity-based, long-term incentives; and
•
Providing incentives to executives for achieving challenging corporate goals.
The HR Committee oversees the development and execution of our compensation program. The HR Committee annually reviews our compensation philosophy and tests its ability to promote meeting the objectives stated above. The HR Committee recommends compensation for the named executive officers, short-term cash bonuses, long-term cash and non-cash compensation and submits its recommendations to the Board for approval. Three independent directors comprise the HR Committee. The HR Committee meets as needed, but no less than quarterly to review compensation and benefit programs with management. It subsequently approves any changes. Our Human Resources, Accounting and Legal Department employees handle the day-to-day design and administration of employee compensation and benefit programs available to our employees.
Setting Executive Compensation
Our compensation program consists of several forms of compensation: base salary, annual performance-based incentive awards, long-term incentives and personal benefits. Base salary and annual performance-based incentive awards are generally cash-based. Long-term incentives typically consist of stock options, stock appreciation rights, restricted stock units and/or restricted stock awards. The Committee reviews the compensation recommendations from the CEO and our independent consultants’ advice on competitive trends regarding base salary, annual incentive awards and long-term incentives. The Committee exercises its collective judgment in establishing executive compensation based on performance, compensation history and market information. The recommendations are then made to the full Board for its approval.
The Role of the Compensation Consultant-Compensation Consultant Independence
In 2012, the HR Committee engaged Frost Human Resource Consulting (“Frost HR Consulting”), as the HR Committee’s independent compensation consultant, to benchmark our executive officer compensation levels with similar positions in our industry peer group. The Committee reviews the relationship annually for any conflicts of interest. To ensure Frost HR Consulting’s independence:
•
The HR Committee directly retained and has the authority to terminate Frost HR Consulting.
•
Frost HR Consulting reports directly to the HR Committee and its Chairperson.
•
Frost HR Consulting meets regularly in executive sessions with the HR Committee.
•
Frost HR Consulting has direct access to all members of the HR Committee during and between meetings.
•
Interactions between Frost HR Consulting and management generally are limited to data gathering and discussions regarding information that has or will be presented to the HR Committee.
•
Frost HR Consulting has procedures in place to prevent conflicts of interest.
•
Frost HR Consulting does not have any business or personal relationship with any member of management or the HR Committee.
•
Frost HR Consulting consultants do not own any of our Company stock.
Peer Group and Compensation Surveys
The HR Committee considers market information from compensation surveys and peer company proxy statements when determining compensation for each of the executive officers. In May 2012, the HR Committee reviewed proxy statement data from a peer group of companies. The surveys used for benchmarking included:
•
Towers Watson 2011 Top Management Compensation Survey
•
William M. Mercer 2011 Energy Industry Compensation Survey
•
Effective Compensation Inc.’s (“ECI”) 2011 Oil and Gas Industry Compensation Survey
Each year, the HR Committee reviews the composition of the peer group and the compensation paid at these companies, as well as their corporate performance and other comparative factors in determining the appropriate compensation levels for our executives. No company in our peer group shares our unique risk profile, which is a function of our portfolio of producing assets and exploratory prospects, as well as the regulatory and political environments in which we operate. Therefore, the HR Committee uses its judgment and business experience in addition to the peer group data in determining executive compensation.
The HR Committee selects peer companies for their shared similarities, including a common industry oil exploration focus, assets, market capitalization and enterprise value, among other factors. Revenue at the peer companies ranges from $35 million to $423 million for 2012 versus $405 million for Harvest, which is our 32% interest of gross revenue from oil sales in our unconsolidated affiliate, Petrodelta, S.A. Our peer companies typically compete with us for executive talent. Our current industry peer group consists of the following companies:
• BPZ Resources, Inc.
• GeoResources, Inc. (later in 2012 acquired by Halcón Resources, LLC)
• Carrizo Oil and Gas Inc.
• Halcón Resources, LLC (formerly Ram Energy Resources, Inc.)
• Crimson Exploration Inc.
• Gulfport Energy, Corp.
• Endeavour International Corp.
• Petroleum Development Corp.
• Energy Partners Ltd (now ELP Oil & Gas Inc.)
• PetroQuest Energy, Inc.
• FX Energy, Inc.
• Toreador Resources, Corp. (later in 2012 acquired by ZaZa Energy Corp) and
• Gastar Exploration Ltd
• VAALCO Energy, Inc.
For 2012, Frost HR Consulting benchmarked the 25th, 50th and 75th percentiles for the data sources mentioned above to provide the HR Committee with an understanding of competitive pay practices. These surveys, equally weighted with the proxy data, consider each element of compensation and are collectively referred to as the “market data” throughout this Compensation Discussion and Analysis. Frost HR Consulting also provides the HR Committee with advice on equity incentive compensation trends, including types and value of awards being used by other public companies.
The Role of the Executives in Human Resources Committee Meetings
The HR Committee invites our CEO, Vice President, Administration and Human Resources and Vice President, General Counsel and Corporate Secretary to attend their meetings. The Vice President, Administration and Human Resources acts as the HR Committee Secretary and provides reports on plan administration and human resources policies and programs. The Vice President, General Counsel and Corporate Secretary provides legal advice on human resource matters. The CEO makes recommendations with respect to specific compensation decisions. The HR Committee, without management present, regularly meets in executive session and with its compensation consultant to review executive compensation matters including market data as well as peer group information.
The CEO makes detailed recommendations to the HR Committee on performance evaluations, base salary changes, and both equity and annual incentive-based compensation for executive officers and senior management (other than the CEO). From time to time, the CEO and members of management are invited to participate in HR Committee meetings to provide information regarding our strategic objectives, financial performance and recommendations regarding compensation plans. Management may be asked to prepare information for any HR Committee meeting. Depending on the agenda for a particular meeting, these materials may include:
•
Reports on our strategic objectives;
•
Financial reports;
•
Reports on achievement of individual and corporate performance objectives;
•
Information regarding compensation programs and compensation levels for executive officers, directors and other employees at peer companies;
•
Information on the total compensation of the executive officers, including base salary, cash incentives, equity awards, and other compensation, and any amounts payable to the executive officers upon voluntary or involuntary termination or following a severance with or without a change in control; and
•
Information regarding all annual and equity incentive-based compensation and health and welfare plans.
Executive Compensation Components
Our compensation program components are designed to reward executive officers’ contributions, while considering our specific operating situation and how they manage this situation consistent with our strategy. Factors considered in compensating our executives include individual experience, skill sets that are required for multi-national oil and gas operations and their proven record of performance. It is essential that we recruit and retain executives that understand the risk and complexity of global operations and our unique business strategy. All of our executive officers are mid-to-late career executives who have worked for larger energy companies and have alternatives; they decided to join the Company for the challenge and potential reward of working for a small, entrepreneurial organization.
The principal components of compensation and their purpose for executive officers in 2012 are:
Element
Form of Compensation
Purpose
Base salary
Cash
Provide competitive, fixed
compensation to attract and retain
executive talent
Annual performance based incentive awards
Cash
Create strong financial incentive for
achieving financial and strategic
successes
Long-term incentive compensation
Stock Options, Stock Appreciation Rights (SARs), Restricted Stock Units (RSU) and Restricted Stock Grants
Provides alignment between executive
and shareholder interests by rewarding
executives for performance based on
appreciation in the Company’s share
price and for retaining executives
Personal benefits
Eligibility to participate in plans extends to all employees
Broad-based employee benefits for
health and welfare and retirement
Base Salary
We pay base salaries to our executive officers to compensate them for specific job responsibilities during the calendar year. In determining base salaries for our executive officers, the HR Committee considers market and competitive benchmark data for the executive’s level of responsibility targeting between the 50th and 75th percentile of executive officers in comparable companies, with variation based on individual executive skill sets. Compared to 2011 market data, our base salaries were between 95.6% and 106.2% of the target market median.
For 2012, the HR Committee moved the Company’s salary management review to February from May to better address cash compensation decisions for both salaries and bonuses. Consequently, in March 2012 the CEO received an annualized salary increase for 2012 of 1.8% and the other named executive officers received an average annualized increase of 3.3%. In March 2013, the CEO received an annual salary increase of 3.5% and the other named executive officers each received an annualized increase of 3.5% as well.
Annual Performance-Based Incentive Awards
Each year, in addition to individual performance objectives, the HR Committee establishes Company performance measures for determining annual incentive awards as follows:
•
Total Shareholder Return (weight 60%)
•
Reserve Additions/Production/Estimated Market Value (“EMV”) (weight 30%)
•
Social Responsibility and Governance (including safety) (weight 10%)
These measures and their weightings are reviewed and modified, if appropriate, in light of changing Company priorities and strategic objectives. The corporate targets and weightings are set by the CEO and reviewed and approved by the HR Committee. The HR Committee focuses on these corporate goals in evaluating Company performance for the purpose of compensation. Individual performance results of the named executive officers are measured and assessed by the CEO.
Among these corporate goals, Total Shareholder Return was weighted at 60%. In 2012, the Company realized a Total Shareholder Return of 22.9% placing it in the first quartile among its selected peer group.
Reserves/Production/EMV was weighted at 30%. The primary measurement for this target is year-over-year P2 reserve additions; although 3P and contingent resources are also taken into consideration. For 2012, proved and probable reserves remained essentially flat over 2011, net of 2012 production. However, production increased by 14.7% over 2011 at Petrodelta, our Venezuelan affiliate.
Social Responsibility and Governance was weighted at 10% and is used at the discretion of the CEO and the Committee in deciding the final corporate rating. As expected, there were no violations of our FCPA policies or our Code of Business Conduct and Ethics. One of our contractors did experience a lost time accident in 2012.
Individual performance and operational results were combined with the Company performance results and weighted equally to determine each executive’s final annual incentive award. Target award levels for annual incentives are set at 100% of base salary for the CEO and 60% of base salary for the other named executive officers. For 2012 performance, awarded in February 2013, the CEO received 137% of his bonus target as a performance-based incentive award. The other named executive officers individual awards ranged from 130% to 143% of their bonus targets.
The HR Committee and the Board each determined that management exceeded expectations in meeting the 2012 Company and individual performance targets.
We believe the Company should have the ability to recover compensation paid to executive officers and key employees under certain circumstances. As a result, the HR Committee adopted the following policy statement in 2011:
“In the event the Board of Directors determines that any fraud or intentional misconduct caused or was a substantial contributing factor to a restatement of our financial statements, the Board of Directors may require reimbursement of any annual incentive compensation paid to an executive officer or certain other key employees to the extent the bonus paid exceeded what would have been paid had the financial results been properly reported. This policy will apply to all annual incentives paid after January 2012.”
Long-Term Incentive Compensation
On May 20, 2010, our stockholders approved the 2010 Long-Term Incentive Plan (the “2010 Plan”). This 2010 Plan allows us to recover any award that the Company deems was not warranted after any restatement of corporate performance.
Long-term incentive awards have been granted under our 2001, 2004, 2006 and 2010 Long Term Incentive Plans (“LTIPs”) and the awards are granted to our executive officers to align their personal financial interests with our stockholders. The LTIPs include provisions for stock options, stock appreciation rights, restricted stock, restricted stock units and cash awards.
Our policy on stock awards is focused on determining the right mix of retention and ownership requirements to drive and motivate our executive officers’ behavior consistent with long-term interests of stockholders. The HR Committee is the administrator of our LTIPs and, subject to Board approval, has full power to determine the size of awards to our executives, to determine the terms and conditions of grants in a manner consistent with the LTIPs and to amend the terms and conditions of any outstanding award.
The CEO presents individual stock award recommendations for executive officers to the HR Committee, and after review and discussion the HR Committee submits its recommendation to the Board for approval. The HR Committee’s policy is to grant awards on the date the Board approves them. Stock options and restricted stock will be granted once each calendar year on a predetermined date or at the effective date of a new hire or promotion, but not within six months of a previous award to the same individual. The price of options and the value of a restricted stock award issued to a new employee will be set at the closing price on the employee’s effective start date. The price of options and the value of a restricted stock award issued to an employee as a result of a promotion will be set at the closing price on the effective date of that promotion. Under no circumstances will a grant date be set retroactively.
The Board has adopted stock retention guidelines as an additional means to promote ownership of stock by executive officers and directors. The guidelines apply to any award of restricted stock or options to purchase our stock granted to executive officers and directors after February 2004. Under these guidelines, an executive officer or director must retain at least 50% of the shares of restricted stock for at least three years after the restriction lapses. Consequences for failure to adhere to these guidelines shall be determined by the HR Committee in its discretion including, without limitation, actions with respect to future compensation and future grants of stock options or restricted stock and performance measures. Under our Insider Trading Policy, executive officers and directors are strictly prohibited from speculative trading in the Company’s securities, including short sales and buying or selling puts or calls on the Company’s securities.
The long-term incentive awards for 2012 included stock options, stock appreciation rights (“SARs”), which can be settled as cash or equity, and restricted stock units (“RSUs”), which can be settled as cash or equity. This mix provides upside potential with the stock options and a more stable award in the form of restricted stock units. Of the total award value, 70% was allocated to options and 30% to restricted shares.
Mix of Long Term Incentives Awarded in 2012
As of December 31, 2012, almost all of the total shares available for grant as options under the LTIPs approved by our stockholders have been granted:
Personal Benefits
Our executive officers are covered under the same health and welfare plans, including our 401(k) plan, as all employees. The executive officers also receive supplemental life insurance to cover the risks of extensive travel required in conducting our global business. We pay 100% of all premiums for the following benefits for employees and their eligible dependents:
•
All employees are entitled to a medical benefit with unlimited maximum lifetime benefits, with an annual out-of-pocket deductible of $3,000 per individual and $9,000 per family.
•
Life and accidental death and dismemberment (“AD&D”) insurance equal to two times annual salary with a minimum of $200,000 and a cap of $300,000 (or $400,000 with evidence of insurability), and additional coverage equal to five times annual salary ($1.0 million maximum) while traveling outside their home country on Company business.
•
Long-term disability benefits provide a monthly benefit of 60% of base salary up to a maximum of $10,000 per month.
•
Participation in our Statutory Profit Sharing Plan 401(k). Eligibility is effective the first day of the month following the date of hire. We use a safe harbor matching formula for Company contributions (dollar for dollar match up to 3% of pay, $0.50 for every dollar on the next 2% of pay subject to the statutory maximum salary limits). Participant and Company contributions are 100% vested from the date of contribution. At termination of employment, employees are eligible to receive their account balance in a lump sum.
•
All employees and their dependents receive annual dental and vision care benefits of $1,500 and $250, respectively, per employee and dependent.
We do not offer a pension plan or a non-qualified deferred compensation plan for executive officers or employees. In 2012, we did not offer perquisites to executive officers or other employees. We offer relocation and Foreign Service premiums to employees serving in an international location. The amount of the premium will vary depending upon the living conditions, political situation and general safety conditions of the international location. Expatriate employees are also provided housing and utilities allowances where applicable. They also receive a cost of living allowance to cover the differential between normal living expenses in the host and home countries and will continue to participate in the employee benefit plans available to home country employees.
Total Direct Compensation
Executive Compensation Compared to Market Data
Compared to 2011 market data, total direct compensation ranged between 82% and 128% of the target market median for all named executive officers. In 2012, their compensation (after their March 2012 base salary increases) fell at the following percentiles:
Executive Compensation Mix
The general mix of compensation for target-level performances in the annual incentive plan, plus the net annualized present value of long-term compensation grants, can range as follows, depending upon the executive officer. The Committee considered the following general percentage mix in establishing the total compensation for the Company’s executive officers for 2012 target performance. It is important to note that the influences on Company financial performance and stock price performance could significantly change the basic mix of compensation components as a percentage of total compensation:
For the CEO, 73.6% of his total direct compensation is considered “at-risk.” The other named executive officers have 67% of their total direct compensation at risk.
Note: Annual incentive (“AI”) for Messrs. Edmiston, Nesselrode and Head includes a special accomplishment award for the sale of Utah in 2011.
Tax and Accounting Implications of Executive Compensation
Deductibility of Executive Compensation
As part of its role, the HR Committee reviews and considers the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended, which imposes a limit of $1.0 million on the amount that a publicly-held corporation may deduct in any year for the compensation paid or accrued with respect to its named executive officers unless the compensation is performance based. None of our executive officers currently receives compensation exceeding the limits imposed by Section 162(m). While we cannot predict with certainty how executive compensation might be affected in the future by Section 162(m) or applicable tax regulations issued, we intend to preserve the tax deductibility of all executive compensation while maintaining our executive compensation program as described in this Compensation Discussion and Analysis.
Employment Agreements
We have entered into Executive Employee Agreements with our current named executive officers: Messrs. Edmiston, Haynes, Speirs, Nesselrode and Head. Two other executive officers who are not named also have executive employment agreements. The contracts have an initial term, which automatically extends for one year upon each anniversary unless a one-year notice not to extend is given by the executive. The current term of the Executive Employment Agreements is through May 31, 2013.
Entitlements based on Terms in Executive
Employment Agreements if we terminate the
employment without cause or notice (not
related to Change of Control) OR the
executive terminates employment for good
reason
Mr.
Edmiston
Mr. Haynes
Mr. Speirs
Mr. Nesselrode
Mr. Head
A lump sum amount equal to a certain multiple of base salary
3 times
2 times
2 times
2 times
2 times
An amount equal to a certain number of years times the maximum annual employer contributions made under out 401(k) plan
3 years
2 years
2 years
2 years
2 years
Vesting of all stock options
Yes
Yes
Yes
Yes
Yes
Vesting of all restricted stock awards
Yes
Yes
Yes
Yes
Yes
Reimbursement of Outplacement Services
Yes
Yes
Yes
Yes
Yes
Restrictions on ability to compete with the Company after termination of employment
2 years
2 years
2 years
2 years
2 years
See the table titled “Potential Payments under Termination or Change of Control” in the Compensation of Executive Officers section below for details on the above information.
The HR Committee believes the termination payment included in these Executive Employment Agreements is needed to attract and retain the executives necessary to achieve our business objectives. However, the HR Committee also believes termination payments should not be guaranteed. Accordingly, a termination payment will not be paid if a termination occurs after notice and lapse of the notice period to terminate the Executive Employment Agreement. Also, a termination payment will not be made if the executive officer resigns other than for good reason. Good reason under the employment contracts includes: (1) a material breach of the employment agreement by the Company; (2) failure to maintain or reelect the executive officer to his position; (3) a significant reduction of the executive officer’s duties, position or responsibilities; (4) a substantial reduction, without good business reasons, of the facilities and perquisites available to the executive officer; (5) a reduction by the Company of the executive officer’s monthly base salary; (6) failure of the Company to continue the executive officer’s participation in any bonus, incentive, profit sharing, performance, savings, retirement or pension policy, plan, program or arrangement on substantially the same or better basis relative to other participants; or (7) the relocation of the executive officer more than fifty miles from the location of the Company’s principal office.
Change of Control
Since it is in our best interest to retain executive officers during uncertain times who will act in the best interests of the stockholders without concern for personal outcome, our Executive Employment Agreements provide benefits in the event of loss of employment for employees in good standing due to a change of control. Change of control is defined as the acquisition of 50% or more of our voting stock, the cessation of the incumbent board of directors to constitute a majority of the board of directors, or the reorganization, merger, or sale or disposition of at least 50% of our assets where we are not the surviving entity. Change of control severance benefits apply to terminations taking place between 240 days before a change of control and 730 days after a change of control.
Entitlements based on Terms in
Executive Employment Agreements if
we terminate the employment without
cause or notice related to a Change of
Control
Mr.
Edmiston
Mr.
Haynes
Mr. Speirs
Mr.
