| ABRAXAS PETROLEUM CORP Item 1A Risk Factors |
| 12 Risks Related to Our Business |
| 12 Risks Related to Our Industry |
| 16 Risks Related to the Common Stock |
| 18 Item 1A Risk Factors Risks Related to Our Business We have a highly leveraged capital structure, which limits our operating and financial flexibility |
| We have a highly leveraged capital structure |
| At March 21, 2006, we had total indebtedness, including our floating rate senior secured notes due 2009, or notes, which we issued in connection with our October 2004 refinancing, of approximately dlra130dtta8 million, all of which is secured indebtedness |
| We also had availability of dlra9dtta2 million under our dlra15dtta0 million senior secured revolving credit facility, all of which is also secured indebtedness |
| Our highly leveraged capital structure will have several important effects on our future operations, including: o a substantial amount of our cash flow from operations will be required to service our indebtedness, which will reduce the funds that would otherwise be available for operations, capital expenditures and expansion opportunities, including developing our properties; o the covenants contained in our revolving credit facility require us to meet certain financial tests and comply with certain other restrictions, including limitations on capital expenditures |
| These restrictions, together with those in the indenture governing the notes, may limit our ability to undertake certain activities and respond to changes in our business and our industry; o our debt level may impair our ability to obtain additional capital, through equity offerings or debt financings, for working capital, capital expenditures, or refinancing of indebtedness; o our debt level makes us more vulnerable to economic downturns and adverse developments in our industry (especially declines in natural gas and crude oil prices) and the economy in general; and o the notes and our revolving credit facility are subject to variable interest rates which makes us vulnerable to interest rate increases |
| We may not be able to fund the substantial capital expenditures that will be required for us to increase our reserves and our production |
| We are required to make substantial capital expenditures to develop our existing reserves and to discover new reserves |
| Historically, we have financed our capital expenditures primarily with cash flow from operations, borrowings under credit facilities, sales of producing properties, and sales of equity securities and we expect to continue to do so in the future; however, we cannot assure you that we will have sufficient capital resources in the future to finance our capital expenditures |
| 12 Volatility in natural gas and crude oil prices, the timing of our drilling program and our drilling results will affect our cash flow from operations |
| Lower prices and/or lower production will also decrease revenues and cash flow, thus reducing the amount of financial resources available to meet our capital requirements, including reducing the amount available to pursue our drilling opportunities |
| If our cash flow from operations does not increase as a result of our planned capital expenditures, a greater percentage of our cash flow from operations will be required for debt service and our planned capital expenditures would, by necessity, be decreased |
| The borrowing base under our revolving credit facility will be determined from time to time by our lenders, consistent with their customary natural gas and crude oil lending practices |
| Reductions in estimates of our natural gas and crude oil reserves could result in a reduction in our borrowing base, which would reduce the amount of financial resources available under our revolving credit facility to meet our capital requirements |
| Such a reduction could be the result of lower commodity prices or production, inability to drill or unfavorable drilling results, changes in natural gas and crude oil reserve engineering, the lenders &apos inability to agree to an adequate borrowing base or adverse changes in the lenders &apos practices regarding estimation of reserves |
| If cash flow from operations or our borrowing base decrease for any reason, our ability to undertake exploitation and development activities could be adversely affected |
| In addition, if the borrowing base under our revolving credit facility is reduced, we would be required to reduce our borrowings under our revolving credit facility so that such borrowings do not exceed the borrowing base |
| This could further reduce the cash available to us for capital spending and, if we did not have sufficient capital to reduce our borrowing level, could cause us to default under our revolving credit facility and the notes |
| We have sold producing properties to provide us with liquidity and capital resources in the past and may do so in the future |
| If we cannot replace the production lost from properties sold with production from new properties, our cash flow from operations will likely decrease which, in turn, would decrease the amount of cash available for debt service and additional capital spending |
| We may be unable to acquire or develop additional reserves, in which case our results of operations and financial condition would be adversely affected |
| Our future natural gas and crude oil production, and therefore our success, is highly dependent upon our ability to find, acquire and develop additional reserves that are profitable to produce |
| The rate of production from our natural gas and crude oil properties and our proved reserves will decline as our reserves are produced unless we acquire additional properties containing proved reserves, conduct successful development and exploitation activities or, through engineering studies, identify additional behind-pipe zones or secondary recovery reserves |
| We cannot assure you that our exploration, exploitation and development activities will result in increases in our proved reserves |