Nesselrode
Mr. Head
A lump sum amount equal to a certain multiple of base salary
3 times
2 times
2 times
2 times
2 times
A lump sum amount equal to a certain multiple of the highest annual bonus over the past 3 years or target bonus, whichever is higher
3 times
2 times
2 times
2 times
2 times
An amount equal to a certain number of years times the maximum annual employer contributions made under out 401(k) plan
3 years
2 years
2 years
2 years
2 years
Continuation of accident, life, disability, dental and health benefits for a certain number of years
3 years
2 years
2 years
2 years
2 years
Excise tax reimbursement and gross up on the reimbursement
Yes
Yes
Yes
Yes
Yes
Vesting of all stock options
Yes
Yes
Yes
Yes
Yes
Vesting of all restricted stock awards
Yes
Yes
Yes
Yes
Yes
Reimbursement of Outplacement Services
Yes
Yes
Yes
Yes
Yes
Restrictions on ability to compete with the Company after termination of employment
2 years
2 years
2 years
2 years
2 years
The change of control benefits in the Executive Employment Agreements contain a double trigger in that both a change of control must occur and the executive officer must be terminated without cause or resign for good reason within a specified period of time after the change of control. The HR Committee believes that the double trigger avoids unnecessarily rewarding an executive officer when a change of control occurs and the executive officer’s status is not changed as a result. However, because of the significant uncertainty that can arise during a period of a potential or actual change of control, the Committee has provided greater benefits to the executive officer in the event of a termination resulting from a change of control. Change of control benefits are detailed in the “Potential Payments under Termination or Change of Control” table in the Compensation of Executive Officers section below.
HUMAN RESOURCES COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the Board’s HR Committee is or has been an officer or employee of the Company or has a relationship requiring disclosure under Item 404(a) of SEC Regulation S-K. No executive officer of the Company serves on the compensation committee or serves as a director of another entity where an executive officer of that entity also serves on the HR Committee or on the Board.
HUMAN RESOURCES COMMITTEE REPORT
The HR Committee has reviewed and discussed with management the Compensation Discussion and Analysis filed in this document. Based on such review and discussions, the HR Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.
R. E. Irelan, Committee Chairman
Igor Effimoff
J. Michael Stinson
COMPENSATION OF EXECUTIVE OFFICERS
Summary Compensation Table
The following table summarizes the compensation of the Company’s named executive officers for the three most recently completed fiscal years ended December 31, 2012, 2011 and 2010.
Notes:
(1) Harvest pays bonuses one year in arrears but reflects the bonus in the table above in the year to which it related. Harvest deferred the payment of bonuses to key employees for 2010 until later in 2011. These bonuses have been included in the above table as 2010 bonuses. Bonuses related to 2011 were paid February 24, 2012 and are reflected in the table above as 2011 bonuses. Bonuses related to 2012 were paid March 1, 2013 and are reflected in the table above as 2012 bonuses.
(2) Harvest uses the Black-Scholes option pricing model to determine the value of each option grant on the date of grant. Harvest does not advocate or necessarily agree that the Black-Scholes option pricing model can properly determine the value of an option. The 2012 calculations for the named executive officers are based on a weighted average expected life of five years, expected volatility of 67.32%, risk-free interest rate of 0.74%, expected dividend yield of 0% and expected annual forfeitures of 3% for stock options and 0% for restricted stock.
(3) In May 2012, Harvest issued stock appreciation rights (SAR) and restricted stock units (RSU) as long-term incentive compensation. These instruments can be settled in cash or equity. Currently, no plan has been approved by the shareholders for equity settlement and Harvest is recording the liability and expense associated with the awards based on the fair market value of the stock at $5.12 on May 17, 2012. The number of awards for each executive that equals the amount above is shown in the following table:
(4) Detail of all other compensation paid:
Grants of Plan-Based Awards
The following table shows information concerning options to purchase Common Stock granted to each of the named executive officers during 2012.
Notes:
(1) Options granted May 17, 2012 vest 1/3 each year over a three year period.
(2) Harvest granted options representing 436,298 shares to employees in 2012.
Outstanding Equity Awards at Fiscal Year End
The following table shows information concerning outstanding equity awards as of December 31, 2012 held by the named executive officers.
(1) The market value of shares is $8.840 per share, based upon the average of the high and low market prices on December 31, 2012.
(2) This stock unit is a right to receive, after vesting, a cash amount equal to the difference between the closing price of the stock on September 15, 2005 and the price of the stock on the date the payment is distributed. Vesting is 1/3 on the last to occur of September 15, 2006 and the date on which the average of the stock price for 10 consecutive trading days is greater than $25 per share. Vesting of 1/3 on September 2007 and 2008 is subject to the same $25 per share condition.
Options Exercised and Stock Vested
The following table provides information regarding the exercise of stock options during 2012 by the named executive officers.
Potential Payments under Termination or Change of Control
The tables below reflect the additional compensation paid to the named executive officers of the Company under the terms of their Executive Employment Agreements in the event of termination without cause or without proper notice, termination following change of control, or termination for disability or death. (See Compensation Discussion and Analysis - Employment Agreements and Change of Control above for a description of the terms of the Executive Employment Agreements.) The amounts shown in the tables assume that such termination was effective as of December 31, 2012, and thus include estimated amounts earned through that date that would be paid out to the named executive officers. The actual amounts can only be determined at the time of separation from the Company.
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
* Until no longer disabled or Social Security Retirement Age
DIRECTOR COMPENSATION
Our philosophy in determining director compensation is to align compensation with the long-term interests of the stockholders, adequately compensate the directors for their time and effort and establish an overall compensation package that will attract and retain qualified directors. In determining overall director compensation, we seek to strike the right balance between the cash and stock components of director compensation. The Board’s policy is that the directors should hold equity ownership in the Company and that a portion of the director fees should consist of Company equity in the form of restricted stock and stock grants. The Board also believes that directors should develop a meaningful equity position over time and has adopted stock retention guidelines applicable to all directors. These guidelines state directors must retain (i) at least 50% of the shares of restricted stock granted to them for at least three years after the restriction lapses and (ii) at least 50% of the net shares of stock received through the exercise of an option or SAR must be retained by a director for at least three years after the exercise date.
Our retainer and meeting fee schedule remained the same in 2012 as it was in 2011, 2010 and 2009. Each non-employee director of the Company received cash compensation as follows:
•
An annual Board retainer of $40,000, plus travel and related expenses;
•
A meeting fee of $1,500 for each board or committee meeting attended;
•
An annual committee retainer of $20,000 for serving as committee chair of the Audit Committee, $15,000 for serving as committee chair of the Human Resources Committee and $10,000 for serving as committee chair of the Nominating and Corporate Governance Committee; and
•
A fee of $1,500 per day for attending business meetings on our behalf in the member’s capacity as a director that requires out of town travel or a substantial commitment of time.
Our director compensation includes additional compensation for the non-executive Chairman of the Board in recognition of the significant added responsibilities and time commitments of that position. In addition to his compensation as a director, he receives a retainer of $120,000 a year; this 2012 retainer remained the same as the retainer in 2011 and 2010.
Under the 2010 Plan, directors are eligible to receive restricted stock, RSUs, stock options and SAR grants. In May 2012, the Board approved a RSU award of $100,000 in value for each director.
The following table sets forth the cash and other compensation paid to the non-employee members of our Board of Directors in 2012.
(1) Includes $4,500 in business meeting fees and $6,000 for travel days.
(2) Includes $1,500 for travel days.
(3) Includes $4,500 in business meeting fees and $1,500 for travel days.
(4) Includes $1,500 in business meeting fees and $4,500 for travel days.
(5) Includes $3,000 in business meeting fees and $4,500 for travel days.
(6) Includes $1,500 for travel days.
(7) The amounts included in this column represent the aggregate grant date fair value of the grant of 19,500 deferred shares granted to each of our non-employee directors on May 17, 2012. As of December 31, 2012, each of the non-employee directors had aggregate outstanding deferred shares as follows: Mr. Chesebro’ - 19,500; Dr. Effimoff - 19,500; Mr. Hardee - 19,500; Mr. Irelan - 19,500; Mr. Murray - 19,500 and Mr. Stinson - 19,500.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
EQUITY COMPENSATION PLAN INFORMATION
As of December 31, 2012
A description of our equity compensation plans is included in this Annual Report on Form 10-K, Part IV, Item 15, Notes to the Consolidated Financial Statements, Note 9 - Stock-Based Compensation and Stock Purchase Plans.
(1) Options were issued to new hire employees as employment inducement grants under a NYSE exception. These options were granted from 2007 through 2012 between $5.85 and $10.25 and vest ratably over three years from the grant date. At December 31, 2012, a total of 125,000 options were issued and outstanding as inducement grants, which are included in the table above, and 106,667 of these options were exercisable. This compensation plan was not approved by security holders.
(2) A SAR is a right to receive on the Exercise Date, after vesting thereof, for each share of Company stock underlying the SAR with respect to which the SAR is exercised, an amount equal to the excess of (a) the Fair Market Value of one share of the Company stock on the Exercise Date over (b) 100 percent of the Fair Market Value of one share of the Stock determined as of the Grant Date (the “SAR Exercise Price”). The grant date for the 2009 SARs was June 18, 2009 and the SAR Exercise Price is $4.595 per share of Company stock. The 2009 SARs vest one-third each year beginning on June 18, 2012 and expire after seven years on June 18, 2016. The grant date for the 2012 SARs was May 17, 2012 and the SAR Exercise Price is $5.12 per share of Company stock. The 2012 SARs vest one-third each year beginning on May 17, 2013 and expire after five years on May 17, 2017. At the sole discretion of the company, a SAR may be settled in cash or with shares of the underlying Company stock from an approved plan that allows the payment of a SAR in the medium of Company stock. This compensation plan was not approved by security holders.
(3) This reflects the weighted average exercise of the stock options and SARs listed in column (a).
(4) Securities remaining available for future issuances from the following plans are:
In addition to the outstanding options and SARs listed above, there are a total of 284,750 shares of restricted stock awards that were granted under all plans that are outstanding as of December 31, 2012. Of these full value awards, 280,750 shares were granted under equity plans approved by security holders. There were 4,000 shares awarded as inducement grants and not approved by security holders.
A “ Stock Unit ” is a right to receive on the Payment Date, after vesting thereof, a cash amount equal to the Fair Market Value of one share of Company stock on the Payment Date. At December 31, 2012, the Company had 530,006 Stock Units outstanding. Stock Units were granted on June 18, 2009 and vest one-third each year beginning June 18, 2012. Stock Units were also granted to employees on May 17, 2012 and vest on May 17, 2015. Stock Units granted to directors on May 17, 2012 vest on May 17, 2013. At the sole discretion of the Company, a Stock Unit may be settled in cash or with shares of the underlying Company stock from an approved plan that allows the payment of the stock unit in the medium of Company stock. This compensation plan was not approved by security holders.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Directors and Named Executive Officers
The following table shows the amount of our common stock beneficially owned (unless otherwise indicated) by our directors and nominees for director, each named executive officer and our directors and named executive officers as a group. Except as otherwise indicated, all information is as of April 24, 2013.
The number of shares of our common stock beneficially owned by each director or named executive officer is determined under rules of the SEC, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares as to which the individual has the sole or shared voting power or investment power and also any shares which the individual has the right to acquire within 60 days after April 24, 2013 through the exercise of stock options or other rights. Unless otherwise indicated, each person has sole investment and voting power (or shares such powers with his spouse) with respect to the shares set forth in the following table.
* Represents less than one percent of the Company’s outstanding common stock.
(1) This number does not include common stock that our directors or named executive officers have a right to acquire within 60 days of April 24, 2013.
(2) Percentages are based upon 39,454,279 shares of common stock outstanding on April 24, 2013.
(3) Percentage should be calculated assuming that the vested options have been exercised by the individual for whom the percent is being calculated.
Certain Beneficial Owners
The following table shows the beneficial owners of more than five percent of the Company’s common stock as of April 24, 2013:
(1) The stockholder has sole voting and dispositive power over the shares indicated unless otherwise disclosed.
(2) The Company’s outstanding common shares as of April 24, 2013 were 39,454,279.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Our Code of Business Conduct and Ethics (the “Code”) applies to all of our directors, officers and employees. Under the Code, individuals subject to the Code and their family members must knowingly avoid owning any interest (other than nominal amounts of stock in publicly-traded companies) in any supplier or customer; consulting with, or being an employee of, any customer, lessor, lessee, contractor, supplier or competitor; purchasing from, or selling to us, assets, goods or services; or serving on the board of directors of any customer, lessor, lessee, contractor, supplier or competitor, except where full disclosure of all facts is made known to us in advance to permit us to protect our interests. Each year we require our executive officers to certify their compliance with the Code. Our Audit Committee has oversight compliance responsibilities for the Code. Exceptions to the Code are reported to the Audit Committee. Waivers of the Code for officers and directors may only be granted by the
Board and waivers for employees may only be granted by the CEO and reported to the Audit Committee. No waivers of the Code were granted in 2012. In addition to the Code, each year we require our directors and executive officers to disclose in writing certain transactions and relationships and this information is used in preparing the proxy statement and in making independence determinations for directors.
For the purposes of this Annual Report on Form 10-K, the Company has no transactions to describe pursuant to SEC Regulation S-K Item 404(a).
DIRECTOR INDEPENDENCE
Of our seven directors standing for re-election, six have been affirmatively determined by the Board to be independent, including our non-executive Chairman of the Board. The directors our Board has determined to be independent are Stephen D. Chesebro’, Dr. Igor Effimoff, H. H. Hardee, Robert E. Irelan, Patrick M. Murray and J. Michael Stinson. The Board’s determination of independence is based upon the standards set forth in our Guidelines for Corporate Governance, which may be found under the Corporate Governance section on our website at http://www.harvestnr.com. The Guidelines for Corporate Governance include the NYSE independence standards. In making its determination of independence, the Board took into account responses of the directors to questions concerning their employment history, compensation, affiliations and family and other relationships.
Item 14.
Item 14. Principal Accountant Fees and Services
During 2012, PricewaterhouseCoopers LLP served as our independent registered public accounting firm and provided certain tax and consulting services to us. Representatives of PricewaterhouseCoopers LLP are expected to attend the annual meeting of stockholders where they will be available to respond to questions and, if they desire, to make a statement.
Audit Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for professional services rendered by it for the audit of our annual financial statements and review of financial statements included in our quarterly reports and services that are normally provided by it in connection with statutory and regulatory filings or engagements in those years were $1,190,000 for the year ended December 31, 2011, and $3,327,212 for the year ended December 31, 2012.
Audit Related Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for assurance and related services by it that are reasonably related to the performance of the audit or review of our financial statements that are not included as “Audit Fees” above were $0 for the year ended December 31, 2011, and $0 for the year ended December 31, 2012.
Tax Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for professional services rendered by it for tax compliance, tax advice and tax planning were $34,870 for the year ended December 31, 2011, and $32,274 for the year ended December 31, 2012.
All Other Fees. The aggregate fees billed by PricewaterhouseCoopers LLP for each of the last two fiscal years for all other products and services provided by it were $0 for the year ended December 31, 2011, and $0 for the year ended December 31, 2012.
All of the foregoing fees were approved by the Audit Committee.
Audit Committee Pre-Approval Policies and Procedures. The Audit Committee’s Charter provides that our independent registered public accounting firm may provide only those services pre-approved by the Audit Committee, subject to de minimus exceptions for non-audit services described in the rules and regulations of the SEC, which are subsequently ratified by the Audit Committee prior to completion of the audit. The Audit Committee annually reviews and pre-approves the audit, review, attestation and permitted non-audit services to be provided during the next audit cycle by the independent registered public accounting firm. To the extent practicable, at the same meeting the Audit Committee also reviews and approves a budget for each of such services.
The Audit Committee may delegate to a member(s) the authority to grant pre-approvals under its policy with respect to audit and permitted non-audit services, provided that any such grant of pre-approval shall be reported to the full Audit Committee no later than its next scheduled meeting.
The Audit Committee has concluded that the provision of non-audit services is compatible with maintaining the registered public accounting firm’s independence.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
Separate financial statements of Petrodelta, S.A. required pursuant to Rule 3-09 of Regulation S-X are filed as Exhibit 99.1.
(b) 3. Exhibits:
 Identifies management contracts or compensating plans or arrangements required to be filed as an exhibit hereto pursuant to Item 15(a) and (b) of Form 10-K.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Harvest Natural Resources, Inc.
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)1 present fairly, in all material respects, the financial position of Harvest Natural Resources, Inc. and its subsidiaries at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule, Schedule II-Valuation and Qualifying Accounts, listed in the index appearing under Item 15(a)2 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because material weaknesses in internal control over financial reporting related to (1) a sufficient complement of accounting and financial reporting resources; (2) accounting for certain transactions for oil and gas properties; (3) accounting for income taxes; (4) appropriate segregation of duties related to certain system access rights and the recording and review of journal entries; (5) preparation and review of certain classification and disclosure matters impacting the financial statements and related notes; and (6) accounting for significant and complex debt and equity transactions existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses referred to above are described in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. We considered these material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the 2012 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management’s report referred to above. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has not generated revenue and has incurred recurring losses and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 3, the Company restated its 2011 and 2010 consolidated financial statements and financial statement schedule to correct errors.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with 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 (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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.
/s/PricewaterhouseCoopers LLP
Houston, Texas
May 2, 2013
S-1
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
S-2
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
See accompanying notes to consolidated financial statements.
S-3
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
See accompanying notes to consolidated financial statements.
S-4
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements.
S-5
Supplemental Schedule of Noncash Investing and Financing Activities:
During the year ended December 31, 2012, we settled 70,994 restricted stock units with Harvest common stock valued at $0.4 million. Also, some of our employees elected to pay withholding tax on restricted stock grants on a cashless basis which resulted in 7,789 shares being added to treasury stock at cost. During the year ended December 31, 2012, capital expenditures of $10.5 million were financed through current liabilities. See Note 3 - Summary of Significant Accounting Policies, Other Assets for a discussion of certain non-cash asset transactions and Note 6 - Long-Term Debt for a discussion of other non-cash equity transactions.
During the year ended December 31, 2011, we issued 0.2 million shares of restricted stock valued at $2.0 million. Also, some of our employees elected to pay withholding tax on restricted stock grants on a cashless basis which resulted in 45,532 shares being added to treasury stock at cost. During the year ended December 31, 2011, capital expenditures of $3.4 million were financed through current liabilities.
During the year ended December 31, 2010, we issued 0.3 million shares of restricted stock valued at $1.8 million. Also some of our employees elected to pay withholding tax on restricted stock grants on a cashless basis, which resulted in 26,260 shares being added to treasury stock at cost; and 1,000 shares held in treasury that had been reissued as restricted stock were forfeited and returned to treasury. During the year ended December 31, 2010, capital expenditures of $7.6 million were financed through current liabilities. During the year ended December 31, 2010, the fair value of our warrant derivative liability of $15.0 million was offset through long-term debt.
See accompanying notes to consolidated financial statements.
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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1 - Organization
Harvest Natural Resources, Inc. (“Harvest”) is an independent energy company engaged in the acquisition, exploration, development, production and disposition of oil and natural gas properties since 1989, when it was incorporated under Delaware law.
We have acquired and developed significant interests in the Bolivarian Republic of Venezuela (“Venezuela”). Our Venezuelan interests are owned through Harvest-Vinccler Dutch Holding, B.V., a Dutch private company with limited liability (“Harvest Holding”). Our ownership of Harvest Holding is through HNR Energia, B.V. (“HNR Energia”) in which we have a direct controlling interest. Through HNR Energia, we indirectly own 80 percent of Harvest Holding and our partner, Oil & Gas Technology Consultants (Netherlands) Coöperatie U.A., a controlled affiliate of Venezolana de Inversiones y Construcciones Clerico, C.A. (“Vinccler”), indirectly owns the remaining 20 percent interest of Harvest Holding. Harvest Holding owns, indirectly through wholly owned subsidiaries, a 40 percent of Petrodelta, S.A. (“Petrodelta”). As we indirectly own 80 percent of Harvest Holding, we indirectly own a net 32 percent interest in Petrodelta, and Vinccler indirectly owns eight percent. Corporación Venezolana del Petroleo S.A. (“CVP”) owns the remaining 60 percent of Petrodelta. Petroleos de Venezuela S.A. (“PDVSA”) owns 100 percent of CVP. Harvest Holding has a direct controlling interest in Harvest Vinccler S.C.A. (“Harvest Vinccler”). Harvest Vinccler’s main business purposes are to assist us in the management of Petrodelta and in negotiations with PDVSA. We do not have a business relationship with Vinccler outside of Venezuela.