| As our proved reserves, and consequently our production decline, our cash flow from operations and the amount that we are able to borrow under our revolving credit facility will also decline |
| In addition, approximately 52prca of our total estimated proved reserves at December 31, 2005 were undeveloped |
| By their nature, estimates of undeveloped reserves are less certain |
| Recovery of such reserves will require significant capital expenditures and successful drilling operations |
| Our production is currently concentrated in one well Approximately 30prca of our current production is from a single well in west Texas |
| If production from this well decreases, it would have a material impact on our revenues, cash flow from operations and financial condition |
| This well is subject to all of the risks typically associated with natural gas wells, including the risks described in "e Risks Related to Our Industry - Our operations are subject to the numerous risks of natural gas and crude oil drilling and production activities "e |
| We may not find any commercially productive natural gas or crude oil reservoirs |
| We cannot assure you that the new wells we drill will be productive or that we will recover all or any portion of our capital investment |
| Dry holes and wells that are 13 productive but do not produce sufficient net revenues after drilling, operating and other costs are unprofitable |
| The inherent risk of not finding commercially productive reservoirs will be compounded by the fact that 52prca of our total estimated proved reserves at December 31, 2005 were undeveloped |
| In addition, our properties may be susceptible to drainage from production by other operations on adjacent properties |
| If the volume of natural gas and crude oil we produce decreases, our cash flow from operations will decrease |
| Restrictive debt covenants could limit our growth and our ability to finance our operations, fund our capital needs, respond to changing conditions and engage in other business activities that may be in our best interest |
| Our revolving credit facility and the indenture governing the notes contain a number of significant covenants that, among other things, limit our ability to: o incur or guarantee additional indebtedness and issue certain types of preferred stock or redeemable stock; o transfer or sell assets; o create liens on assets; o pay dividends or make other distributions on capital stock or make other restricted payments, including repurchasing, redeeming or retiring capital stock or subordinated debt or making certain investments or acquisitions; o engage in transactions with affiliates; o guarantee other indebtedness; o make any change in the principal nature of our business; o prepay, redeem, purchase or otherwise acquire any of our or our restricted subsidiaries &apos indebtedness; o permit a change of control; o directly or indirectly make or acquire any investment; o cause a restricted subsidiary to issue or sell our capital stock; and o consolidate, merge or transfer all or substantially all of the consolidated assets of Abraxas and our restricted subsidiaries |
| In addition, our revolving credit facility requires us to maintain compliance with specified financial ratios and satisfy certain financial condition tests |
| Our ability to comply with these ratios and financial condition tests may be affected by events beyond our control, and we cannot assure you that we will meet these ratios and financial condition tests |
| These financial ratio restrictions and financial condition tests could limit our ability to obtain future financings, make needed capital expenditures, withstand a future downturn in our business or the economy in general or otherwise conduct necessary or desirable corporate activities |
| A breach of any of these covenants or our inability to comply with the required financial ratios or financial condition tests could result in a default under our revolving credit facility and the notes |
| A default, if not cured or waived, could result in all of our indebtedness, including the notes, becoming immediately due and payable |
| Even if new financing were then available, it may not be on terms that are acceptable to us |
| The marketability of our production depends largely upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities |
| The marketability of our production depends in part upon processing and transportation facilities |
| Transportation space on such gathering systems and pipelines is occasionally limited and at times unavailable due to repairs or 14 improvements being made to such facilities or due to such space being utilized by other companies with priority transportation agreements |
| Our access to transportation options can also be affected by US Federal and state regulation of natural gas and crude oil production and transportation, general economic conditions and changes in supply and demand |
| These factors and the availability of markets are beyond our control |
| If market factors dramatically change, the financial impact on us could be substantial and adversely affect our ability to produce and market natural gas and crude oil |
| Hedging transactions have in the past and may in the future impact our cash flow from operations |
| We enter into hedging arrangements from time to time to reduce our exposure to fluctuations in natural gas and crude oil prices and to achieve more predictable cash flow |
| In 2003 and 2005, we incurred hedging costs of dlra842cmam000 and dlra592cmam000, respectively, resulting from the price floors we established |
| For the year ended December 31, 2004, we recognized a gain from hedging activities of approximately dlra118cmam000 |
| Currently, we believe our hedging arrangements, which are in the form of price floors, do not expose us to significant financial risk |
| We cannot assure you that the hedging transactions we have entered into, or will enter into, will adequately protect us from financial loss due to circumstances such as: o highly volatile natural gas and crude oil prices; o our production being less than expected; or o a counterparty to one of our hedging transactions defaulting on our contractual obligations |