In addition to our interests in Venezuela, we hold exploration acreage in four projects:
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Mainly onshore in West Sulawesi in the Republic of Indonesia (“Indonesia”) through the Budong-Budong Production Sharing Contract (“Budong PSC”) (see Note 14 - Indonesia),
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Offshore of the Republic of Gabon (“Gabon”) through the Dussafu Marin Permit (“Dussafu PSC”) (see Note 15 - Gabon),
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Onshore in the Sultanate of Oman (“Oman”) through the Oman Exploration and Production Sharing Agreement (“EPSA”) Al Ghubar / Qarn Alam license (“Block 64 EPSA”) (see Note 16 - Oman), and
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Offshore of the People’s Republic of China (“China”) through the Wab-21 Petroleum Contract (see Note 17 - China).
Note 2 - Liquidity and Going Concern
Historically, our primary ongoing source of cash has been dividends from Petrodelta and the sale of oil and gas properties. See Note 5 - Dispositions - Discontinued Operations. Currently, our source of cash is expected to be generated by accessing debt and/or equity markets, and/or farm-downs.
Our primary ongoing use of cash has been to fund oil and gas exploration projects, debt, interest, and general and administrative costs. We require capital principally to fund the exploration and development of new oil and gas properties. As is common in the oil and gas industry, we have various contractual commitments pertaining to exploration, development and production activities. See Note 14 - Indonesia and Note 15 - Gabon for our contractual commitments.
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The environments in which we operate are often difficult and the ability to operate successfully depends on a number of factors including our ability to control the pace of development, our ability to apply “best practices” in drilling and development, and the fostering of productive and transparent relationships with local partners, the local community and governmental authorities. Financial risks include our ability to control costs and attract financing for our projects. In addition, often the legal systems of certain countries are not mature and their reliability can be uncertain. This may affect our ability to enforce contracts and achieve certainty in our rights to develop and operate oil and natural gas projects, as well as our ability to obtain adequate compensation for any resulting losses. Our strategy depends on our ability to have significant influence over operations and financial control.
Our operations are subject to various risks inherent in foreign operations. These risks may include, among other things, loss of revenue, property and equipment as a result of hazards such as expropriation, nationalization, war, insurrection, civil unrest, strikes and other political risks, increases in taxes and governmental royalties, being subject to foreign laws, legal systems and the exclusive jurisdiction of foreign courts or tribunals, renegotiation of contracts with governmental entities, changes in laws and policies, including taxes, governing operations of foreign-based companies, currency restrictions and exchange rate fluctuations and other uncertainties arising out of foreign government sovereignty over our international operations. Our international operations may also be adversely affected by the U.S. Foreign Corrupt Practices Act and similar worldwide anti-corruption laws, laws and policies of the United States affecting foreign policy, foreign trade, taxation and the possible inability to subject foreign persons to the jurisdiction of the courts in the United States.
There are also a number of variables and risks related to our minority equity investment in Petrodelta that could significantly utilize our cash balances, and affect our capital resources and liquidity. Petrodelta’s capital commitments are determined by its business plan, and Petrodelta’s capital commitments are expected to be funded by internally generated cash flow. The total capital required to develop the fields in Venezuela may exceed Petrodelta’s available cash and financing capabilities, and there may be operational or contractual consequences due to this inability. Petrodelta’s ability to fully develop the fields in Venezuela will require a significant investment. Due to PDVSA’s liquidity constraints, PDVSA has not been providing the necessary monetary support and contractual adherence required by Petrodelta. If we are called upon to fund our share of Petrodelta’s operations, our failure to do so could be considered a default under the Conversion Contract and cause the forfeiture of some or all our shares in Petrodelta.
Petrodelta currently represents our only source of earnings. Petrodelta also has a material impact on our results of operations for any quarter or annual reporting period. See Note 13 - Investment in Equity Affiliate - Petrodelta, S.A. Petrodelta operates under a business plan, the success of which relies heavily on the market price of oil. To the extent that market prices of oil decline, the business plan, and thus our equity investment and/or operations and/or profitability, could be adversely affected.
Operations in Venezuela are subject to various risks inherent in foreign operations. It is possible the legal or fiscal framework for Petrodelta could change and the Venezuela government may not honor its commitments. Our ability to implement or influence Petrodelta’s business plan, assure quality control and set the timing and pace of development could also be adversely impacted. No assurance can be provided that events beyond our control will not adversely affect the value of our minority investment in Petrodelta.
Between Petrodelta’s formation in October 2007 and June 2010, Petrodelta declared and paid dividends of $105.5 million to HNR Finance, B.V. (“HNR Finance”), a wholly owned subsidiary of Harvest Holding ($84.4 million net to our 32 percent interest). See Note 18 - Related Party Transactions for a discussion of our obligations to our non-controlling interest holder, Vinccler, for any dividend received from Petrodelta. As discussed below, on November 12, 2010, Petrodelta’s board of directors declared a dividend of $30.6 million; however, such dividend has not been received. There is uncertainty with respect to the timing of the receipt of such dividend or whether future dividends will be declared and/or paid. We have and will continue to monitor our investment in Petrodelta. Should the dividend receivable not be collected, or facts and circumstances surrounding our investment change, our results of operations and our investment in Petrodelta could be adversely impacted.
We have incurred losses from continuing operations since 2007 and negative cash flows since 2009 and have utilized the proceeds from the sale of property and debt to fund our operations. For the year ended December 31, 2012, we incurred a net loss attributable to Harvest of approximately $12.2 million and negative cash flows from operations of approximately $26.4 million. At December 31, 2012, we had retained earnings of approximately $181.4 million and working capital of approximately $40.5 million. We currently do not have any revenue or operating cash inflow and, as indicated above, historically our main source of cash has been dividends
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from Petrodelta. On November 12, 2010, Petrodelta’s board of directors declared a dividend of $30.6 million, $12.2 million net to HNR Finance ($9.8 million net to our 32 percent interest). The dividend was ratified by Petrodelta’s shareholders on March 14, 2011. Due to Petrodelta’s liquidity constraints caused by PDVSA’s insufficient monetary support and contractual adherence, this dividend has not yet been received, although it is due and payable. Our other main source of cash is the sale of assets. As discussed in Note 5 - Dispositions, on June 21, 2012, we announced entering into an agreement for the sale of our investment in Petrodelta. However, the buyer’s sole shareholder did not approve the transaction, and on February 19, 2013, we exercised our right to terminate the agreement.
We expect that for 2013 we will not generate revenue, will continue to generate losses from operations, and our cash flows will not be sufficient to cover our operating expense; therefore, expected continued losses from operations and use of cash will be funded through debt or equity financings, farm-downs, delay of the discretionary portion of our capital spending to future periods and/or operating cost reductions. To meet our capital needs, we are considering multiple alternatives, including, but not limited to, additional debt and/or equity financing, farm-down, delay of the discretionary portion of our capital spending to future periods and/or operating cost reductions. Our ability to continue as a going concern also depends upon the success of our planned exploration and development activities. There can be no guarantee of future capital acquisition, fundraising or explorations success or that we will realize the value of our unevaluated exploratory well costs. We believe that we will continue to be successful in securing any funds necessary to continue as a going concern. However, our current cash position and our ability to access additional capital may limit our available opportunities or not provide sufficient cash for operations.
Failure to generate sufficient cash flow, raise additional capital through debt or equity financings, farm-downs, and/or further reduce operating costs could have a material adverse effect on our ability to meet our short- and long-term liquidity needs and achieve our intended long-term business objectives.
While we believe the issuance of additional equity securities, short- or long-term debt financing, farm-downs, delay of the discretionary portion of our capital spending to future periods and/or operating cost reductions could be put into place which would not jeopardize our operations and future growth plans, these circumstances raise substantial doubt about our ability to continue to operate as a going concern.
The audit opinion on our financial statements as of and for the year ended December 31, 2012 includes an explanatory paragraph expressing substantial doubt regarding our ability to continue as a going concern. Our financial statements have been prepared under the assumption that we will continue as a going concern, which contemplates that we will continue in operation for the foreseeable future and will be able to realize assets and settle liabilities and commitments in the normal course of business. The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or amounts and classification of liabilities that could result should we be unable to continue as a going concern.
Note 3 - Summary of Significant Accounting Policies
Restatement of Prior Period Financial Statements
In connection with the preparation of our Annual Report on Form 10-K for the year ended December 31, 2012, we concluded that there were errors in previously filed financial statements. In the course of our review, management determined that (a) certain warrants issued in 2010 in connection with our $60 million term loan facility (the “Warrants”) were improperly valued at inception and improperly classified as equity instruments rather than liability instruments. As a result of the improper classification of the Warrants, (b) the debt discount and associated interest expense related to the amortization of the debt discount was understated for all periods in which the associated debt was outstanding, and (c) the consolidated statement of operations and comprehensive income (loss) for each reporting period was misstated by the omission of the changes in fair value of the Warrants as a liability instrument. Additionally, (d) certain exploration overhead was incorrectly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed, and (e) certain leasehold maintenance and other costs were improperly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed. Finally, (f) advances to equity affiliate were improperly classified as an operating activity rather than an investing activity and (g) certain costs were improperly classified as an investing activity rather than an operating activity on the consolidated statement of cash flows. Such errors impacted annual periods ended December 31, 2010 and 2011 and quarterly periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012, and September 30, 2012.
As a result of the errors related to the Warrants described above, loss on extinguishment of debt was understated for the year ended December 31, 2011 and the quarters ended June 30, 2011, September 30, 2011 and December 31, 2011.
Additionally, an error was identified in the calculation of earnings (loss) per diluted share for the year ended December 31, 2011 and the three and six months ended June 30, 2011, and an additional error was identified related to the improper expensing of costs associated with debt conversions that should have been recorded to equity for the quarters ended March 31, 2012 and September 30, 2012.
We have restated our segment footnote information to reflect the applicable errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense. Such errors impacted annual periods ended December 31, 2010 and 2011 and quarterly periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012 and September 30, 2012. We also restated our financial statement schedule to reflect adjustments to the balance sheet related to income taxes for the years ended December 31, 2010 and 2011.
In assessing the severity of the errors, management determined that the errors were material to the consolidated financial statements for the years ended December 31, 2011 and 2010 and quarterly information for all quarters in 2011 and the first, second and third quarters of 2012. In addition to the errors described above, we made corrections for previously identified immaterial errors and errors affecting classification within the consolidated statement of operations and comprehensive income (loss) related to impairment of oil and gas properties and income taxes and the consolidated balance sheets related to income taxes.
The audited financial statements, related notes and analyses for the years ended December 31, 2011 and 2010 have been retrospectively restated in this Annual Report on Form 10-K for the year ended December 31, 2012. We will amend our Quarterly Reports on Form 10-Q/A for each of the quarterly periods shortly after the filing of this Annual Report on Form 10-K.
The following tables set forth the effect of the adjustments described above on the consolidated statements of operations and comprehensive income (loss), the consolidated statements of cash flows and the consolidated statements of stockholders’ equity for the years ended December 31, 2011 and 2010, and the consolidated balance sheet as of December 31, 2011.
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Consolidated Statements of Operations and Comprehensive Income (Loss)
(a) For 2011, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $2,210 thousand offset by a reclassification from exploration expense to impairment of oil and gas properties of $3,335 thousand for amounts that were erroneously classified as exploration expense. For 2010, relates to lease maintenance costs that were erroneously capitalized as oil and gas properties rather than as exploration expense.
(b) Represents change in fair value of the Warrants for the period. Such Warrants were previously erroneously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(c) The fair value of the Warrants was not appropriately determined at inception because certain features of the Warrants were not originally considered in the fair value calculation. The corrected fair value of the Warrants at inception exceeds the original valuation by $3,878 thousand. As a result of this change in the fair value of the Warrants, the original discount allocated to the debt was understated by approximately $3,878 thousand; therefore, the additional amortization of the discount on debt, which is a component of interest expense, was understated for each period the debt was outstanding. For 2011, income tax expense of $237 thousand was improperly classified as interest expense.
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(d) As noted in (c) above, the correction in the fair value of the Warrants and its classification as a liability resulted in an increased discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(e) In addition to the impact on EPS related to the adjustments described in (a) through (d) above and (f) and (g) below, diluted EPS has been adjusted to reflect an error in the calculation of the weighted average common shares outstanding for dilutive EPS as of December 31, 2011. The weighted average common shares utilized for the calculation of diluted EPS was erroneously 39,339 thousand rather than 34,117 thousand.
(f) Reclassification of impairment of oil and gas properties expense in 2011 of $3,335 thousand that was previously erroneously presented as exploration expense.
(g) Represents income tax improperly classified as interest expense.
Consolidated Balance Sheets
(a) Relates to a deferred tax asset that was erroneously reported gross of the related liability.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Relates to the reclassification of the Warrants out of additional paid in capital to warrant derivative liabilities. The fair value of the Warrants was not appropriately determined at inception because certain features of the Warrants were not originally considered in the fair value calculation. Thus, the correction of the error to record the Warrants as a liability does not agree to the correction of the error removing the Warrants from equity. Additionally, the Warrants were not properly marked to market at the end of each period. The warrant derivative liability was valued at $15,000 thousand at inception with subsequent reductions in fair value of $344 thousand in 2010 and $9,786 thousand in 2011.
(d) Relates to the reversal of the amount recorded to equity at inception for the Warrants of $11,122 thousand and the reversal of the amount removed from additional paid in capital of $2,730 thousand when a portion of the Warrants were redeemed by the Company. In May 2011, additional paid in capital was debited for $2,730 thousand for the reversal of the original fair value of such warrants which was an error as they did not qualify for equity classification.
(e) Relates to (a) net increase in expense in 2010 and 2011 related to exploration expense of $2,523 thousand (inclusive of the reclassification of exploration expense to impairment of oil and gas properties of $3,335 thousand), (b) net increase in unrealized gain on warrant derivatives of $10,130 thousand for cumulative 2010 and 2011, (c) net increase in interest expense of $2,921 thousand cumulative for 2010 and 2011, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011 (e) net increase in income tax expense of $237 thousand for income taxes improperly classified as interest expense, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(f) Relates to reclassification of the Warrants as described in (d) above plus the impact of retained earnings described in (e) above.
(g) Represents other current liabilities that were improperly classified as interest payable and income taxes payable.
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Consolidated Statements of Cash Flows
(a) For 2011, relates to the $2,288 thousand of lease maintenance costs, exploration overhead and $900 thousand of certain investment costs that were improperly classified as an investing activity rather than an operating activity. In addition, Advances to Equity Affiliates of $(682) thousand were previously erroneously classified as an operating activity rather than an investing activity.
(b) For 2010, relates to $167 thousand of lease maintenance costs and $(558) thousand of certain investment costs that were improperly classified as an investing activity rather than an operating activity. In addition, Advances to Equity Affiliates of $3,221 thousand were improperly classified as an operating activity rather than an investing activity.
In addition to the above, we have restated the Consolidated Statements of Stockholder’s Equity to reflect the reclassification of the Warrants from equity to warrant derivative liability and to restate the January 1, 2010 beginning balances to reflect cumulative adjustments related to the previously described errors that affect periods prior to the year ended December 31, 2010 as follows:
(a) Relates to lease maintenance costs that were erroneously capitalized as oil and gas properties rather than expensed prior to January 1, 2010 (the “Beginning Retained Earnings Adjustment”).
(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability.
(b) The adjustment to retained earnings relates to (a) lease maintenance costs of $313 thousand that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense, (b) the reduction in the fair value of the Warrants for the year ended December 31, 2010 of $344 thousand, additional amortization of debt of $1,098 thousand resulting from the increased discount allocated to the debt, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized as oil and gas properties rather than expensed to exploration expense prior to January 1, 2010.
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(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the reversal of the original fair value of certain Warrants that did not qualify for equity classification.
(b) The adjustment to retained earnings relates to (a) net increase in 2010 and 2011 expense related to exploration expense of $2,523 thousand that was erroneously capitalized as oil and gas properties rather than expensed as exploration expense (includes consideration of reclassification between exploration expense and impairment of oil and gas properties), (b) net increase in unrealized gain on warrant derivatives of $10,130 thousand for cumulative 2010 and 2011, (c) net increase in interest expense of $2,921 thousand cumulative for 2010 and 2011, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011, (e) net increase in income tax expense of $237 thousand for income taxes improperly classified as interest expense, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
In addition to the above, we have restated Operating Segments to reflect the errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense.
(a) Relates to reclassification of noncontrolling interest from United States segment to Venezuela segment and elimination of intrasegment revenue erroneously reported gross of intrasegment expense.
(b) For 2011, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $1,505 thousand and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense of $1,383 thousand. For 2010, relates to elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(c) For 2011, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $415 thousand and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense of $1,830 thousand. For 2010, relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense of $313 thousand and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense of $786 thousand.
(d) Relates to elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(e) Relates to the impact of (a) through (d) above.
(a) Relates to elimination of intrasegment receivables erroneously reported gross of related intrasegment payable.
Principles of Consolidation
The consolidated financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. Third-party interests in our majority-owned subsidiaries are presented as noncontrolling interests.
Presentation of Comprehensive Income (Loss)
We adopted ASU No. 2011-05 (ASU 2011-05), which is included in ASC 220, “Comprehensive Income”, effective January 1, 2012 and have elected to utilize the “single continuous statement” for presentation of all nonowner changes in stockholders’ equity.
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Reporting and Functional Currency
The United States Dollar (“U.S. Dollar”) is the reporting and functional currency for all of our controlled subsidiaries and Petrodelta. Amounts denominated in non-U.S. Dollar currencies are re-measured into U.S. Dollars, and all currency gains or losses are recorded in the consolidated statements of operations and comprehensive income (loss). There are many factors that affect foreign exchange rates and the resulting exchange gains and losses, many of which are beyond our influence.
See Note 12 - Venezuela for a discussion of currency exchange rates and currency exchange risk on Harvest Vinccler’s and Petrodelta’s businesses.
Cash and Cash Equivalents
Cash equivalents include money market funds and short term certificates of deposit with original maturity dates of less than three months.
Restricted Cash
Restricted cash is classified as current or non-current based on the terms of the agreement. Restricted cash at December 31, 2012 represents cash held in a U.S. bank used as collateral for a standby letter of credit issued in support of a performance bond for a joint study. Restricted cash at December 31, 2011 represents cash held in a U.S. bank used as collateral for a standby letter of credit issued as a payment guarantee for electric wireline services to be provided during the drilling of the two exploratory wells on Block 64 EPSA. The restricted cash was returned to us on April 18, 2012.
Financial Instruments
Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, accounts receivable, dividend receivable, notes payable and derivative financial instruments. We maintain cash and cash equivalents in bank deposit accounts with commercial banks with high credit ratings, which, at times may exceed the federally insured limits. We have not experienced any losses from such investments. Concentrations of credit risk with respect to accounts receivable are limited due the nature of our receivables, which include primarily income tax receivables. In the normal course of business, collateral is not required for financial instruments with credit risk.
Notes Receivable
Notes receivable bear interest and can have due dates that are less than one year or more than one year. Amounts outstanding under the notes bear interest at a rate based on the current prime rate and are recorded at face value. Interest income is recognized over the life of the note.
Each note is analyzed to determine if it is impaired pursuant to ASU 2010-20, which is included in ASC 310, “Receivables”. A note is impaired if it is probable that we will not collect all principal and interest contractually due. We do not accrue interest when a note is considered impaired. All cash receipts on impaired notes are applied to reduce the accrued interest on the note until the interest is made current and, thereafter, applied to reduce the principal amount of such notes.
Other Assets
Other assets consist of business development acquisition costs associated with new business development projects, prepaid expenses which are expected to be realized in the next 12 to 24 months deferred financing costs and a long-term receivable for value added tax (“VAT”) credits related to the Budong PSC. New business development acquisition costs are reclassified to oil and gas properties or expensed depending on management’s assessment of the project under ASC 932-360-35-19 “Sufficient Progress Assessment”. Deferred financing costs relate to specific financing and are amortized over the life of the financing to which the costs relate. See Note 6 - Long-Term Debt. The VAT receivable is reimbursed through the sale of hydrocarbons. See Note 14 - Indonesia for development plans for the Budong PSC.
At December 31, 2012, other assets included $0.2 million of long-term prepaid expenses, $3.2 million of deferred financing costs and $3.5 million of long-term VAT receivable. At December 31, 2011, other assets consisted of $0.4 million of new business development costs, $1.0 million of deferred financing costs and $3.3 million of long-term VAT receivable.
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Other Assets at December 30, 2012 also includes a blocked payment of $0.7 million (2011: $0.7 million) net to our 66.667 percent interest related to our drilling operations in Gabon in accordance with the U.S. sanctions against Libya as set forth in Executive Order 13566 of February 25, 2011, and administered by the United States Treasury Department’s Office of Foreign Assets Control (“OFAC”). See Note 7 - Commitments and Contingencies.
Investment in Equity Affiliates
We evaluate our investments in unconsolidated companies under ASC 323, “Investments - Equity Method and Joint Ventures.” Investments in which we have significant influence are accounted for under the equity method of accounting. Under the equity method, Investment in Equity Affiliates is increased by additional investments and earnings and decreased by dividends and losses.
We review our Investment in Equity Affiliates for impairment whenever events and circumstances indicate a loss in investment value is other than a temporary decline. At December 31, 2012, we reviewed our investment in Petrodelta under the terms of the share purchase agreement (see Note 6 - Dispositions, Share Purchase Agreement (“SPA”)). The SPA purchase price, subject to adjustment as described in the SPA, exceeded the carrying value of our equity investment, the dividend receivable and advances to equity affiliate. As such, we concluded that there was no impairment to our equity investment as of December 31, 2012.
There are many factors to consider when evaluating an equity investment for possible impairment. Currency devaluations, inflationary economies, and cash flow analysis are some of the factors we consider in our evaluation for possible impairment. At December 31, 2012, there were no events that would indicate that our equity investment in Petrodelta had sustained a loss in value that is other than temporary.
The SPA was terminated on February 19, 2013 and a devaluation of the Bolivar occurred on February 8, 2013. We do not believe either of these events impact our conclusion regarding the value of our equity investment at December 31, 2012.
We measure and disclose our noncontrolling interests in accordance with the provisions of ASC 810 “Consolidation”. Our noncontrolling interest relates to Vinccler’s indirectly owned 20 percent interest in Harvest Holding (see Note 1 - Organization).
Oil and Gas Properties
The major components of property and equipment at December 31 are as follows (in thousands):
Property and equipment are stated at cost less accumulated depletion, depreciation and amortization (“DD&A”). Costs of improvements that appreciably improve the efficiency or productive capacity of existing properties or extend their lives are capitalized. Maintenance and repairs are expensed as incurred. Upon retirement or sale, the cost of property and equipment, net of the related accumulated DD&A, is removed and, if appropriate, gains or losses are recognized in investment earnings and other. We did not record any depletion expense in the years ended December 31, 2012, 2011, or 2010.
We follow the successful efforts method of accounting for our oil and gas properties. Under this method, exploration costs such as exploratory geological and geophysical costs, delay rentals and exploration overhead are charged against earnings as incurred. Costs of drilling exploratory wells are capitalized pending determination of whether proved reserves can be attributed to the area as a result of drilling the well. If management determines that proved reserves, as that term is defined in Securities and Exchange Commission (“SEC”) regulations, have not been
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discovered, capitalized costs associated with the drilling of the exploratory well are charged to expense. Costs of drilling successful exploratory wells, all development wells, and related production equipment and facilities are capitalized and depleted or depreciated using the unit-of-production method as oil and gas is produced. At December 31, 2012, we expensed to dry hole costs $0.7 million related to the drilling of Karama-1 (“KD-1”) and first sidetrack, KD-1ST, on the Budong PSC and $4.9 million related to the drilling of Al Ghubar North-A (“AGN-1”) on Block 64 EPSA. At December 31, 2011, we expensed to dry hole costs $14.0 million related to the drilling of Lariang-1 (“LG-1”) on the Budong PSC, $26.0 million related to the drilling of KD-1 and KD-1ST on the Budong PSC, $6.9 million related to the drilling of Mafraq South-A (“MFS-1”) on Block 64 EPSA, and $2.8 million related to the drilling of AGN-1 on Block 64 EPSA. See Note 14 - Indonesia and Note 16 - Oman.
Leasehold acquisition costs are initially capitalized. Acquisition costs of unproved leaseholds are assessed for impairment during the holding period. Costs of maintaining and retaining unproved leaseholds, as well as impairment of unsuccessful leases, are included in exploration expense. Impairment is based on specific identification of the lease. Costs of expired or abandoned leases are charged to exploration expense, while costs of productive leases are transferred to proved oil and gas properties.
Proved oil and gas properties are reviewed for impairment at a level for which identifiable cash flows are independent of cash flows of other assets when facts and circumstances indicate that their carrying amounts may not be recoverable. In performing this review, future net cash flows are determined based on estimated future oil and gas sales revenues less future expenditures necessary to develop and produce the reserves. If the sum of these undiscounted estimated future net cash flows is less than the carrying amount of the property, an impairment loss is recognized for the excess of the property’s carrying amount over its estimated fair value, which is generally based on discounted future net cash flows. We did not have any proved oil and gas properties in 2012, 2011 or 2010.
Costs of drilling and equipping successful exploratory wells, development wells, asset retirement liabilities and costs to construct or acquire offshore platforms and other facilities, are depleted using the unit-of-production method based on total estimated proved developed reserves. Costs of acquiring proved properties, including leasehold acquisition costs transferred from unproved leaseholds, are depleted using the unit-of-production method based on total estimated proved reserves. All other properties are stated at historical acquisition cost, net of allowance for impairment, and depreciated using the straight-line method over the useful lives of the assets.
Unproved property costs, excluding oilfield inventories, consist of (in millions):
At December 31, 2012, we impaired the carrying value of Block 64 EPSA, $6.4 million, and WAB -21, $2.9 million. At December 31, 2011, we impaired the carrying value of West Bay, $3.3 million.
Other Administrative Property
Furniture, fixtures and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are recorded at cost and amortized using the straight-line method over the life of the applicable lease. For the year ended December 31, 2012, depreciation expense was $0.4 million (2011: $0.5 million, 2010: $0.5 million).
Reserves
We measure and disclose our oil and gas reserves in accordance with the provisions of the SEC’s Modernization of Oil and Gas Reporting and ASC 932, “Extractive Activities - Oil and Gas” (“ASC 932”). All of our reserves are owned through our equity investment in Petrodelta. We do not have any wholly owned reserves at December 31, 2012.
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Capitalized Interest
We capitalize interest costs for qualifying oil and gas properties. The capitalization period begins when expenditures are incurred on qualified properties, activities begin which are necessary to prepare the property for production and interest costs have been incurred. The capitalization period continues as long as these events occur. The average additions for the period are used in the interest capitalization calculation. During the year ended December 31, 2012, we capitalized interest costs for qualifying oil and gas property additions of $3.0 million (2011: $2.3 million, 2010: $1.8 million).
Derivative Financial Instruments
Under ASC 480 “Distinguishing Liabilities from Equity”, certain of our financial instruments with anti-dilution protection features do not meet the conditions to obtain equity classification, as there are conditions which may require settlement by transferring assets, and are required to be carried as derivative liabilities, at fair value, with changes in fair value reflected in our consolidated statements of operations and comprehensive income (loss). See Note 10 - Warrant Derivative Liabilities for additional disclosures. In the occurrence of a fundamental change, we are required to repurchase the Warrants at the higher of (1) the fair market value of the warrant and (2) a valuation based on a computation of the option value of the Warrant using the Black-Scholes calculation method using the assumptions described in the Warrant Agreement. A fundamental change is defined as “the occurrence of one of the following events: a) a person or group becomes the direct or indirect owner of more than 50% of the voting power of the outstanding common stock, b) a merger event or similar transaction in which the majority owners before the transaction fail to own a majority of the voting power of the Company after the transaction, and c) approval of a plan of liquidation or dissolution of the Company or sale of all or substantially all of the Company’s assets.”
Fair Value Measurements
We measure and disclose our fair values in accordance with the provisions of ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy assigns the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 measurements are inputs that are observable for assets or liabilities, either directly or indirectly, other than quoted prices included within Level 1. We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable.
Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques (such the Monte Carlo model) are highly volatile and sensitive to changes in the trading market price of our common stock. Since derivative financial instruments are initially and subsequently carried at fair value, our (income) loss will reflect the volatility in these estimate and assumption changes.
Inherent in the Monte Carlo valuation model are assumptions related to expected stock price volatility, expected life, risk-free interest rate and dividend yield. We estimate the volatility of our common stock based on historical volatility that matched the expected remaining life of the warrants. The risk-free interest rate is based on the U.S. Treasury yield curve as of the valuation dates for a maturity similar to the expected remaining life of the warrants. The expected life of the warrants is assumed to be equivalent to their remaining contractual term. The dividend rate is based on the historical rate, which we anticipate to remain at zero.
As part of our overall valuation process, management employs processes to evaluate and validate the methodologies, techniques and inputs, including review and approval of valuation judgments, methods, models, process controls, and results. These processes are designed to help ensure that the fair value measurements and disclosures are appropriate, consistently applied, and reliable.
The Monte Carlo model is used on the warrants to appropriately value the potential future exercise price adjustments triggered by the anti-dilution provisions. See Note 10 - Warrant Derivative Liability. This requires Level 3 inputs which are based on our estimates of the probability and timing of potential future financings and fundamental transactions. The assumptions we used are summarized in the following tables for warrants that were outstanding as of any of the balance sheet dates presented on our consolidated balance sheets:
The following tables set forth by level within the fair value hierarchy our financial liabilities that were accounted for at fair value as of December 31, 2012 and 2011. As required by ASC 820, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value liabilities and their placement within the fair value hierarchy levels.
We record the net change in the fair value of the derivative positions listed above in unrealized gain (loss) on warrant derivative liabilities in our consolidated statements of operations and comprehensive income (loss). During the year ended December 31, 2012, an unrealized loss of $0.6 million was recorded to reflect the change in fair value of the warrants (2011: $9.8 million unrealized gain, 2010: $0.3 million unrealized gain).
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The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of ASC 825, Financial Instruments. The estimated fair value amounts have been determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The following table presents the estimated fair values of our fixed interest rate, long-term debt instrument (Level 3) as of December 31, 2012.
The fair value of our fixed interest debt instruments (Level 3) was calculated using a pricing model which incorporates transaction details such as contractual terms, maturity and, in certain instances, timing and amount of future cash flows, as well as assumptions related to liquidity and credit valuation adjustments of marketplace participants.
Changes in Level 3 Instruments Measured at Fair Value on a Recurring Basis
The following table provides a reconciliation of financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
During the year ended December 31, 2012, there were no transfers between Level 1, Level 2 and Level 3 liabilities.
Share-Based Compensation
We use a fair value based method of accounting for stock-based compensation. We utilize the Black-Scholes option pricing model to measure the fair value of stock options and stock appreciation rights (“SARs”). Restricted stock and restricted stock units (“RSUs”) are measured at their intrinsic values. See Note 9 - Stock-Based Compensations and Stock Purchase Plans.
Income Taxes
Deferred income taxes reflect the net tax effects, calculated at currently enacted rates, of (a) future deductible/taxable amounts attributable to events that have been recognized on a cumulative basis in the financial statements or income tax returns, and (b) operating loss and tax credit carryforwards. A valuation allowance for deferred tax assets is recorded when it is more likely than not that the benefit from the deferred tax asset will not be realized.
We classify interest related to income tax liabilities as interest expense, and if applicable, penalties are recognized as a component of interest expense.
We do not provide deferred income taxes on undistributed earnings of our foreign subsidiaries for possible future remittances as all such earnings are permanently reinvested as part of our ongoing business.
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New Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2012-02, which is included in ASC 350, “Intangibles - Goodwill and Other”. This update gives an entity the option first to assess qualitative factors in assessing whether an asset is impaired. ASU No. 2012-02 is effective for annual and interim impairment test performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of ASU No. 2012-02 did not have a material impact on our consolidated financial position, results of operation or cash flows.
In January 2013, FASB issued ASU No. 2013-01, which is included in ASC 210, “Balance Sheet”, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” (“ASU No. 2013-01”). This update clarifies that the scope of ASU 2011-11: “Disclosures about Offsetting Assets and Liabilities” applies only to derivatives accounted for under ASC 815 “Derivatives and Hedging”, included bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities lending transactions that are either offset in accordance with ASC 210-20-45 or ASC 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. ASU No. 2013-01 is effective for fiscal years and interim periods within those years, beginning on or after January 1, 2013. Entities should provide the required disclosures retrospectively for all comparative periods presented. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial position, results of operation or cash flows.
In February 2013, FASB issued ASU No. 2013-02, which is included in ASC 220, “Comprehensive Income”, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU NO. 2013-02”). This update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under USGAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under USGAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under USGAAP that provide additional detail about those amounts. The amendments of ASU No. 2013-02 do not change the current requirements for reporting net income or other comprehensive income in financial statements. ASU No. 2013-02 is effective for fiscal years and interim periods within those years, beginning on or after December 15, 2012. Early adoption is permitted. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial position, results of operation or cash flows.
In February 2013, FASB issued ASU No. 2013-04, which is included in ASC 405, “Liabilities”, “Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date”. This update provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation with the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing guidance in USGAAP. Examples of obligations within the scope to ASU No. 2013-04 include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. ASU No. 2013-04 is effective for fiscal years and interim periods within those years beginning after December 5, 2013. Entities should provide the required disclosures retrospectively for all comparative periods presented. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial position, results of operation or cash flows.
In March 2013, FASB issued ASU No. 2013-05, which is included in ASC 830, “Foreign Currency Matters”, “Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU 2013-05”). This update resolves the diversity in practice regarding the release into net income of the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. ASU No. 2013-05 is effective for fiscal years and interim periods within those years beginning after December 5, 2013. ASU No. 2013-05 is not expected to have a material impact on our consolidated financial position, results of operation or cash flows.
Use of Estimates
The preparation of financial statements in conformity with USGAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved oil and natural gas reserve volumes and future development costs. Actual results could differ from those estimates.
Note 4 - Earnings Per Share
Basic earnings per common share (“EPS”) are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock.
(a) Includes net income attributable to noncontrolling interest.
The year ended December 31, 2012 per share calculations above exclude 3.9 million options and 2.4 million warrants because they were anti-dilutive. The year ended December 31, 2011 per share calculations above exclude 3.7 million options and 1.6 million warrants because they were anti-dilutive. The year ended December 31, 2010 per share calculations above exclude 2.9 million options and 1.6 million warrants because they were anti-dilutive.
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Note 5 - Dispositions
Share Purchase Agreement (“SPA”)
On June 21, 2012, we announced that we and our wholly owned subsidiary HNR Energia had entered into a SPA with PT Pertamina (Persero), a state-owned limited liability company existing under the laws of Indonesia (“Buyer”) under which HNR Energia agreed to sell, indirectly through subsidiaries, all of its interests in Venezuela for a cash purchase price of $725.0 million, subject to adjustment as described in the SPA.
The closing of the transaction was subject to receipt of three approvals, in addition to satisfaction of other conditions standard in transactions of this type: (a) approval by the Ministerio del Poder Popular de Petroleo y Mineria representing the Government of the Bolivarian Republic of Venezuela (which indirectly owns the other 60 percent interest in Petrodelta); (b) approval by the Government of the Republic of Indonesia in its capacity as Buyer’s sole shareholder; and (c) approval by the holders of a majority of Harvest’s common stock.
After receiving notice from Buyer that Buyer’s sole shareholder, the Government of Indonesia, had decided not to approve the transaction described in the SPA, on February 19, 2013, HNR Energia exercised its right to terminate the agreement in accordance with its terms.
Discontinued Operations
On May 17, 2011, we closed the transaction to sell the Antelope Project. The sale had an effective date of March 1, 2011. We received cash proceeds of approximately $217.8 million which reflects increases to the purchase price for customary adjustments and deductions for transaction related costs. We do not have any continuing involvement with the Antelope Project. The related gain on the sale was reported in discontinued operations in the second quarter of 2011.
During the year ended December 31, 2012, we incurred $0.1 million of expense related to settlement of royalty payments to the Mineral Management Services, write-offs of $5.2 million of accounts and note receivable and $3.6 million of accounts payable, carry obligation related to the settlement of all outstanding claims with a private third party on the Antelope Project. The note receivable related to a prospect leasing cost financing arrangement. The note receivable plus accrued interest was approximately $3.3 million at December 31, 2011, and was secured by a portion of the production from the Bar F #1-20-3-2 in Utah.
Revenue and net loss on the disposition of the Antelope Project are shown in the table below:
Note 6 - Long-Term Debt
Long-term debt consists of the following (in thousands):
On October 11, 2012, we closed the sale of $79.8 million aggregate principal amount of 11 percent senior unsecured notes due October 11, 2014. Under the terms of the notes, interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1, beginning January 1, 2013. The purchase price of the notes was paid in
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cash, except for approximately $10.5 million in principal amount, which was exchanged by a single purchaser in exchange for approximately $6.0 million in face value of that purchaser’s existing 8.25 percent unsecured senior convertible notes issued by Harvest in 2010. The 11 percent senior unsecured notes are general unsecured obligations, ranking equally in right of payment with all our future senior unsecured indebtedness. The senior unsecured notes are effectively subordinated to our secured indebtedness and are structurally subordinated to indebtedness and other liabilities of our subsidiaries. The net cash proceeds of the offering were approximately $63.5 million after deducting the issuance discount (approximately $2.8 million), placement fees, and other transaction costs (approximately $3.0 million).
The 11 percent senior unsecured notes were issued at a price of 96 percent of principal amount, or $3.2 million of original issue discount (“OID”). The OID is recorded as a discount on debt. Warrants to purchase up to 0.8 million share of our common stock with an exercise price of $10.00 per share were issued in connection with the 11 percent senior unsecured notes. See Note 9 - Stock-Based Compensation and Stock Purchase Plans, Common Stock Warrants. The fair value of the warrants, $2.8 million, is classified as Discount on Debt with a corresponding credit to additional paid in capital on our consolidated balance sheet at December 31, 2012. The OID is being amortized over the life of the debt. The discount on debt is amortized over the life of the debt.
If the event that a sale of assets (farm-outs are not included in the definition of a sale of assets in the indenture) for more than $5.0 million in the aggregate occurs, we are required to offer to all noteholders of our 11 percent senior unsecured notes to purchase the maximum principal amount of our 11 percent senior unsecured notes that may be purchased out of the sale proceeds at an offer price in cash in an amount equal to 105.5 percent of the principal amount plus accrued and unpaid interest, if any. In the event of a change in control or a sale of Petrodelta, the noteholders of our 11 percent senior unsecured notes have the right to require us to repurchase all or any part of the 11 percent senior unsecured notes at a repurchase price equal to 101 percent in the case of a change in control or 105.5 percent in the case of a sale of Petrodelta plus accrued interest. We assessed the prepayment requirements and concluded they qualified as an embedded derivative. We considered the probabilities of these events occurring and determined that the derivative had an immaterial value at December 31, 2012.
The indenture relating to the notes includes various additional covenants, including a covenant that we file annual reports on Form 10-K with the Securities and Exchange Commission, post the report on our web site and provide the report to the note holders within the time periods specified in the Commission’s rules and regulations. Because we did not timely file our annual report for the year ended December 31, 2012, we are in breach of this covenant. The indenture states that failure to comply with this covenant will be an event of default if the breach continues for a period of 60 days. Therefore, our failure to timely file our annual report for the year ended December 31, 2012, is not currently an event of default for purposes of the indenture, and if we are able to file our annual report within that 60-day period, there will be no event of default as a result of our late filing.
Financing costs associated with the 11 percent senior unsecured notes are being amortized over the life of the notes and are recorded in other assets. The balance for financing costs was $3.2 million at December 31, 2012.
On February 17, 2010, we closed an offering of $32.0 million in aggregate principal amount of our 8.25 percent senior convertible notes. Under the terms of the notes, interest was payable semi-annually in arrears on March 1 and September 1 of each year, beginning September 1, 2010. The senior convertible notes matured on March 1, 2013 unless earlier redeemed, repurchased or converted. The notes were convertible into shares of our common stock at a conversion rate of 175.2234 shares of common stock per $1,000 principal amount of senior convertible notes, equivalent to a conversion price of approximately $5.71 per share of common stock. The 8.25 percent senior convertible notes were general unsecured obligations, ranking equally with all of our other unsecured senior indebtedness, if any, and senior in right of payment to any of our subordinated indebtedness, if any.