| We have experienced significant operating losses in the past |
| We recorded net losses from continuing operations for 2003 of dlra12dtta8 million |
| We recorded net income from continuing operations for 2004 and 2005 of dlra3dtta0 million and dlra6dtta3 million, respectively |
| Net income from continuing operations in 2004 included dlra12dtta6 million of gain on debt extinguishment relating to our October 2004 refinancing and a deferred tax benefit of dlra6dtta1 million |
| Lower natural gas and crude oil prices increase the risk of ceiling limitation write-downs |
| We use the full cost method to account for our natural gas and crude oil operations |
| Accordingly, we capitalize the cost to acquire, explore for and develop natural gas and crude oil properties |
| Under full cost accounting rules, the net capitalized cost of natural gas and crude oil properties may not exceed a "e ceiling limit "e which is based upon the present value of estimated future net cash flows from proved reserves, discounted at 10prca |
| If net capitalized costs of natural gas and crude oil properties exceed the ceiling limit, we must charge the amount of the excess to earnings |
| This is called a "e ceiling limitation write-down "e |
| This charge does not impact cash flow from operating activities, but does reduce our stockholders &apos equity and earnings |
| The risk that we will be required to write-down the carrying value of natural gas and crude oil properties increases when natural gas and crude oil prices are low |
| In addition, write-downs may occur if we experience substantial downward adjustments to our estimated proved reserves |
| An expense recorded in one period may not be reversed in a subsequent period even though higher natural gas and crude oil prices may have increased the ceiling applicable to the subsequent period |
| We have incurred ceiling limitation write-downs in the past |
| We cannot assure you that we will not experience additional ceiling limitation write-downs in the future |
| Use of our net operating loss carryforwards may be limited |
| At December 31, 2005, we had, subject to the limitation discussed below, dlra190dtta0 million of net operating loss carryforwards for US tax purposes |
| These loss carryforwards will expire through 2025 if not utilized |
| In addition, as to a portion of the US net operating loss carryforwards, the amount of such carryforwards that we can use annually is limited under US tax law |
| Moreover, uncertainties exist as to the future utilization of the operating loss carryforwards under the criteria set forth under FASB Statement Nodtta 109 |
| 15 Therefore, we have established a valuation allowance of dlra73dtta0 million and dlra67dtta0 million for deferred tax assets at December 31, 2004 and 2005, respectively |
| We depend on our Chairman, President and CEO and the loss of his services could have an adverse effect on our operations |
| We depend to a large extent on Robert L G Watson, our Chairman of the Board, President and Chief Executive Officer, for our management and business and financial contacts |
| Watson may terminate his employment agreement with us at any time on 30 days notice, but, if he terminates without cause, he would not be entitled to the severance benefits provided under the terms of that agreement |
| Watson is not precluded from working for, with or on behalf of a competitor upon termination of his employment with us |
| Watson were no longer able or willing to act as our Chairman, the loss of his services could have an adverse effect on our operations |
| In addition, in connection with the initial public offering by our previously wholly-owned subsidiary, Grey Wolf Exploration Inc, we, Grey Wolf and Mr |
| Watson devoting two-thirds of his time to his positions and duties with us and one-third of his time to his position and duties with Grey Wolf |
| In consideration for receiving Mr |
| Watsonapstas services, Grey Wolf makes an annual payment to Abraxas of USdlra100cmam000 and reimburses Abraxas for Mr |
| Watsonapstas expenses incurred in connection with providing such services |
| Risks Related to Our Industry Market conditions for natural gas and crude oil, and particularly volatility of prices for natural gas and crude oil, could adversely affect our revenue, cash flows, profitability and growth |
| Our revenue, cash flows, profitability and future rate of growth depend substantially upon prevailing prices for natural gas and crude oil |
| Natural gas prices affect us more than crude oil prices because most of our production and reserves are natural gas |
| Prices also affect the amount of cash flow available for capital expenditures and our ability to borrow money or raise additional capital |
| Lower prices may also make it uneconomical for us to increase or even continue current production levels of natural gas and crude oil |
| Prices for natural gas and crude oil are subject to large fluctuations in response to relatively minor changes in the supply and demand for natural gas and crude oil, market uncertainty and a variety of other factors beyond our control, including: o changes in foreign and domestic supply and demand for natural gas and crude oil; o political stability and economic conditions in oil producing countries, particularly in the Middle East; o general economic conditions; o domestic and foreign governmental regulation; and o the price and availability of alternative fuel sources |
| In addition to decreasing our revenue and cash flow from operations, low or declining natural gas and crude oil prices could have additional material adverse effects on us, such as: o reducing the overall volume of natural gas and crude oil that we can produce economically, thereby adversely affecting our revenue, profitability and cash flow and our ability to perform our obligations with respect to the notes; o reducing our borrowing base under the credit facility; and o impairing our borrowing capacity and our ability to obtain equity capital |