Non-cash payment of debt during the year ended December 31, 2011 was $0.5 million of senior convertible notes converted into 0.1 million share of common stock at a conversion rate of $5.71 per share. Non-cash payment of debt during the year ended December 31, 2012 was $25.5 million of the senior convertible notes exchanged for 4.6 million shares of common stock at an effective exchange price of $5.59 per share. The difference between the exchange price and the market price on the date of the transaction is recorded as debt conversion expense on our consolidated statements of operations and comprehensive income (loss). The remaining balance of the senior convertible notes, $6.0 million, was repaid by way of a non-cash exchange for approximately $10.5 million of the 11 percent senior unsecured notes, the value of which was agreed to by us and the noteholder that the noteholder would have otherwise attained had the noteholder converted the note into shares of common stock. The difference between the value of the senior convertible notes exchanged and the senior unsecured notes received is recorded as a loss on extinguishment of debt on our consolidated statements of operations and comprehensive income (loss).
Financing costs associated with the 8.25 percent senior convertible notes were amortized over the life of the notes and were recorded in other assets. In connection with the exchange of convertible notes into our common stock, we reclassified $0.6 million of deferred financing costs to additional paid in capital. Financing costs for the convertible notes were fully amortized or reclassified at December 31, 2012 (2011: $1.0 million).
On October 29, 2010, we closed a $60.0 million term loan facility with MSD Energy Investments Private II, LLC (“MSD Energy”), an affiliate of MSD Capital, L.P., as the sole lender under the term loan facility. Under the terms of the term loan facility, interest was paid on a monthly basis at the initial rate of 10 percent and had a maturity of October 28, 2012. The initial rate of interest was scheduled to increase to 15 percent on July 28, 2011, the Bridge Date. Financing costs associated with the term loan facility were being amortized over the remaining life of the loan and were recorded in other assets. See Note 9 - Stock-Based Compensation and Stock Purchase Plans - Common Stock Warrants for a discussion of the warrants that were issued in connection with the $60.0 million term loan facility.
In May 2011, we prepaid our $60 million term loan facility. The early repayment resulted in a loss on extinguishment of debt of $13.1 million (Restated). The loss on extinguishment of debt includes the write off of the discount on debt ($10.6 million), a prepayment premium of 3.5 percent of the amount outstanding ($2.1 million), and expensing of financing costs related to the term loan facility ($0.4 million).
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The principal payment requirements for our long-term debt outstanding at December 31, 2012 are as follows (in thousands):
Note 7 - Commitments and Contingencies
We have employment contracts with five executive officers which provide for annual base salaries, eligibility for bonus compensation and various benefits. The contracts provide for a lump sum payment as a multiple of base salary in the event of termination of employment without cause. In addition, these contracts provide for payments as a multiple of base salary and bonus, excise tax reimbursement, outplacement services and a continuation of benefits in the event of termination without cause following a change in control. By providing one year notice, these agreements may be terminated by either party on or after May 31, 2013.
We have regional/technical offices in the United Kingdom and Singapore, and field offices in Jakarta, Indonesia; Port Gentil, Gabon; and Muscat, Oman to support field operations in those areas. At December 31, 2012, we had the following lease commitments for office space:
We have various contractual commitments pertaining to exploration, development and production activities. We entered the third exploration phase of the Dussafu PSC on May 28, 2012. The third exploration phase of the Dussafu PSC has a $7.0 million ($4.7 million net to our 66.667 percent interest) work commitment over a four year period. This commitment was fulfilled with the drilling of DTM-1. In January 2013, the Budong PSC partners were granted a four year extension of the initial six year exploration term of the Budong PSC to January 15, 2017. The extension of the initial exploration term includes an exploration well, which if not drilled by January 2016, results in the termination of the Budong PSC. Also, if this exploration well is not drilled within 18 months of the date of the Government of Indonesia approval of this transaction, we will be required to pay our partner in the Budong PSC $3.2 million. See Note 14 - Indonesia. These work commitments are non-discretionary; however, we do have the ability to control the pace of expenditures.
The following related class action lawsuits were filed on the dates specified in the United States District Court, Southern District of Texas: John Phillips v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (March 22, 2013); Sang Kim v. Harvest Natural Resources, Inc., James A. Edmiston, Stephen C. Haynes, Stephen D. Chesebro’, Igor Effimoff, H. H. Hardee, Robert E. Irelan, Patrick M. Murray and J. Michael Stinson (April 3, 2013); Chris Kean v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 11, 2013); Prastitis v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 17, 2013); Alan Myers v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 22, 2013); and Edward W. Walbridge and the Edward W. Walbridge Trust v. Harvest Natural Resources, Inc., James A. Edmiston and Stephen C. Haynes (April 26, 2013). The complaints allege that the Company made certain false or misleading public statements and demand that the defendants pay unspecified damages to the class action plaintiffs based on stock price declines. On April 18, 2013, the second, third and fourth listed actions were consolidated into the Phillips case. The Company and the other named defendants intend to vigorously defend the consolidated and other listed lawsuits.
On March 25, 2013, the Securities and Exchange Commission, notified the Company that it is conducting an inquiry related to certain matters disclosed in the Company’s Form 12B-25 announcing that it would be unable to file on a timely basis its 2012 Annual Report on Form 10-K, including certain errors in the Company’s financial statements and weaknesses in the Company’s internal controls. The Company is engaged in discussions with the Commission concerning these matters.
In June 2012, the operator of the Budong PSC received notice of a claim related to the ownership of part of the land comprising the Karama-1 (“KD-1”) drilling site. The claim asserts that the land on which the drill site is located is partly owned by the claimant. The operator purchased the site from local landowners in January 2010, and the purchase was approved by BPMIGAS, Indonesia’s oil and gas regulatory authority. The claimant is seeking compensation of 16 billion Indonesia Rupiah (approximately $1.7 million, $1.2 million net to our 71.61 percent cost sharing interest) for land that was purchased at a cost of $4,100 in January 2010. On or about March 8, 2013, the operator learned that the court has ruled to dismiss the claim because the claim had not been filed against the proper parties to the claim. The claimant can appeal the dismissal once the ruling has been issued in writing.
In May 2012, Newfield Production Company (“Newfield”) filed notice pursuant to the Purchase and Sale Agreement between Harvest (US) Holdings, Inc. (“Harvest US”), a wholly owned subsidiary of Harvest, and Newfield dated March 21, 2011 (the “PSA”) of a potential environmental claim involving certain wells drilled on the Antelope Project. The claim asserts that locations constructed by Harvest US were built on, within, or otherwise impact or potentially impact wetlands and other water bodies. The notice asserts that to the extent of potential penalties or other obligations that might result from potential violations that Harvest US indemnifies Newfield pursuant to the PSA. In June 2012, we provided Newfield with notice pursuant to the PSA (1) denying that Newfield has any right to indemnification from us, (2) alleging that any potential environmental claim related to Newfield’s notice would be an assumed liability under the PSA and (3) asserting that Newfield indemnify us pursuant to the PSA. We dispute Newfield’s claims and plan to vigorously defend against them. We are unable to estimate the amount or range of any possible loss.
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On May 31, 2011, the United Kingdom branch of our subsidiary, Harvest Natural Resources, Inc. (UK), initiated a wire transfer of approximately $1.1 million ($0.7 million net to our 66.667 percent interest) intending to pay Libya Oil Gabon S.A. (“LOGSA”) for fuel that LOGSA supplied to our subsidiary in the Netherlands, Harvest Dussafu, B.V., for the company’s drilling operations in Gabon. On June 1, 2011, our bank notified us that it had been required to block the payment in accordance with the U.S. sanctions against Libya as set forth in Executive Order 13566 of February 25, 2011, and administered by OFAC, because the payee, LOGSA, may be a blocked party under the sanctions. The bank further advised us that it could not release the funds to the payee or return the funds to us unless we obtain authorization from OFAC. On October 26, 2011, we filed an application with OFAC for return of the blocked funds to us. Unless that application is approved, the funds will remain in the blocked account, and we can give no assurance when, or if, OFAC will permit the funds to be released. As of May 2, 2013, our October 26, 2011 application for the return of the blocked funds remains pending with OFAC.
Robert C. Bonnet and Bobby Bonnet Land Services vs. Harvest (US) Holdings, Inc., Branta Exploration & Production, LLC, Ute Energy LLC, Cameron Cuch, Paula Black, Johnna Blackhair, and Elton Blackhair in the United States District Court for the District of Utah. This suit was served in April 2010 on Harvest and Elton Blackhair, a Harvest employee, alleging that the defendants, among other things, intentionally interfered with Plaintiffs’ employment agreement with the Ute Indian Tribe - Energy & Minerals Department and intentionally interfered with Plaintiffs’ prospective economic relationships. Plaintiffs seek actual damages, punitive damages, costs and attorney’s fees. We dispute Plaintiffs’ claims and plan to vigorously defend against them. We are unable to estimate the amount or range of any possible loss.
Uracoa Municipality Tax Assessments. Our Venezuelan subsidiary, Harvest Vinccler, has received nine assessments from a tax inspector for the Uracoa municipality in which part of the Uracoa, Tucupita and Bombal fields are located as follows:
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Three claims were filed in July 2004 and allege a failure to withhold for technical service payments and a failure to pay taxes on the capital fee reimbursement and related interest paid by PDVSA under the Operating Service Agreement (“OSA”). Harvest Vinccler has filed a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss one of the claims and has protested with the municipality the remaining claims.
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Two claims were filed in July 2006 alleging the failure to pay taxes at a new rate set by the municipality. Harvest Vinccler has filed a protest with the Tax Court in Barcelona, Venezuela, on these claims.
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Two claims were filed in August 2006 alleging a failure to pay taxes on estimated revenues for the second quarter of 2006 and a withholding error with respect to certain vendor payments. Harvest Vinccler has filed a protest with the Tax Court in Barcelona, Venezuela, on one claim and filed a protest with the municipality on the other claim.
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Two claims were filed in March 2007 alleging a failure to pay taxes on estimated revenues for the third and fourth quarters of 2006. Harvest Vinccler has filed a protest with the municipality on these claims.
Harvest Vinccler disputes the Uracoa tax assessments and believes it has a substantial basis for its positions. Harvest Vinccler is unable to estimate the amount or range of any possible loss. As a result of the SENIAT’s, the Venezuelan income tax authority, interpretation of the tax code as it applies to operating service agreements, Harvest Vinccler has filed claims in the Tax Court in Caracas against the Uracoa Municipality for the refund of all municipal taxes paid since 1997.
Libertador Municipality Tax Assessments. Harvest Vinccler has received five assessments from a tax inspector for the Libertador municipality in which part of the Uracoa, Tucupita and Bombal fields are located as follows:
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One claim was filed in April 2005 alleging the failure to pay taxes at a new rate set by the municipality. Harvest Vinccler has filed a protest with the Mayor’s Office and a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss the claim. On April 10, 2008, the Tax Court
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suspended the case pending a response from the Mayor’s Office to the protest. If the municipality’s response is to confirm the assessment, Harvest Vinccler will defer to the competent Tax Court to enjoin and dismiss the claim.
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Two claims were filed in June 2007. One claim relates to the period 2003 through 2006 and seeks to impose a tax on interest paid by PDVSA under the OSA. The second claim alleges a failure to pay taxes on estimated revenues for the third and fourth quarters of 2006. Harvest Vinccler has filed a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss both claims.
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Two claims were filed in July 2007 seeking to impose penalties on tax assessments filed and settled in 2004. Harvest Vinccler has filed a motion with the Tax Court in Barcelona, Venezuela, to enjoin and dismiss both claims.
Harvest Vinccler disputes the Libertador allegations set forth in the assessments and believes it has a substantial basis for its position. Harvest Vinccler is unable to estimate the amount or range of any possible loss. As a result of the SENIAT’s interpretation of the tax code as it applies to operating service agreements, Harvest Vinccler has filed claims in the Tax Court in Caracas against the Libertador Municipality for the refund of all municipal taxes paid since 2002.
On May 4, 2012, Harvest Vinccler learned that the Political Administrative Chamber of the Supreme Court of Justice has issued a decision dismissing one of Harvest Vinccler’s claims against the Libertador Municipality. Harvest Vinccler continues to believe that it has sufficient arguments to maintain its position in accordance with the Venezuelan Constitution. Harvest Vinccler plans to present a request of Constitutional Revision to the Constitutional Chamber of the Supreme Court of Justice once it is notified officially of the decision. As of May 2, 2013, Harvest Vinccler has not received official notification of the decision. Harvest Vinccler is unable to predict the impact of this decision on the remaining outstanding municipality claims and assessments.
We are a defendant in or otherwise involved in other litigation incidental to our business. In the opinion of management, there is no such litigation which will have a material adverse impact on our financial condition, results of operations and cash flows.
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Note 8 - Taxes
Taxes on Income
The tax effects of significant items comprising our net deferred income taxes as of December 31, 2012, are as follows:
Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets (“DTAs”). A significant piece of objective negative evidence evaluated was the cumulative losses incurred in our foreign operating entities over the three-year period ended December 31, 2012. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth. We have therefore placed a valuation allowance (“VA”) on all of our foreign DTAs with the exception of $0.8 million related to NOL carryforwards in Venezuela which would be realized upon settlement of uncertain tax positions.
Management also reviewed the earnings history of our U.S. operations and determined that, with the exception of 2010 and 2011 when we had domestic production from our Utah assets and subsequently sold those assets, we have a history of domestic losses and are not currently involved in any domestic exploration and production activity. We have therefore placed a VA on our domestic DTAs, with the exception of $22 thousand that we expect to be realized by our UK branch.
The components of loss from continuing operations before income taxes are as follows:
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The provision (benefit) for income taxes on continuing operations consisted of the following at December 31:
A comparison of the income tax expense (benefit) on continuing operations at the federal statutory rate to our provision for income taxes is as follows:
Rate differentials for foreign income result from tax rates different from the U.S. tax rate being applied in foreign jurisdictions.
We do not provide deferred income taxes on undistributed earnings of our foreign subsidiaries for possible future remittances as all such earnings are permanently reinvested as part of our ongoing business. Any dividends that are repatriated in the future would come out future earnings from our foreign subsidiaries. At December 31, 2012, we have the following net operating losses available for carryforward (in thousands):
If the U.S. operating loss carryforwards are ultimately realized, approximately $1.5 million will be credited to additional paid in capital for tax benefits associated with deductions for income tax purposes related to stock options and convertible debt.
Accumulated Undistributed Earnings of Foreign Subsidiaries
As of December 31, 2012, the book-tax outside basis difference in our foreign subsidiary that has been indefinitely reinvested was approximately $331 million. No U.S. taxes have been recorded on these earnings. In general, it is our practice and intention to reinvest the earnings of our non-U.S. subsidiaries in those operations. All of our current exploration activity is outside of the U.S. We currently intend to utilize our unremitted foreign earnings to fund international projects, including the development of our properties in Gabon, Indonesia and South America.
Under ASC 740-30-25-17, no deferred tax liability must be recorded if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings or that the earnings will be remitted in a tax-free manner. Management must consider numerous factors in determining timing and amounts of possible future distribution of these earnings to the parent company and whether a U.S. deferred tax liability should be recorded for these earnings. These factors include the future operating and capital requirements of both the parent company and the subsidiaries, remittance restrictions imposed by foreign governments or financial agreements and tax consequences of the remittance, including possible application of U.S. foreign tax credits and limitations on foreign tax credits that may be imposed by the Internal Revenue Service (“IRS”) or IRS regulations.
If we were to make a distribution of our foreign earnings in the form of dividends, we would likely be subject to U.S. income taxes. Pursuant to ASC 740-30-50-2, we have estimated that the potential U.S. tax cost if we were to repatriate all of our currently unremitted foreign earnings through a dividend would be approximately $113 million based upon our foreign tax credit position in the U.S.
Accounting for Uncertainty in Income Taxes
The FASB issued ASC 740-10 (prior authoritative literature: Financial Interpretation No. [“FIN”] 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 [“FIN 48”]) to create
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a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.
We or one of our subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local tax examinations by tax authorities for years before 2008. Our primary income tax jurisdictions and their respective open audit years are:
A reconciliation of the beginning amount, and current year additions, of unrecognized tax benefits follows:
If the above tax benefits were recognized, the full amount would affect the effective tax rate. We have accrued interest of $0.1 million, and penalty of $0.3 million, a deduction for which has been recorded in pretax income. We believe that it is likely that $5.0 million of the uncertain tax position will be resolved within the next twelve months, and the amount of unrecognized tax benefits will significantly decrease.
Note 9 - Stock-Based Compensation and Stock Purchase Plans
Total share-based compensation expense, which includes stock options, restricted stock, stock appreciation rights (“SARs”), and restricted stock units (“RSUs”), totaled $5.2 million for the year ended December 31, 2012 (2011: $4.8 million, 2010: $5.7 million). All awards utilize the straight line method of amortization over vesting terms. RSUs and SARs can be cash settled and are accounted for as liability instruments.
The cash flows resulting from tax deductions in excess of the compensation cost recognized for share-based awards (excess tax benefits) are classified as financing cash flows. The actual tax benefit realized from share-based awards during the year ended December 31, 2011 was $2.5 million. We did not realize tax benefits from share-based awards during the years ended December 31, 2012 or 2010.
Long Term Incentive Plans
As of December 31, 2012, we had several long term incentive plans under which stock options, restricted stock, SARs and RSUs can be granted to eligible participants including employees, non-employee directors and consultants of our Company or subsidiaries:
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2010 Long Term Incentive Plan (“2010 Plan”) - Provides for the issuance of up to 1,700,000 shares of our common stock in satisfaction of stock options, SARs, restricted stock, RSUs and other stock-based awards. No more than 500,000 shares may be granted as restricted stock and no individual may be granted more than 1,000,000 stock options or SARs. In the event of a change in control, all outstanding stock options and SARs become immediately exercisable to the extent permitted by the plan, and any restrictions on restricted stock and RSUs lapse.
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2006 Long Term Incentive Plan (“2006 Plan”) - Provides for the issuance of up to 1,825,000 shares of our common stock in satisfaction of stock options, SARs and restricted stock. No more than 325,000 shares may be granted as restricted stock, and no individual may be granted more than 900,000 options or SARs and not more than 175,000 share of restricted stock during any period of three consecutive calendar years. The 2006 Plan also permits the granting of performance awards to eligible employees and consultants. In the event of a change in control, all outstanding stock options and SARs become immediately exercisable to the extent permitted by the plan, and any restrictions on restricted stock lapse.
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2004 Long Term Incentive Plan (“2004 Plan”) - Provides for the issuance of up to 1,750,000 shares of our common stock in satisfaction of stock options, SARs and restricted stock. No more than 438,000 shares may be granted as restricted stock, and no individual may be granted more than 438,000 options and not more than 110,000 share of restricted stock over the life of the plan. The 2004 Plan also permits the granting of performance awards to eligible employees and consultants. In the event of a change in control, all outstanding stock options and SARs become immediately exercisable to the extent permitted by the plan, and any restrictions on restricted stock lapse.
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2001 Long Term Stock Incentive Plan (“2001 Plan”) - Provides for the issuance of up to 1,697,000 shares of our common stock in the form of Incentive Stock Options and Non-Qualified Stock Options. No officer may be granted more than 500,000 stock options during any one fiscal year, as adjusted for any changes in capitalization, such as stock splits. In the event of a change in control, all outstanding options become immediately exercisable to the extent permitted by the plan.
Stock Options
Stock options granted under the plans must be no less than the fair market value of our common stock on the date of grant. Stock options granted under the plans generally are exercisable in varying cumulative periodic installments after one year. Stock options granted under the plans expire five to ten years from the date of grant. Stock options to purchase 85,006 common shares remained available for grant as of December 31, 2012 (2011: 507,298). Of the common shares available for grant as of December 31, 2012, all of these shares are also available for issuance in the form of restricted shares.
The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option-pricing model which uses assumptions for the risk-free interest rate, volatility, dividend yield and the expected term of the options. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for a period equal to the expected term of the option. Expected volatility is based on historical volatilities of our stock. We do not assume any dividend yield since we do not pay dividends. The expected term of options granted is the weighted average life of stock options and represents the period of time that options are expected to be outstanding.
We also consider an estimated forfeiture rate for these stock option awards, and we recognize compensation cost only for those shares that are expected to vest, on a straight-line basis over the requisite service period of the award, which is generally the vesting term of three to five years. The forfeiture rate is based on historical experience.
Stock option transactions under our various stock-based employee compensation plans are presented below:
Of the options outstanding, 2.5 million were exercisable at weighted-average exercise price of $10.12 as of December 31, 2012 (2011: 2.2 million at $10.15; 2010: 1.8 million at $10.27).
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During the year ended December 31, 2012, we awarded stock options vesting over three years to purchase 451,298 of our common shares to our employees and executive officers (2011: 498,500 stock options; 2010: 477,000 stock options).
The value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
(1) Expected volatilities are based on historical volatilities of our stock.
A summary of our unvested stock option awards as of December 31, 2012, and the changes during the year then ended is presented below:
The total intrinsic value of stock options exercised during the year ended December 31, 2012 was $0.3 million (2011: $1.4 million; 2010: $2.5 million). The total fair value of stock options that vested during the year ended December 31, 2012, was $1.9 million (2011: $2.7 million; 2010: $2.6 million).
As of December 31, 2012, there was $2.4 million of total future compensation cost related to unvested stock option awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 2.6 years.
Restricted Stock
Restricted stock is issued on the grant date, but cannot be sold or transferred. Restricted stock granted to directors vest one year after date of grant. Restricted stock granted to employees vest at the third year after date of grant. Vesting of the restricted stock is dependent upon the employee’s continued service to Harvest.
A summary of our restricted stock awards as of December 31, 2012, and the changes during the year then ended is presented below:
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During 2012, we awarded 2,000 shares of restricted stock to new hire employees as employment inducement grants under a New York Stock Exchange (“NYSE”) exception (2011: 181,050 shares to employees and directors). These awards had an aggregate fair value at their date of grant of $11,700 (2011: $2.0 million). The restricted stock is schedule to vest at the third year after date of grant for employees and one year after date of grant for directors. The value of the restricted stock that vested during the year ended December 31, 2012 was $0.8 million (2011: $3.4 million; 2010: $1.4 million). The weighted average grant date fair value of awards granted in 2011 was $11.21 and 2010 was $7.10.
As of December 31, 2012 there was $0.8 million of total future compensation cost related to unvested restricted stock awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 1.2 years.
Stock Appreciation Rights (“SARs”)
All SAR awards granted to date have been granted outside of active long-term incentive plans and are held by Harvest employees. SARs granted in 2009 vest ratably over three years beginning with the third year of grant. SARs granted in 2012 vest ratably over three years beginning in the first year of grant. Vesting of SARs is dependent upon the employee’s continued service to Harvest. SAR awards are settled either in cash or Harvest common stock if available through an equity compensation plan. For recording of compensation, we assume the SAR award will be cash-settled and record compensation expense based on the fair value of the SAR awards at the end of each period.
SAR award transactions under our employee compensation plans are presented below:
Of the SAR awards outstanding, 74,997 were exercisable at weighted-average exercise price of $4.60 as of December 31, 2012 (2011: 83,000 at $4.60; 2010: none).
During the year ended December 31, 2012, we awarded 707,202 SARs vesting over three years to our employees and executive officers (2011: none; 2010: none).
The value of each SAR award is estimated on the date of grant using the Black-Scholes option pricing model using the assumptions discussed above.
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A summary of our unvested SAR awards as of December 31, 2012, and the changes during the year then ended is presented below:
The total intrinsic value of SAR awards exercised during the year ended December 31, 2012 was $0.3 million. No SAR awards were exercised during the years ended December 31, 2011 or 2010. The total fair value of SAR awards that vested during the year ended December 31, 2012, was $0.3 million (2011: $0.2 million; 2010: none).
As of December 31, 2012, there was $3.7 million of total future compensation cost related to unvested SAR awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 2.3 years.
Restricted Stock Units (“RSUs”)
All RSU awards granted to date have been granted outside of active long-term incentive plans, are held by Harvest employees and directors, and are settled either in cash or Harvest common stock if available through an equity compensation plan. RSU awards granted in 2009 vest ratably over three years beginning with the third year of grant. RSU awards granted in 2012 to employees vest at the third year after date of grant. RSU awards granted in 2012 to directors vest one year after date of grant. Vesting of the RSU awards is dependent upon the employee’s and director’s continued service to Harvest.
A summary of our RSU awards as of December 31, 2012, and the changes during the year then ended is presented below:
During 2012, we awarded 388,000 RSUs to employees (2011: none, 2010: none). These RSU awards had an aggregate fair value at their date of grant of $2.0 million (2011: none, 2010: none). The 70,994 RSU awards which vested in 2012 were settled with Harvest common stock. The value of the RSU awards that vested during the year ended December 31, 2012 was $0.4 million (2011: $0.6 million; 2010: none).
As of December 31, 2012 there was $2.7 million of total future compensation cost related to unvested RSU awards that are expected to vest. That cost is expected to be recognized over a weighted average period of 2.0 years.
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Common Stock Warrants
In connection with a $60 million term loan facility issued in November 2010, we issued (1) 1.2 million warrants exercisable at any time on or after the closing date of the term loan facility for a period of five years from the closing date on a cashless exercise basis at $15 per share until July 28, 2011, the Bridge Date, at which time the exercise price per share would be repriced to equal the lower of $15 or 120 percent of the average closing bid price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date (“Tranche A”); (2) 0.4 million warrants exercisable at any time on or after the closing date of the term loan facility for a period of five years from the closing date on a cashless exercise basis at $20 per share until the Bridge Date, at which time the exercise price per share would be repriced to equal the lower of $15 or 120 percent of the average closing bid price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date (“Tranche B”); and (3) 4.4 million warrants exercisable at any time on or after the Bridge Date for a period of five years from the Bridge Date on a cashless exercise basis at the lower of $15 per share or 120 percent of the average closing price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date (“Tranche C”) (“collectively “the Warrants”). Tranche C was redeemable by Harvest for $0.01 per share at any time prior to the Bridge Date in conjunction with the repayment of the loan prior to the Bridge Date.
On May 17, 2011, in connection with the payment of the term loan facility, we redeemed all of Tranche C at $0.01 per share. The cost to redeem Tranche C ($44,000) was expensed to loss on extinguishment of debt in the six months ended June 30, 2011.
On July 28, 2011, the Bridge Date, Tranche A and Tranche B were repriced to $14.78 per warrant which is the lower of $15 or 120 percent of the average closing bid price of Harvest’s common stock for the 20 trading days immediately preceding the Bridge Date.
The Warrants include anti-dilution provisions which adjust the number of warrants and the exercise price per warrant based on the issuance of additional shares. The induced conversions related to the $32 million senior convertible notes triggered the anti-dilution provision which resulted in the issuance of 118,327 additional warrants in the year ended December 31, 2012 (2011: 2,007 additional warrants). In addition, the exercise price per share for all Warrants was repriced to $13.75 per warrant. The Warrants are classified as a liability on our consolidated balance sheets and marked to market. See Note 3 - Summary of Significant Accounting Policies, Restatement of Prior Period Financial Statements.
In the occurrence of a fundamental change, we are required to repurchase the Warrants at the higher of (1) the fair market value of the warrant and (2) a valuation based on a computation of the option value of the Warrant using the Black-Scholes calculation method using the assumptions described in the Warrant Agreement. A fundamental change is defined as “the occurrence of one of the following events: a) a person or group becomes the direct or indirect owner of more than 50% of the voting power of the outstanding common stock, b) a merger event or similar transaction in which the majority owners before the transaction fail to own a majority of the voting power of the Company after the transaction, and c) approval of a plan of liquidation or dissolution of the Company or sale of all or substantially all of the Company’s assets.”
In connection with the 11 percent senior unsecured notes issued October 11, 2012, we issued warrants to purchase up to 0.7 million share of our common stock with an exercise price of $10.00 per share. The warrants can be exercised at any time up until the three-year anniversary of the closing. The Black-Scholes option pricing model was used in pricing the warrants. The fair value of the warrants, $2.8 million, is classified as a discount on debt with a corresponding credit to additional paid in capital on our consolidated balance sheet at December 31, 2012.
The dates the warrants were issued, the expiration dates, the exercise prices and the number of warrants issued and outstanding at December 31, 2012 were:
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Note 10 - Warrant Derivative Liabilities
As of December 31, 2012, warrant derivative financial instruments consisted of 1,720,334 warrants (2011: 1,602,007 warrants) issued under the warrant agreements dated November 2010 in connection with a $60 million term loan facility (see Note 9 - Stock-Based Compensation and Stock Purchase Plans, Common Stock Warrants). The fair value of the warrants as of December 31, 2012 was $3.18 per warrant (2011: $3.04 per warrant).
These warrant agreements include provisions wherein we may be required to settle the warrant agreement by transferring assets. Consequently, under ASC 480-10-25-8, these warrants must be treated as a derivative liability, bifurcated from the host instrument, and recorded at fair value at each reporting date. In the occurrence of a fundamental change, we are required to repurchase the Warrants at the higher of (1) the fair market value of the warrant and (2) a valuation based on a computation of the option value of the Warrant using the Black-Scholes calculation method using the assumptions described in the Warrant Agreement. A fundamental change is defined as “the occurrence of one of the following events: a) a person or group becomes the direct or indirect owner of more than 50% of the voting power of the outstanding common stock, b) a merger event or similar transaction in which the majority owners before the transaction fail to own a majority of the voting power of the Company after the transaction, and c) approval of a plan of liquidation or dissolution of the Company or sale of all or substantially all of the Company’s assets.”
All our warrant derivative contracts are recorded at fair value and are located in the balance sheet as warrant derivative liability. The following table summarizes the effect on our income (loss) associated with changes in the fair values of our derivative financial instruments:
Note 11 - Operating Segments
We regularly allocate resources to and assess the performance of our operations by segments that are organized by unique geographic and operating characteristics. The segments are organized in order to manage
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regional business, currency and tax related risks and opportunities. Operations included under the heading “United States” include corporate management, cash management, business development and financing activities performed in the United States and other countries, which do not meet the requirements for separate disclosure. All intersegment revenues, other income and equity earnings, expenses and receivables are eliminated in order to reconcile to consolidated totals. Corporate general and administrative and interest expenses are included in the United States segment and are not allocated to other operating segments.
(a) Includes net income attributable to noncontrolling interest.
Note 12 - Venezuela
Harvest Vinccler’s and Petrodelta’s functional and reporting currency is the U.S. Dollar. They do not have currency exchange risk other than the official prevailing exchange rate that applies to their operating costs denominated in Venezuela Bolivars (“Bolivars”) (4.30 Bolivars per U.S. Dollar). However, during the year ended December 31, 2012, Harvest Vinccler exchanged approximately $1.5 million (2011: $1.2 million) through the Sistema de Transacciones con Títulos en Moneda Extranjera (“SITME”) and received an average exchange rate of 5.16 Bolivars (2011: 5.19 Bolivars) per U.S. Dollar. Petrodelta does not have, and has not had, any Bolivars pending government approval for settlement for U.S. Dollars at the official exchange rate or the SITME exchange rate.
The monetary assets that are exposed to exchange rate fluctuations are cash, accounts receivable, and other current assets. The monetary liabilities that are exposed to exchange rate fluctuations are accounts payable, accruals and other current liabilities. All monetary assets and liabilities incurred at the official Bolivar exchange rate are settled at the official Bolivar exchange rate. At December 31, 2012, the balances in Harvest Vinccler’s Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 6.2 million Bolivars and 5.7 million Bolivars, respectively. At December 31, 2012, the balances in Petrodelta’s Bolivar denominated monetary assets and liabilities accounts that are exposed to exchange rate changes are 277.2 million Bolivars and 2,646.2 million Bolivars, respectively.
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On February 8, 2013, the Venezuelan government published in the Official Gazette the Exchange Agreement No. 14 which establishes new exchange rates for the Bolivar/U.S. Dollar currencies that became effective February 9, 2013. The exchange rate established in the Agreement is 6.30 Bolivars per U.S. Dollar. The Exchange Agreement also announced the elimination of SITME effective February 8, 2013. All exchanges of Bolivars must now transact through the Central Bank. As a result of the February 2013 devaluation, Harvest Vinccler estimates the impact of the devaluation to be approximately $0.1 million gain on revaluation of its assets and liabilities, and Petrodelta estimates the impact of the devaluation to be approximately $54.8 million gain on revaluation of its assets and liabilities.
On May 7, 2012, the Organic Law on Employment, Male and Female Workers (“Labor Law”) was published in the Official Gazette, the official government publication where laws, decrees, resolutions, instructions, and other regulations of general interest issued by the central government of Venezuela are published in order to make those acts valid and official. The Labor Law’s purpose is to regulate the relations between workers and employers. In August 2012, the labor contract between PDVSA and the labor union was signed. The new labor contract awarded salary increases to both union and non-union labor retroactive to December 2011. The new labor contract increased the effect of the Labor Law on Petrodelta by increasing the salaries on which the Labor Law benefits are calculated. Per the actuarial study that PDVSA commissioned, the effect of the Labor Law on Petrodelta’s business was $3.8 million ($1.2 million net to our 32 percent interest) for the year ended December 31, 2012. The Labor Law had no impact to Harvest Vinccler.
Note 13 - Investment in Equity Affiliates - Petrodelta, S.A.
See Note 5 - Dispositions, Share Purchase Agreement (“SPA”).
On October 25, 2007, the Venezuelan Presidential Decree which formally transferred to Petrodelta the rights to the Petrodelta Fields subject to the conditions of the Conversion Contract was published in the Official Gazette. Petrodelta is governed by its own charter and bylaws and will engage in the exploration, production, gathering, transportation and storage of hydrocarbons from the Petrodelta Fields for a maximum of 20 years from that date. Petrodelta operates a portfolio of properties in eastern Venezuela including large proven oil fields as well as properties with substantial opportunities for both development and exploration. Petrodelta is to undertake its operations in accordance with Petrodelta’s business plan as set forth in its conversion contract. Under its conversion contract, work programs and annual budgets adopted by Petrodelta must be consistent with Petrodelta’s business plan. Petrodelta’s business plan may be modified by a favorable decision of the shareholders owning at least 75 percent of the shares of Petrodelta.
The sale of oil and gas by Petrodelta to the Venezuelan government is pursuant to a Contract for Sale and Purchase of Hydrocarbons with PDVSA Petroleo S.A. (“PPSA”) signed on January 17, 2008. The form of the agreement is set forth in the Conversion Contract. Crude oil delivered from the Petrodelta Fields to PPSA is priced with reference to Merey 16 published prices, weighted for different markets, and adjusted for variations in gravity and sulphur content, commercialization costs and distortions that may occur given the reference price and prevailing market conditions. Merey 16 published prices are quoted and sold in U.S. Dollars. Natural gas delivered from the Petrodelta Fields to PPSA is priced at $1.54 per thousand cubic feet. Natural gas deliveries are paid in Bolivars, but the pricing for natural gas is referenced to the U.S. Dollar. PPSA is obligated to make payment to Petrodelta of each invoice within 60 days of the end of the invoiced production month by wire transfer, in U.S. Dollars in the case of payment for crude oil and natural gas liquids delivered, and in Bolivars in the case of payment for natural gas delivered, in immediately available funds to the bank accounts designated by Petrodelta. Major contracts for capital expenditures and lease operating expenditures are denominated in U.S. Dollars. Any dividend paid by Petrodelta will be made in U.S. Dollars.
When the Sales Contract was executed, Petrodelta was producing only one type of crude, Merey 16. Beginning in October 2011, the Ministry of the People’s Power for Petroleum and Mining (“MENPET”) determined that Petrodelta’s production flowing through the COMOR transfer point was a heavier type of crude, Boscan. Since Petrodelta was producing only Merey 16 when the Sales Contract was executed, the Boscan gravity and sulphur correction factors and crude pricing formula are not included in the Sales Contract. However, under the Sales Contract, PPSA is obligated to receive all of Petrodelta’s production. All production deliveries for all of Petrodelta’s fields have been certified by MENPET and acknowledged by PPSA. All pricing factors to be used in the Merey 16 and Boscan pricing formulas have been provided by and certified by MENPET to Petrodelta.
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Since the Sales Contract provides for only one crude pricing formula, the Sales Contract had to be amended to include the Boscan pricing formula to allow Petrodelta to invoice PPSA for El Salto crude oil deliveries. From October 1, 2011 through June 30, 2012, Petrodelta used the Boscan pricing formula as published in the Official Gazette on January 11, 2007 to record revenue from El Salto deliveries. Petrodelta subsequently received from PDVSA Trade and Supply a draft amendment to the Sales Contract. The pricing formula in the draft amendment was used to record revenue for El Salto field deliveries from July 1, 2012 through December 31, 2012, and revenue for El Salto deliveries for October 1, 2011 through June 30, 2012 was revised to reflect the pricing formula in the draft amendment. The only item included in the draft amendment is the Boscan pricing formula to be used in invoicing El Salto crude oil deliveries. All other terms and conditions of the Sales Contract remain in force. On January 28, 2013, Petrodelta’s board of directors endorsed the amendment to the Sales Contract. The amendment has to be approved by CVP’s board of directors and HNR Finance’s board of directors. Once these approvals are received, the amendment to the Sales Contract will be executed and PPSA will be invoiced for the deliveries.
At December 31, 2012, El Salto deliveries, net of royalties, covering the delivery months of October 2011 through December 2012 totaled approximately 4.0 MBls (1.3 MBls net to our 32 percent interest). The draft amendment to the Sales Contract pricing formula for Boscan based upon the deliveries and factors certified by MENPET, results in revenue for these deliveries of $352.7 million ($112.9 million net to our 32 percent interest). As of December 31, 2012, these deliveries for El Salto remain uninvoiced to PPSA.
As discussed in previous filings, PDVSA has failed to pay on a timely basis certain amounts owed to contractors that PDVSA has contracted to do work for Petrodelta. PDVSA purchases all of Petrodelta’s oil production. PDVSA and its affiliates have reported shortfalls in meeting their cash requirements for operations and planned capital expenditures, and PDVSA has fallen behind in certain of its payment obligations to its contractors, including contractors engaged by PDVSA to provide services to Petrodelta. In addition, PDVSA has fallen behind in certain of its payment obligations to Petrodelta, which payments Petrodelta would otherwise use to pay its contractors, including Harvest Vinccler. As a result, Petrodelta has experienced, and is continuing to experience, difficulty in retaining contractors who provide services for Petrodelta’s operations. We cannot provide any assurance as to whether or when PDVSA will become current on its payment obligations. Inability to retain contractors or to pay them on a timely basis is having an adverse effect on Petrodelta’s operations and on Petrodelta’s ability to carry out its business plan.
Harvest Vinccler has advanced certain costs on behalf of Petrodelta. These costs include consultants in engineering, drilling, operations, seismic interpretation, and employee salaries and related benefits for Harvest Vinccler employees seconded into Petrodelta. Currently, we have three employees seconded into Petrodelta. Costs advanced are invoiced on a monthly basis to Petrodelta. Harvest Vinccler is considered a contractor to Petrodelta, and as such, Harvest Vinccler is also experiencing the slow payment of invoices. During the year ended December 31, 2012, Harvest Vinccler advanced to Petrodelta $0.5 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advance. Petrodelta and Petrodelta’s board have not indicated that the advances are not payable, nor that they will not be paid. At December 31, 2012, we reclassified $2.1 million of the Advances to Affiliate to a long-term receivable due to slow payment and age of the advances. During the year ended December 31, 2011, we advanced Petrodelta $0.8 million for continuing operations costs, and Petrodelta repaid $0.1 million of the advances. Although payment is slow and the balance is increasing, payments continue to be received.