| 16 Estimates of our proved reserves and future net revenue are uncertain and inherently imprecise |
| The process of estimating natural gas and crude oil reserves is complex involving decisions and assumptions in evaluating the available geological, geophysical, engineering and economic data |
| Accordingly, these estimates are imprecise |
| Actual future production, natural gas and crude oil prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable natural gas and crude oil reserves most likely will vary from those estimated |
| Any significant variance could materially affect the estimated quantities and present value of reserves set forth in this report |
| In addition, we may adjust estimates of proved reserves to reflect production history, results of exploitation and development, prevailing natural gas and crude oil prices and other factors, many of which are beyond our control |
| The estimates of our reserves are based upon various assumptions about future production levels, prices and costs that may not prove to be correct over time |
| In particular, estimates of natural gas and crude oil reserves, future net revenue from proved reserves and the PV-10 thereof for our natural gas and crude oil properties are based on the assumption that future natural gas and crude oil prices remain the same as natural gas and crude oil prices at December 31, 2005 |
| The sales prices as of such date used for purposes of such estimates were dlra8dtta84 per Mcf of natural gas and dlra56dtta92 per Bbl of crude oil |
| This compares with dlra4dtta94 per Mcf of natural gas and dlra41dtta01 per Bbl of crude oil as of December 31, 2004 |
| These estimates also assume that we will make future capital expenditures of approximately dlra84dtta2 million in the aggregate through 2024, with the majority expected to be incurred from 2006 to 2009, which are necessary to develop and realize the value of proved undeveloped reserves on our properties |
| Any significant variance in actual results from these assumptions could also materially affect the estimated quantity and value of reserves set forth in this report |
| The present value of future net revenues we disclose may not be the current market value of our estimated natural gas and crude oil reserves |
| In accordance with SEC requirements, the estimated discounted future net cash flows from proved reserves are generally based on prices and costs as of the end of the period of the estimate |
| Actual future prices and costs may be materially higher or lower than the prices and costs as of the end of the year of the estimate |
| Any changes in consumption by natural gas purchasers or in governmental regulations or taxation will also affect actual future net cash flows |
| The timing of both the production and the expenses from the development and production of natural gas and crude oil properties will affect the timing of actual future net cash flows from proved reserves and their present value |
| In addition, the 10prca discount factor, which is required by the SEC to be used in calculating discounted future net cash flows for reporting purposes, is not necessarily the most accurate discount factor |
| The effective interest rate at various times and the risks associated with us or the natural gas and crude oil industry in general will affect the accuracy of the 10prca discount factor |
| Our operations are subject to the numerous risks of natural gas and crude oil drilling and production activities |
| Our natural gas and crude oil drilling and production activities are subject to numerous risks, many of which are beyond our control |
| These risks include the risk of fire, explosions, blow-outs, pipe failure, abnormally pressured formations and environmental hazards |
| Environmental hazards include oil spills, natural gas leaks, ruptures and discharges of toxic gases |
| In addition, title problems, weather conditions and mechanical difficulties or shortages or delays in delivery of drilling rigs and other equipment could negatively affect our operations |
| Substantial losses also may result from injury or loss of life, severe damage to or destruction of property, clean-up responsibilities, regulatory investigation and penalties and suspension of operations |
| In accordance with industry practice, we maintain insurance against some, but not all, of the risks described above |
| We cannot assure you that our insurance will be adequate to cover losses or liabilities |
| Also, we cannot predict the continued availability of insurance at premium levels that justify its purchase |
| We operate in a highly competitive industry which may adversely affect our operations |
| We operate in a highly competitive environment |
| The principal resources necessary for the exploration and production of natural gas and crude oil are leasehold prospects under which natural gas and crude oil reserves may be discovered, drilling rigs and related equipment to explore for such reserves and knowledgeable personnel to conduct all phases of natural gas and crude oil operations |
| We must compete for such resources with both major natural gas and 17 crude oil companies and independent operators |
| Many of these competitors have financial and other resources substantially greater than ours |
| Although we believe our current operating and financial resources are adequate to preclude any significant disruption of our operations in the immediate future, we cannot assure you that such materials and resources will be available to us |
| The unavailability or high cost of drilling rigs, equipment, supplies, insurance, personnel and crude oil field services could adversely affect our ability to execute our exploration and development plans on a timely basis and within our budget |
| Our industry is cyclical and, from time to time, there is a shortage of drilling rigs, equipment, supplies, insurance or qualified personnel |