In April 2011, the Venezuelan government published in the Official Gazette the Law Creating a Special Contribution on Extraordinary Prices and Exorbitant Prices in the International Hydrocarbons Market (“Windfall Profits Tax”). Windfall Profits Tax is deductible for Venezuelan income tax purposes. In February 2013, the Venezuelan government published in the Official Gazette an amendment to the Windfall Profits Tax. The amended Windfall Profits Tax establishes new levels for contribution of extraordinary prices (under $80 per barrel) and exorbitant prices (over $100 per barrel), and levels in-between, to the Venezuelan government. During the year ended December 31, 2012, Petrodelta recorded $291.4 million for Windfall Profits Tax (2011: $237.6 million).
One section of the Windfall Profits Tax states that royalties paid to Venezuela are capped at $70 per barrel, but the cap on royalties has not been defined as being applicable to in-cash, in-kind, or both. Per instructions received from PDVSA, Petrodelta reports royalties, whether paid in-cash or in-kind, at $70 per barrel (royalty barrels x $70). The difference between the $70 royalty cap and the current oil price is to be reflected on the income statement as a reduction in oil sales. For the year ended December 31, 2012, the reduction to oil sales due to the $70 cap applied to all royalty barrels was $113.7 million ($36.4 million net to our 32 percent interest) (2011: $85.0 million [$27.2 million net to our 32 percent interest]).
Per our interpretation of the Windfall Profits Tax, the $70 cap on royalty barrels should only be applied to the 3.33 percent royalty which Petrodelta pays in cash. We have applied the $70 cap to only the 3.33 percent royalty
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paid in cash and the current oil sales price to the 30 percent royalty paid in-kind for the year months ended December 31, 2012. With assistance from Petrodelta, we have recalculated Petrodelta’s oil sales and royalties to apply the current oil price to its total barrels produced and to the 30 percent royalty paid in-kind and applied the $70 cap to the 3.33 percent royalty paid in cash for the year ended December 31, 2012. For the year ended December 31, 2012, net oil sales (oil sales less royalties) are slightly higher, $11.4 million ($3.6 million net to our 32 percent interest) (2011: $8.5 million [$2.7 net to our 32 percent interest]) under this method than the method advised by PDVSA and the method of applying the current oil price to total barrels produced and to total royalty barrels. We have reported revenues and royalties for Petrodelta under this method.
On November 12, 2010, Petrodelta’s board of directors declared a dividend of $30.6 million, $12.2 million net to HNR Finance ($9.8 million net to our 32 percent interest). Petrodelta shareholder approval of the dividend was received on March 14, 2011. Due to Petrodelta’s liquidity constraints caused by PDVSA’s insufficient monetary support and contractual adherence, as of May 2, 2012, this dividend has not been received, although it is due and payable. Petrodelta’s board of directors declared this dividend and has never indicated that the dividend is not payable, nor that it will not be paid. The dividend receivable is classified as a long-term receivable at December 31, 2012 due to the uncertainty in the timing of payment. There is uncertainty with respect to the timing of the receipt of this dividend and whether future dividends will be declared or paid. We have and will continue to monitor our investment in Petrodelta. Should the dividend receivable not be collected or facts and circumstances surrounding our investment change, our results of operations and investment in Petrodelta could be adversely impacted.
The Organic Law on Sports, Physical Activity and Physical Education (“Sports Law”) was published in the Official Gazette on August 23, 2011. The purpose of the Sports Law is to establish the public service nature of physical education and the promotion, organization and administration of sports and physical activity. Funding of the Sports Law is by contributions made by companies or other public or private organizations that perform economic activities for profit in Venezuela. The contribution is one percent of annual net or accounting profit and is not deductible for income tax purposes. Per the Sports Law, contributions are to be calculated on an after-tax basis. However, in March 2012, CVP has instructed Petrodelta to calculate the contribution on a before-tax basis contrary to the Sports Law. For the year ended December 31, 2012, this method of calculation overstates the liability for the Sports Law contribution by $2.5 million ($0.8 million net to our 32 percent interest). We have adjusted for the overaccrual of the Sports Law in the December 31, 2012 Net Income from Equity Affiliate.
Petrodelta’s reporting and functional currency is the U.S. Dollar. HNR Finance owns a 40 percent interest in Petrodelta. Petrodelta’s financial information is prepared in accordance with International Financial Reporting Standards (“IFRS”) which we have adjusted to conform to USGAAP. The two major differences between IFRS and USGAAP, for which we adjust, are deferred taxes and depletion expense.
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Deferred tax. IFRS allows the inclusion of monetary temporary differences impacted by inflationary adjustments. USGAAP does not. Net Income Equity Affiliate is increased or decreased by the deferred tax benefit created by the monetary temporary differences impacted by inflationary adjustments.
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Depletion expense. Oil and gas reserves used by Petrodelta in calculating depletion expense under IFRS are provided by MENPET. MENPET reserves are not prepared using the guidance on extractive activities for oil and gas (ASC 932). At least annually, we prepare reserve reports for Petrodelta using ASC 932. Petrodelta depletion is recalculated using the USGAAP compliant reserves.
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All amounts through Net Income Equity Affiliate represent 100 percent of Petrodelta. Summary financial information has been presented below at December 31, 2012 and 2011, and for the years ended December 31, 2012, 2011 and 2010:
Fusion Geophysical, LLC (“Fusion”)
On January 28, 2011, Fusion Geophysical, LLC’s (“Fusion”) 69 percent owned subsidiary, FusionGeo, Inc., was acquired by a private purchaser pursuant to an Agreement and Plan of Merger. We received $1.4 million for our equity investment.
At December 31, 2009, we fully impaired the carrying value of our equity investment in Fusion. Accordingly, we did not record net losses incurred by Fusion in the year ended December 31, 2011 of $0.2 million ($0.1 million net to our 49 percent interest) or (2010: $2.4 million [$1.2 million net to our 49 percent interest]) as doing so would have caused our equity investment to go into a negative position.
Note 14 - Indonesia
In 2007, we entered into a Farmout Agreement to acquire a 47 percent interest in the Budong PSC located mostly onshore West Sulawesi, Indonesia. In April 2008, the Government of Indonesia approved the assignment to
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us of the 47 percent interest in the Budong PSC. Our partner is the operator through the exploration phase as required by the terms of the Budong PSC, and we have an option to become operator, if approved by the Government of Indonesia and SKK Migas in any subsequent development and production phase.
We acquired our original 47 percent interest in the Budong PSC by committing to fund the first phase of the exploration program up to a cap of $17.2 million, including the acquisition of 2-D seismic and drilling of the first two exploration wells under a Farmout Agreement with our partner in the Budong PSC. Prior to drilling the first exploration well, our partner had a one-time option to increase the level of the carried interest to a maximum of $20.0 million. On September 15, 2010, our partner exercised their option to increase the carry obligation by $2.7 million to a total of $19.9 million. The additional carry increased our ownership by 7.4 percent to 54.4 percent. On March 3, 2011, the Government of Indonesia approved this change in ownership interest.
On January 5, 2011, we exercised our first refusal right to a proposed transfer of interest by the operator to a third party, which allowed us to acquire an additional 10 percent ownership in the Budong PSC at a cost of $3.7 million payable ten business days after completion of the first exploration well. The $3.7 million was paid on April 18, 2011. Closing of this acquisition increased our participating ownership interest in the Budong PSC to 64.4 percent with our cost sharing interest becoming 64.51 percent until first commercial production. On August 11, 2011, the Government of Indonesia approved this change in ownership interest.
The initial exploration term of the Budong PSC was due to expire on January 15, 2013. In September 2012, the operator of the Budong PSC, on behalf of us and the other co-venturer, submitted a request to BPMIGAS under the terms of the Budong PSC for a four-year extension of the initial six-year exploration term of the Budong PSC. In January 2013, we received written approval from SKK Migas of the four-year extension of the initial six-year exploration term.
In November 2012, the Indonesia constitutional court declared BPMIGAS, Indonesia’s oil and gas regulatory authority, to be unconstitutional. In January 2013, SKK Migas, the Special Task Force for oil and gas upstream sector, was formed to replace BPMIGAS.
In December 2012, we signed a farmout agreement with the operator of the Budong PSC to acquire an additional 7.1 percent participating interest and to become operator of the Budong PSC. We assumed the role of interim operator effective January 16, 2013. Closing of this acquisition will increase our participating ownership interest in the Budong PSC to 71.5 percent with our cost sharing interest becoming 72 percent until first commercial production. The consideration for this transaction is that we will fund 100 percent of the costs of the first exploration well of the four-year extension to the Budong PSC. If the exploration well is not drilled within 18 months of the date of approval from the Government of Indonesia of this transaction, our partner has the right to give notice that the consideration be paid in cash, or $3.2 million. The acquisition of the additional participating interest and the transfer of operatorship are dependent on approval by the Government of Indonesia.
We have satisfied all work commitments for the current exploration phase of the Budong PSC. However, the extension of the initial exploration term includes an exploration well, which if not drilled by January 2016, results in the termination of the Budong PSC.
During the initial exploration period, the Budong PSC covered 1.35 million acres. The Budong PSC includes a ten-year exploration period and a 20-year development phase. Pursuant to the terms of the Budong PSC, at the end of the first three-year exploration phase, 45 percent of the original area was to be relinquished to SKK Migas. In January 2010, 35 percent of the original area was relinquished and ten percent of the required relinquishment was deferred until 2011. In January 2011, the deferred ten percent of the original total contract area was relinquished to SKK Migas. The Budong PSC currently covers 0.75 million acres. However, pursuant to the request for extension of the initial exploration term, the contract area held by the Budong PSC at the beginning of the extension period should be reduced, per the terms of the Budong PSC, from the current 55 percent to 20 percent of the original contract area. If the full amount of the required relinquishment is required, 0.3 million acres would remain in the Budong PSC contract area. In January 2013, our partner, on our behalf, submitted a relinquishment proposal of 10 percent to SKK Migas. The retained area will contain all the areas of geological interest to the Budong PSC partners.
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Operational activities during 2012 focused on a review of geological and geophysical data obtained from the drilling of LG-1 and KD-1 wells to upgrade the prospectivity of the block and to define a prospect for potential drilling in 2013. We have completed remapping of both the Lariang and Karama Basins with eight leads in the Lariang Basin and five leads in the Karama Basin having been identified. The identification of these leads is the basis for the four-year extension request of the first six-year exploration term.
The Budong PSC represents $5.3 million of unproved oil and gas properties on our December 31, 2012 balance sheet (2011: $5.3 million).
Note 15 - Gabon
We are the operator of the Dussafu PSC with a 66.667 percent ownership interest. Located offshore Gabon, adjacent to the border with the Republic of Congo, the Dussafu PSC covers an area of 680,000 acres with water depths up to 1,650 feet.
The Dussafu PSC partners and the Republic of Gabon, represented by the Ministry of Mines, Energy, Petroleum and Hydraulic Resources, entered into the third exploration phase of the Dussafu PSC with an effective date of May 28, 2012. The Direction Generale Des Hydrocarbures (“DGH”) agreed to lengthen the third exploration phase to four years until May 27, 2016. The third exploration phase of the Dussafu PSC has a $7.0 million ($4.7 million net to our 66.667 percent interest) work commitment over a four year period. This commitment was fulfilled with the drilling of DTM-1.
Operational activities during the year ended December 31, 2012 included completion of the processing of 545 square kilometers of seismic which was acquired in the fourth quarter of 2011 and well planning. The 3-D Pre-Stack Time Migration (“PSTM”) was completed in July 2012.
Well planning progressed to drill an exploration well in the fourth quarter of 2012 on the Tortue prospect. DTM-1 well was spud November 19, 2012. DTM-1 was drilled with the Scarabeo 3 semi-submersible drilling unit. On January 4, 2013, we announced that DTM-1 had reached the Dental Formation and discovered oil in both the Gamba and Dentale formations. Additional technical evaluation is on-going and is expected to take several months.
See Note 7 - Commitments and Contingencies for a discussion of legal matters related to our Gabon operations.
The Dussafu PSC represents $76.4 million of unproved oil and gas properties on our December 31, 2012 balance sheet (2011: $48.9 million).
Note 16 - Oman
In 2009, we signed an EPSA with Oman for Block 64 EPSA. We have an 80 percent working interest and our partner, Oman Oil Company, has a 20 percent carried interest in Block 64 EPSA during the initial period. Block 64 EPSA was a block designated for exploration and production of non-associated gas and condensate, which the Oman Ministry of Oil and Gas carved out of the Block 6 Concession operated by Petroleum Development of Oman (“PDO”). PDO has continued to produce oil from several shallow oil fields within Block 64 EPSA area.
All work commitments for the First Phase exploration period on Block 64 EPSA have been completed. Operational activities during 2012 include post well evaluation and review of geological and geophysical data obtained from the drilling of the MFS-1and AGN-1 wells. On March 12, 2013, we elected to not request an extension of the First Phase or enter the Second Phase of Block 64 EPSA and Block 64 will be relinquished effective June 30, 2013. The carrying value of Block 64 EPSA of $6.4 million was written off to impairment expense at December 31, 2012. During the first half of 2013, we will terminate operations and close the field office.
Block 64 EPSA represented $5.3 million of unproved oil and gas properties on our December 31, 2011 balance sheet.
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Note 17 - China
In December 1996, we acquired a petroleum contract with China National Offshore Oil Corporation (“CNOOC”) for the WAB-21 area. The WAB-21 petroleum contract covers 6.2 million acres in the South China Sea, with an option for an additional 1.25 million acres under certain circumstances, and lies within an area which is the subject of a border dispute between China and Socialist Republic of Vietnam (“Vietnam”). Vietnam has executed an agreement on a portion of the same offshore acreage with another company. The border dispute has lasted for many years, and there has been limited exploration and no development activity in the WAB-21 area due to the dispute. Due to the border dispute between China and Vietnam, we have been unable to pursue an exploration program during Phase One of the contract. As a result, we have obtained license extensions, with the current extension in effect until May 31, 2013. The Joint Management Committee has approved an extension of the license until May 31, 2015. We are meeting with CNOOC in April 2013 to discuss the ratification of the extension. Regular meetings are held with CNOOC with contingent work programs being planned and annual budgets being set. While no assurance can be given, we believe we will continue to receive contract extensions so long as the border disputes persist. Even though there continues to be increasing activity on the Vietnamese blocks which we believe confirms our view of WAB-21’s prospectivity, we impaired the carrying value of WAB-21 of $2.9 million at December 31, 2012 due to our continued inability to pursue an exploration program. However, we continue to seek permission to acquire regional 2-D seismic and localized 3-D seismic.
WAB-21 represented $2.9 million of unproved oil and gas properties on our December 31, 2011 balance sheet.
Note 18 - Related Party Transactions
Dividends declared and paid by Petrodelta are paid to HNR Finance. HNR Finance must declare a dividend in order for the partners, Harvest and Vinccler, to receive their respective shares of Petrodelta’s dividend. Between 2008 and 2010, Petrodelta declared three dividends, totaling $105.5 million, which have been received by HNR Finance and one dividend, totaling $12.2 million, which has not yet been received by HNR Finance. HNR Finance declared a dividend in 2008 in the amount of $72.5 million. HNR Finance has not declared a dividend for the remaining $33.0 million. At December 31, 2012, Vinccler’s share of the undistributed dividends is $9.0 million.
Note 19 - Subsequent Events
On February 20, 2013, we announced that the SPA had been termination as a result of the Government of Indonesia voting not to approve the transaction. See Note 5 - Dispositions, Share Purchase Agreement (“SPA”).
On March 25, 2013, SKK Migas approved the transfer of operatorship of the Budong PSC to us.
On April 9, 2013, the Government of Indonesia approved the acquisition of the additional 7.1 percent participating interest in the Budong PSC.
We conducted our subsequent events review up through the date of the issuance of this Annual Report on Form 10-K.
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HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
Quarterly Financial Data (unaudited)
Summarized quarterly financial data is as follows:
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As noted above, the amounts per quarter were restated. Presented below are restated quarterly financial statements for each of the three quarters of 2012 and all quarters of 2011.
During 2012, we identified accounting errors subsequent to filing our Quarterly Reports on Form 10-Q for the periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012 and September 30, 2012. As discussed in Note 3, in the course of management’s ongoing review and analysis and management’s review of the design and operating effectiveness of internal control over financial reporting, we concluded that there were errors in previously filed financial statements. In the course of our review, management determined that (a) certain warrants issued in 2010 in connection with our $60 million term loan facility (the “Warrants”) were improperly valued at inception and improperly classified as equity instruments rather than liability instruments. As a result of the improper classification of the Warrants, (b) the debt discount and associated interest expense related to the amortization of the debt discount was understated for all periods in which the associated debt was outstanding, and (c) the consolidated statement of operations and comprehensive income (loss) for each reporting period was misstated by the omission of the changes in fair value of the Warrants as a liability instrument. Additionally, (d) certain exploration overhead was incorrectly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed, and (e) certain leasehold maintenance and other costs were improperly capitalized to oil and gas properties, which under the successful efforts method of accounting should have been expensed. Finally, (f) advances to equity affiliate were improperly classified as an operating activity rather than an investing activity and (g) certain costs were improperly classified as an investing activity rather than an operating activity on the consolidated statement of cash flows. As a result of the errors related to the Warrants described above, loss on extinguishment of debt was understated for the quarters ended June 30, 2011, September 30, 2011 and December 31, 2011. Additionally, an error was identified in the calculation of earnings (loss) per diluted share for the three and six months ended June 30, 2011, and an additional error was identified related to the improper expensing of costs associated with debt conversions that should have been recorded to equity for the quarters ended March 31, 2012 and September 30, 2012.
We have restated our segment footnote information to reflect the applicable errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense. Such errors impacted the quarterly periods ended March 31, 2011, June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012, and September 30, 2012.
In assessing the severity of the corrections, management determined that the errors were material to the consolidated financial statements as of and for the quarters ended March 31, 2011 June 30, 2011, September 30, 2011, December 31, 2011, March 31, 2012, June 30, 2012 and September 30, 2012. In addition to the errors described above, we have also made corrections for previously identified immaterial errors and errors affecting classification within the consolidated statement of operations and comprehensive income (loss) related to impairment of oil and gas properties and income taxes and the consolidated balance sheets related to income taxes. Management concluded that we should restate our financial statements included in our Quarterly Report on Form 10-Q for the periods ending March 31, 2012, June 30, 2012, and September 30, 2012, and recommended that the Audit Committee authorize such restatement.
Set forth below is a summary of the nature of the errors. Correction explanations are provided following each of the financial statements affected.
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CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2012, June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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2012 Consolidated Balance Sheet Corrections:
(a) Represents a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Income tax effect of the adjustments and income taxes improperly classified as interest payable in 2011.
(d) Represents the fair value of the Warrants at the reporting date.
(e) For the three months ended March 31, 2012 and six months ended June 30, 2012, the adjustment to additional paid-in capital relates to (a) the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification and (b) deferred financing costs of $439 thousand that were erroneously expensed rather than capitalized to additional paid-in capital. For the nine months ended September 30, 2012, the adjustment to additional paid-in capital relates to (a) the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification and (b) deferred financing costs of $265 thousand that were erroneously expensed rather than capitalized to additional paid-in capital.
(f) Relates to the improper expensing of costs associated with debt conversion.
(g) Relates to a deferred tax asset that was erroneously reported gross of the related liability.
(h) Represents other current liabilities that were improperly classified as interest payable and income taxes payable.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2012, June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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YTD 2012 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(b) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(c) Relates to the improper expensing of accrued interest associated with debt conversions.
(d) Relates to the improper expensing of costs associated with debt conversions.
(e) Represents a previously identified immaterial error.
(f) Income tax effects of adjustments.
(g) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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Quarter 2012 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(b) Represents changes in fair value of the Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(c) Relates to the improper expensing of deferred financing costs associated with the debt conversions.
(d) Income tax effect of adjustments.
(e) Represents a previously identified immaterial error.
(f) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
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CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(dollars in millions, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2012, June 30, 2012 and September 30, 2012 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
2012 Consolidated Statements of Cash Flows Corrections:
(a) Relates to certain costs improperly classified as an investing activity rather than an operating activity.
(b) Relates to the improper classification of Advances to Equity Affiliate as an operating activity rather than an investing activity.
(c) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Relates to the improper expensing of deferred financing costs associated with the debt conversions that should have been recorded to equity.
(e) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(f) Represents a previously identified immaterial error.
(g) Income tax effects of the adjustments.
(h) Relates to the previously identified improper expensing of costs associated with debt conversion.
(i) Relates to the improper expensing of accrued interest associated with the debt conversions that should have been recorded to equity.
In addition to the above, we have restated the Consolidated Statements of Stockholder’s Equity for the nine months ended September 30, 2012 to reflect the reclassification of the Warrants from equity to warrant derivative liability and to restate the January 1, 2011 beginning balances to reflect cumulative adjustments related to the previously described errors as follows:
(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability.
(b) The adjustment to retained earnings relates to (a) lease maintenance costs of $313 thousand that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense, (b) the reduction in the fair value of the Warrants for the year ended December 31, 2010 of $344 thousand, additional amortization of debt of $1,098 thousand resulting from the increased discount allocated to the debt, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(a) The adjustment to additional paid-in capital relates to the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification.
(b) The adjustment to retained earnings relates to (a) net increase in 2010 and 2011 expense related to exploration expense of $2,523 thousand that was erroneously capitalized as oil and gas properties rather than expensed as exploration expense (includes consideration of reclassification between exploration expense and impairment of oil and gas properties), (b) net increase in unrealized gain on warrant derivatives of $10,130 thousand for cumulative 2010 and 2011, (c) net increase in interest expense of $2,921 thousand cumulative for 2010 and 2011, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011, (e) net increase in income tax expense of $237 thousand for income taxes improperly classified as interest expense, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(a) The adjustment to additional paid-in capital relates to (a) the reclassification of the Warrants from equity to warrant derivative liability of $11,122 thousand offset by an error recorded in 2011 for $2,730 thousand for the for the reversal of the original fair value of certain Warrants that did not qualify for equity classification and (b) deferred financing costs of $265 thousand that were erroneously expensed rather than capitalized to additional paid-in capital.
(b) The adjustment to retained earnings relates to (a) net increase in 2010, 2011 and nine months 2012 expense related to exploration expense of $3,823 thousand that was erroneously capitalized as oil and gas properties rather than expensed as exploration expense (includes consideration of reclassification between exploration expense and impairment of oil and gas properties), (b) net increase in unrealized gain on warrant derivatives of $9,170 thousand for cumulative 2010, 2011 and nine months 2012, (c) net increase in interest expense of $2,619 thousand cumulative for 2010, 2011, and nine months 2012, (d) net increase in loss on extinguishment of debt of $3,450 thousand for 2011, (e) increase in net income from equity affiliate of $373 thousand less noncontrolling interest of $75 thousand due to a previously identified immaterial error, (f) net increase in income tax expense of $238 thousand for income taxes improperly classified as interest expense, (g) net decrease in debt conversion expense of $12 thousand for the improper expensing of deferred financing costs associated with the debt conversions that should have been recorded in equity, offset by a reduction to retained earnings of $693 thousand prior to January 1, 2010 for adjustments to leasehold maintenance costs that were improperly capitalized rather than expensed prior to January 1, 2010.
(c) The adjustment to noncontrolling interest relates to the net increase in net income from equity affiliated due to a previously identified immaterial error.
In addition to the above, we have restated Operating Segments to reflect the errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenue erroneously reported gross of related intrasegment expense.
(a) Represents a previously identified immaterial error.
(b) Relates to elimination of intrasegment receivables erroneously reported gross of related intrasegment payable.
(c) Relates to elimination of intrasegment receivables erroneously reported gross of related intrasegment payable and a deferred tax asset that was erroneously reported gross of the related liability.
(a) Represents a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Represents change in the fair value of the Warrants for the reporting period and improper expensing of debt conversion costs and lease maintenance costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
(a) Represents a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(c) Represents change in the fair value of the Warrants for the reporting period and improper expensing of debt conversion costs and lease maintenance costs that were erroneously capitalized as oil and gas properties rather than expensed to exploration expense.
(d) Represents a previously identified classification error between income tax on discontinued operations and income tax on continuing operations.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2011, June 30, 2011 and September 30, 2011 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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YTD 2011 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense. This amount was offset by a reclassification from exploration expense to impairment of oil and gas properties of $3,335 thousand in the six months ended June 30, 2011 and nine months ended September 30, 2011, respectively, for amounts that were erroneously classified as exploration expense.
(b) Represents the reclassification from exploration expense to impairment of oil and gas properties for amounts that were erroneously classified as exploration expense.
(c) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(d) As a result of the change in the fair value of the Warrants, the original discount allocated to the debt was understated; therefore, the additional amortization of the discount on debt, which is a component of interest expense, was understated for each period the debt was outstanding and income tax improperly classified as interest expense.
(e) The correction in the fair value of the Warrants and its classification as a liability resulted in an increase discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(f) Relates to income tax improperly classified as interest expense.
(g) Relates to previously identified immaterial error.
(h) Diluted EPS has been adjusted to reflect an error in the calculation of the weighted average common shares outstanding for dilutive EPS for the six months ended June 30, 2011. The weighted average common shares utilized for the calculation of diluted EPS was erroneously 40,027 thousand rather than 33,992 thousand.
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CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2011, June 30, 2011 and September 30, 2011 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
Quarter 2011 Consolidated Statements of Operations and Comprehensive Income (Loss) Corrections:
(a) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense. For the three months ended June 30, 2011, this amount was offset by a reclassification from exploration expense to impairment of oil and gas properties of $3,335 thousand for amounts that were erroneously classified as exploration expense.
(b) Represents the reclassification from exploration expense to impairment of oil and gas properties for amounts that were erroneously classified as exploration expense.
(c) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(d) As a result of the change in fair value of the Warrants, the original discount allocated to the debt was understated; therefore, the additional amortization of the discount on debt, which is a component of interest expense, was understated for each period the debt was outstanding.
(e) The correction in the fair value of the Warrants and its classification as a liability resulted in an increase discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(f) Income tax effects of the adjustments.
(g) Relates to previously identified immaterial error.
(h) Diluted EPS has been adjusted to reflect an error in the calculation of the weighted average common shares outstanding for dilutive EPS for the three months ended June 30, 2011. The weighted average common shares utilized for the calculation of diluted EPS was erroneously 40,260 thousand rather than 34,039 thousand.
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CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands, except per share data)
“As Previously Reported” reflects balances reported in the March 31, 2011, June 30, 2011 and September 30, 2011 Quarterly Report on Form 10-Q. “As Restated” reflects the final restated balances.
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2011 Consolidated Statements of Cash Flows Corrections:
(a) Represents the reclassification from impairment of long-lived assets to impairment of oil and gas properties for amounts that were erroneously classified as impairment of long-lived assets.
(b) As a result of the change in the fair value of the Warrants, the original discount allocated to the debt was understated; therefore, the additional amortization of the discount on debt was understated for each period the debt was outstanding.
(c) The correction in the fair value of the Warrants and its classification as a liability resulted in an increased discount on debt which also impacted the resulting loss on extinguishment of debt originally recorded in May 2011 when the debt was retired.
(d) Relates to previously identified immaterial error.
(e) Represents changes in fair value of Warrants for the period. Such Warrants were previously classified as equity and were, therefore, not marked to market at the end of each reporting period.
(f) Relates to certain costs improperly classified as an investing activity rather than an operating activity.
(g) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(h) Relates to the improper classification of Advances to Equity Affiliate as an operating activity rather than an investing activity.
(i) Relates to income tax payable improperly classified as interest payable.
(j) Income tax effect of the adjustments and income tax payable improperly classified as interest payable.
In addition to the above, we have restated Operating Segments to reflect the errors stated above and (a) reclassify noncontrolling interest from United States segment to Venezuela segment, (b) eliminate intrasegment receivables erroneously reported gross of related intrasegment payable, and (c) eliminate intrasegment revenues erroneously reported gross of related intrasegment expense.
(a) Relates to a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(c) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Represents (a) change in fair value of the Warrants for the reporting period, (b) understatement of interest expense and debt discount which resulted from the improper classification of the Warrants, (c) lease maintenance costs erroneously capitalized as oil and gas properties rather than expensed to exploration expense, and (d) for the periods ended June 30, 2011 and September 30, 2011, changes in the loss on extinguishment of debt due to the correction in discount on debt related to the improper classification of the Warrants.
(a) Relates to a previously identified immaterial error.
(b) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense and elimination of intrasegment revenue erroneously reported gross of related intrasegment expense.
(c) Relates to lease maintenance costs and exploration overhead costs that were erroneously capitalized as oil and gas properties rather than expensed as exploration expense.
(d) Represents (a) changes in fair value of the Warrants for the reporting period, (b) understatement of interest expense and debt discount which resulted from the improper classification of the Warrants, (c) lease maintenance costs erroneously capitalized as oil and gas properties rather than expensed to exploration expense, and (d) for the periods ended June 30, 2011 and September 30, 2011, changes in the loss on extinguishment of debt due to the correction in discount on debt related to the improper classification of the Warrants.
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Supplemental Information on Oil and Natural Gas Producing Activities (unaudited)
The following tables summarize our proved reserves, drilling and production activity, and financial operating data at the end of each year. Tables I through III provide historical cost information pertaining to costs incurred in exploration, property acquisitions and development; capitalized costs; and results of operations. Tables IV through VI present information on our estimated proved reserve quantities, standardized measure of estimated discounted future net cash flows related to proved reserves, and changes in estimated discounted future net cash flows.
TABLE I - Total costs incurred in oil and natural gas acquisition, exploration and development activities (in thousands):
* See Note 3 - Summary of Significant Accounting Policies - Restatement of Prior Period Financial Statements for additional information.
TABLE II - Capitalized costs related to oil and natural gas producing activities (in thousands):
(a) Drilling activities were completed in September 2011 for Dussafu Ruche Marin-1 (“DRM-1”) exploratory well on the Dussafu PSC. DRM-1 well costs of $39.2 million were suspended pending further exploration and development activities. Exploration activities continued in 2012 with the acquisition of additional seismic and the spud of our second exploration well, DTM-1, on November 19, 2012.
* See Note 3 - Summary of Significant Accounting Policies - Restatement of Prior Period Financial Statements for additional information.
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We regularly evaluate our unproved properties to determine whether impairment has occurred. We have excluded from amortization our interest in unproved properties and the cost of uncompleted exploratory activities. The principal portion of such costs is expected to be included in amortizable costs during the next two to three years.
Unproved property costs at December 31, 2012 relates to two on-going projects. Costs incurred by year are as follows (in thousands):
* See Note 3 - Summary of Significant Accounting Policies - Restatement of Prior Period Financial Statements for additional information.
TABLE III - Results of operations for oil and natural gas producing activities (in thousands):
TABLE IV - Quantities of Oil and Natural Gas Reserves
Estimating oil and gas reserves is a very complex process requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. This data may change substantially over time as a result of numerous factors such as production history, additional development activity and continual reassessment of the viability of production under various economic and political conditions. Consequently, material upward or downward revisions to existing reserve estimates may occur from time to time; although, every reasonable efforts is made to ensure that reported results are the most accurate assessment available. We ensure that the data provided to our external independent experts, and their interpretation of that data, corresponds with our development plans and management’s assessment of each reservoir. The significance of subjective decisions required and variances in available data make estimates generally less precise than other estimates presented in connection with financial statement disclosures.
We measure and disclose our oil and gas reserves in accordance with the provisions of the SEC’s Modernization of Oil and Gas Reporting and ASC 932, “Extractive Activities - Oil and Gas” (“ASC 932”).
The process for preparation of our oil and gas reserves estimates is completed in accordance with our prescribed internal control procedures, which include verification of data provided for, management reviews and review of the independent third party reserves report. The technical employee responsible for overseeing the
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process for preparation of the reserves estimates has a Bachelor of Arts in Engineering Science, a Master of Science in Petroleum Engineering, has more than 25 years of experience in reservoir engineering and is a member of the Society of Petroleum Engineers.
All reserve information in this report is based on estimates prepared by Ryder Scott Company L.P. (“Ryder Scott”), independent petroleum engineers. The technical personnel responsible for preparing the reserve estimates at Ryder Scott meet the requirements regarding qualifications, independence, objectivity and confidentiality set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers. Ryder Scott is an independent firm of petroleum engineers, geologists, geophysicists and petrophysicists; they do not own an interest in our properties and are not employed on a contingent fee basis.
See the following section Additional Supplemental Information on Oil and Natural Gas Producing Activities (unaudited) for Venezuela Equity Affiliate as of December 31, 2012, 2011 and 2010, TABLE IV - Quantities of Oil and Natural Gas Reserves for Petrodelta’s reserves.
The table shown below represents our interests in the United States. On May 17, 2011, we closed the transaction to sell our Antelope Project. The sale had an effective date of March 1, 2011. We received cash proceeds of approximately $217.8 million which reflected increases to the purchase price for customary adjustments and deductions for transaction related costs. We do not have any continuing involvement with the Antelope Project. The related gain on the sale was reported in discontinued operations in the second quarter of 2011. The Antelope Project has been classified as discontinued operations.
TABLE V - Standardized Measure of Discounted Future Net Cash Flows Related to Proved Oil and Natural Gas Reserve Quantities
The standardized measure of discounted future net cash flows is presented in accordance with the provisions of the accounting standard on disclosures about oil and gas producing activities. In preparing this data, assumptions and estimates have been used, and we caution against viewing this information as a forecast of future economic conditions.
Future cash inflows are estimated by applying the average price during the 12-month period, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, adjusted for fixed and determinable escalations provided by the contract, to the estimated future production of year-end proved reserves. Future cash inflows are reduced by estimated future production and development costs to
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determine pre-tax cash inflows. Future income taxes are estimated by applying the year-end statutory tax rates to the future pre-tax cash inflows, less the tax basis of the properties involved, and adjusted for permanent differences and tax credits and allowances. The resultant future net cash inflows are discounted using a ten percent discount rate.
The table shown below represents our net interest at December 31, 2011 and 2010.
TABLE VI - Changes in the Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves:
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Additional Supplemental Information on Oil and Natural Gas Producing Activities (unaudited) for Petrodelta S.A.
The following tables summarize the proved reserves, drilling and production activity, and financial operating data at the end of each year for our net 32 percent interest in Petrodelta. Tables I through III provide historical cost information pertaining to costs incurred in exploration, property acquisitions and development; capitalized costs; and results of operations. Tables IV through VI present information on our estimated proved reserve quantities, standardized measure of estimated discounted future net cash flows related to proved reserves, and changes in estimated discounted future net cash flows.
Petrodelta (32 percent ownership) is accounted for under the equity method, and has been included at its ownership interest in the consolidated financial statements and the following Tables based on a year ending December 31 and, accordingly, results of operations for oil and natural gas producing activities in Venezuela reflect the year ended December 31, 2012, 2011 and 2010.
TABLE I - Total costs incurred in oil and natural gas acquisition, exploration and development activities (in thousands):
TABLE II - Capitalized costs related to oil and natural gas producing activities (in thousands):
TABLE III - Results of operations for oil and natural gas producing activities (in thousands):
(1) Expenses include operating expenses, production taxes and Windfall Profits Tax. Net to our 32 percent interest, Windfall Profits Tax for December 31, 2012 was $93.2 million (2011: $76.0 million, 2010: $4.5 million).
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TABLE IV - Quantities of Oil and Natural Gas Reserves
We measure and disclose our oil and gas reserves in accordance with the provisions of the SEC’s Modernization of Oil and Gas Reporting and ASC 932, “Extractive Activities - Oil and Gas” (“ASC 932”).
Petrodelta is producing from, and continuing to develop, the Petrodelta Fields. Petrodelta has both developed and undeveloped oil and gas reserves identified in all six fields. Petrodelta produces the fields in accordance with a business plan originally defined by its Conversion Contract executed in late 2007. Proved Undeveloped (“PUD”) oil and gas reserves are drilled in accordance with Petrodelta’s business plan, but can be revised where drilling results indicate a change is warranted.
During 2012, Petrodelta drilled and completed 12 production wells. Six of the wells were previously identified Proved Undeveloped (“PUD”) locations and six wells were previously classified Probable, Possible or undefined locations. In 2012, an additional ten PUD locations were identified through drilling activity; however, ten PUD locations which are scheduled to be drilled five years after the wells were originally identified have been reclassified as Probable reserves. At December 31, 2012, Petrodelta had a total of 157 PUD (22.9 MMBOE) locations identified. Since the implementation of its 2007 business plan, Petrodelta has drilled 67 gross production wells (2008 nine wells [1.4 MMBOE], 2009 15 wells [2.0 MMBOE], 2010 16 wells [2.0 MMBOE], 2011 15 wells [2.1 MMBOE], and 2012 12 wells [2.2 MMBOE]) which have moved to the proved developed producing (“PDP”) category. Of these 67 locations drilled since 2008, 33 (5.9 MMBOE) represent the movements of PUD locations to PDP locations. The other 34 new producing wells (3.8 MMBOE) were previously classified Probable, Possible or un-defined.
Petrodelta has a track record of identifying, executing and converting its PUD locations to PDP locations in accordance with the business plan defined by the conversion contract executed in 2007 and subsequent updates. However, the timing and pace of the development is controlled by the majority owner, PDVSA through CVP, although we have substantial negative control provisions as a noncontrolling interest shareholder. In 2010, Petrodelta submitted a revised business plan to PDVSA which substantially increases the total projected drilling activity and production volumes compared to the 2007 business plan, but which is otherwise consistent with the 2007 business plan. The 2010 business plan, as approved by PDVSA, contemplates sustained drilling activities through the year 2024 to fully develop the El Salto and Temblador fields. As a noncontrolling interest shareholder in Petrodelta, HNR Finance has limited ability to control the development plans that are periodically prepared and/or approved by the Venezuelan government. Since this constraint represents a hindrance to development not experienced by typical operations, the PUD locations which are now scheduled to be drilled five years after they were originally identified have been reclassified as Probable reserves.
Proved undeveloped reserves of 22.9 MMBOE from 157 gross PUD locations are all scheduled to be drilled within the period from 2013 to 2016 and within five years from when these locations were first identified.
All above MMBOE represent our net 32 percent interest, net of a 33.33 percent royalty.
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The tables shown below represent HNR Finance’s 40 percent ownership interest and our net 32 percent ownership interest, both net of a 33.33 percent royalty, in Venezuela in each of the years.
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TABLE V - Standardized Measure of Discounted Future Net Cash Flows Related to Proved Oil and Natural Gas Reserve Quantities
The standardized measure of discounted future net cash flows is presented in accordance with the provisions of the accounting standard on disclosures about oil and gas producing activities. In preparing this data, assumptions and estimates have been used, and we caution against viewing this information as a forecast of future economic conditions.
Future cash inflows are estimated by an applying the average price during the 12-month period, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, adjusted for fixed and determinable escalations provided by the contract, to the estimated future production of year-end proved reserves. Our average prices used were $89.77 per barrel for oil for the El Salto field and $100.41 per barrel
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for the other fields, and $1.54 per Mcf for gas. Future cash inflows were reduced by estimated future production and development costs to determine pre-tax cash inflows. Future income taxes were estimated by applying the year-end statutory tax rates to the future pre-tax cash inflows, less the tax basis of the properties involved, and adjusted for permanent differences and tax credits and allowances. The resultant future net cash inflows are discounted using a ten percent discount rate.
The table shown below represents HNR Finance’s net interest in Petrodelta.
(1) Future production costs include operating costs, production taxes and Windfall Profits Tax. For 2012, Windfall Profits Tax equates to $1.5 million, or 74 percent, of the $2.0 million of discounted future production costs.
(2) Future production costs include operating costs, production taxes and Windfall Profits Tax. For 2011, Windfall Profits Tax equates to $1.6 million, or 68 percent, of the $2.4 million of discounted future production costs.
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TABLE VI - Changes in the Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves (in thousands):
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on the 2nd of May 2013, on behalf of the registrant and in the capacities indicated:
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SCHEDULE Valuation and Qualifying Accounts SCHEDULE II
HARVEST NATURAL RESOURCES, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts
(in thousands)
* Amounts charged to other accounts include net operating losses and income tax credits.
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