| During these periods, the costs and delivery times of rigs, equipment and supplies are substantially greater |
| In addition, the demand for, and wage rates of, qualified drilling rig crews rise as the number of active rigs in service increases |
| As a result of increasing levels of exploration and production in response to strong prices of natural gas and crude oil, the demand for oilfield services has risen and the costs of these services are increasing |
| Our natural gas and crude oil operations are subject to various Federal, state and local regulations that materially affect our operations |
| Matters regulated include permits for drilling operations, drilling and abandonment bonds, reports concerning operations, the spacing of wells and unitization and pooling of properties and taxation |
| At various times, regulatory agencies have imposed price controls and limitations on production |
| In order to conserve supplies of natural gas and crude oil, these agencies have restricted the rates of flow of natural gas and crude oil wells below actual production capacity |
| Federal, state and local laws regulate production, handling, storage, transportation and disposal of natural gas and crude oil, by-products from natural gas and crude oil and other substances and materials produced or used in connection with natural gas and crude oil operations |
| To date, our expenditures related to complying with these laws and for remediation of existing environmental contamination have not been significant |
| We believe that we are in substantial compliance with all applicable laws and regulations |
| However, the requirements of such laws and regulations are frequently changed |
| We cannot predict the ultimate cost of compliance with these requirements or their effect on our operations |
| Risks Related to the Common Stock We do not pay dividends on common stock |
| We have never paid a cash dividend on our common stock and the terms of the revolving credit facility and the indenture relating to the notes limit our ability to pay dividends on our common stock |
| Shares eligible for future sale may depress our stock price |
| At March 21, 2006, we had 42cmam588cmam327 shares of common stock outstanding of which 3cmam991cmam679 shares were held by affiliates and, in addition, 2cmam588cmam963 shares of common stock were subject to outstanding options granted under certain stock option plans (of which 1cmam699cmam838 shares were vested at March 21, 2006) |
| All of the shares of common stock held by affiliates are restricted or control securities under Rule 144 promulgated under the Securities Act of 1933, as amended (the "e Securities Act "e ) |
| The shares of the common stock issuable upon exercise of the stock options have been registered under the Securities Act |
| Sales of shares of common stock under Rule 144 or another exemption under the Securities Act or pursuant to a registration statement could have a material adverse effect on the price of the common stock and could impair our ability to raise additional capital through the sale of equity securities |
| 18 The price of our common stock has been volatile and could continue to fluctuate substantially |
| Our common stock is traded on The American Stock Exchange |
| The market price of our common stock has been volatile and could fluctuate substantially based on a variety of factors, including the following: o fluctuations in commodity prices; o variations in results of operations; o legislative or regulatory changes; o general trends in the industry; o market conditions; and o analysts &apos estimates and other events in the natural gas and crude oil industry |
| Subject to the rules of The American Stock Exchange, our articles of incorporation authorize our board of directors to issue one or more series of preferred stock and set the terms of the preferred stock without seeking any further approval from holders of our common stock |
| Any preferred stock that is issued may rank ahead of our common stock in terms of dividends, priority and liquidation premiums and may have greater voting rights than our common stock |
| Anti-takeover provisions could make a third party acquisition of Abraxas difficult |
| Our articles of incorporation and bylaws provide for a classified board of directors, with each member serving a three-year term, and eliminate the ability of stockholders to call special meetings or take action by written consent |
| Each of the provisions in the articles of incorporation and bylaws could make it more difficult for a third party to acquire Abraxas without the approval of our board |
| In addition, the Nevada corporate statute also contains certain provisions that could make an acquisition by a third party more difficult |
| An active market may not develop for our common stock |
| Our common stock is quoted on The American Stock Exchange |
| While there is currently one specialist in our common stock, this specialist is not obligated to continue to make a market in our common stock |
| In this event, the liquidity of our common stock could be adversely impacted and a stockholder could have difficulty obtaining accurate stock quotes |
| Future issuance of additional shares of our common stock could cause dilution of ownership interests and adversely affect our stock price |
| We may in the future issue our previously authorized and unissued securities, resulting in the dilution of the ownership interests of our current stockholders |
| We are currently authorized to issue 200cmam000cmam000 shares of common stock with such rights as determined by our board of directors |
| The potential issuance of such additional shares of common stock may create downward pressure on the trading price of our common stock |
| We may also issue additional shares of our common stock or other securities that are convertible into or exercisable for common stock for capital raising or other business purposes |
| Future sales of substantial amounts of common stock, or the perception that sales could occur, could have a material adverse effect on the price of our common stock |