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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------------------
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
COMMISSION FILE NUMBER 0-28814
COTTON VALLEY RESOURCES CORPORATION
(Name of Small Business Issuer as Specified in Its Charter)
Yukon, Canada 98-0164357
(State or other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
6510 Abrams Road, Suite 300, Dallas, TX 75231
(Address of Principal Executive Offices) (Zip Code)
(214) 221-6500
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12 (b) of the Exchange Act: None
Securities registered under Section 12 (g) of the Exchange Act:
Common Stock, without par value
(Title of Class)
Check whether the Issuer (1) has filed all reports required to
be filed by Section 13 or 15 (d) of the Exchange Act during the past
12 months (or for such shorter period that the Issuer was required to
file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Check if there is no disclosure of delinquent filers in response
to Item 405 of Regulation S-B contained in this form, and no
disclosure will be contained, to the best of the Issuer's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-KSB or any amendment to this
Form 10-KSB. [X]
The Issuer's revenues for the fiscal year ended June 30, 1998,
were $1,825,852.
The Issuer had 17,273,278 shares of common stock outstanding as
of September 15, 1998.
The aggregate market value of the voting and non-voting common
stock held by non-affiliates of the Issuer, computed by reference to
the average bid and asked prices of such common stock as of September
15, 1998, was $6,333,672.
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1998 ANNUAL REPORT (S.E.C. FORM 10-KSB)
INDEX
Securities and Exchange Commission
Item Number and Description
PART I
Item 1 Business 3
Item 2 Properties 11
Item 3 Legal Proceedings 15
Item 4 Submission of Matters to a Vote of Security Holders 17
PART II
Item 5 Market for the Company's Common Stock and Related
Stockholder Matters 17
Item 6 Management's Discussion and Analysis or Plan of Operation 18
Item 7 Consolidated Financial Statements and Unaudited
Supplemental Information 22
Item 8 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 45
PART III
Item 9 Directors, Executive Officers, Promoters and Control
Persons of the Issuer; Compliance With
Section 16(a) of the Exchange Act 45
Item 10 Executive Compensation 47
Item 11 Security Ownership of Certain Beneficial Owners and
Management 48
Item 12 Certain Relationships and Related Transactions 49
PART IV AND SIGNATURES AND EXHIBIT INDEX
Item 13 Exhibits, Financial Statements and Reports on Form 8-KSB 51
Signatures 51
Exhibit Index 52
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________________________________________________________________________
PART I
________________________________________________________________________
ITEM 1. BUSINESS
General
Cotton Valley Resources Corporation (referred to herein as
either "Cotton Valley" or the "Company") is a development stage
independent energy company engaged in the exploration and
development, acquisition and operation of oil and gas properties with
a geographic focus in major oil and gas producing regions in the
United States. The Company was incorporated in the Province of
Ontario, Canada, originally as Cotton Valley Energy Limited, on
February 15, 1995. From its inception through June 30, 1997, the
Company was engaged principally in organization and capitalization
activities and did not generate material revenues from operations.
For the year ended June 30, 1998, the Company concentrated on
acquiring additional properties and integrated engineering and
development.
On June 30, 1995 in a one-for-one share and warrant exchange,
the Company acquired all the issued and outstanding shares of Cotton
Valley Energy Corporation ("CV Energy"), a Nevada corporation. On
June 14, 1996, the Company completed an amalgamation with Arjon
Enterprises, Inc. ("Arjon"), a Province of Ontario, Canada
corporation. As a result of the Arjon amalgamation, the Company's
name was changed to Cotton Valley Resources Corporation and its
shares of Common Stock began trading through the Canadian Dealing
Network. Arjon was a public Canadian company formed more than 50
years ago to operate a gold mine. At the time of the amalgamation,
Arjon had not engaged in business for more than 25 years, it had no
material liabilities, and its only asset was a Cotton Valley Energy
Limited debenture in the amount of $146,300. The shareholders of
Arjon received 686,551 shares of Common Stock in the amalgamation.
On April 30, 1996, the Company organized Cotton Valley Operating
Company, a Texas corporation ("CV Operating") to operate the
Company's oil and gas properties. The Company on February 25, 1997,
organized Cotton Valley Energy, Inc., an Oklahoma corporation
("CVEI") to acquire and operate the N.E. Alden Field properties in
Caddo County, Oklahoma. CVEI commenced operations on March 3, 1997.
Aspen Energy Corporation, a Nevada corporation ("Aspen"), was an
inactive subsidiary of the Company, formed on May 1, 1996, which was
used to accommodate the merger of Aspen Energy Corporation, a New
Mexico corporation ("Old Aspen") into Aspen on July 31, 1997. The
principal asset of Old Aspen was its interest in the Means Unit
in Andrews County, Texas (the "Means Unit"). On May 27, 1998, Aspen
organized Cotton Valley Means, Inc. as a Texas corporation ("CV
Means") and transferred all of its interest in the Means Unit to CV
Means to facilitate a $10 million financing relating to the
development of this property. See "Business -- Recent Developments;
Means Unit Credit Facility."
In addition to CV Energy, CV Operating, CVEI, Aspen and CV
Means, the Company recently organized Mustang Well Servicing Company,
a Nevada corporation ("Mustang Well Servicing"), Mustang Oilfield
Equipment Company, a Nevada corporation ("Mustang Equipment"), and
Mustang Horizontal Services, Inc., a Nevada corporation ("Mustang
Horizontal") (collectively, the "Mustang Service Companies"). All of
the Company's subsidiaries are wholly owned by the Company, except
for CV Means which is a wholly-owned subsidiary of Aspen. See
"Certain Relationships and Related Transactions."
Business Strategy
The Company's current business strategy is to: (i) complete its
registration requirements of its outstanding convertible debentures;
(ii) continue to increase reserves, production and cash flows by
acquiring properties, or companies with properties, with development
opportunities; (iii) develop existing reserves through low risk
developmental drilling or recompletion programs; (iv) concentrate on
development activities within a limited number of core areas; (v)
acquire and refurbish used oil field equipment for use in development
activities and for resale; and (vi) provide well servicing for the
Company's and other wells. Although the Company continuously is
seeking acquisitions of reserves and oil field equipment, there can
be no assurance that the Company will be able to identify and acquire
reserves or oil field equipment upon terms favorable to the Company
or obtain the necessary financing on favorable terms.
The following are key elements of the Company's strategy:
o Exploitation and Development of Existing Properties. The
Company has a significant inventory of exploitation projects,
including development drilling, workovers and recompletions.
The Company intends to maximize the value of its properties
through development activities including in-fill drilling,
waterflooding and other enhanced recovery techniques.
o Management of Operating Costs. The Company emphasizes strict
cost controls in all aspects of its business and intends to
seek the lowest cost of operations by either operating its own
properties or having the properties operated by others under
contract.
o Property Acquisitions. Although the Company has a significant
inventory of exploitation and development opportunities, it
continues to pursue strategic acquisitions which fit its
objectives of increasing oil and gas reserves with development
potential.
Risk Factors
Holders of the Common Stock and future investors in the Company
should be aware of the following factors in evaluating their
investment in Cotton Valley.
Limited Operating History; Capital Intensive Business; Need for
Additional Funds. From its inception in February 1995 through June
30, 1997, the Company was engaged principally in organization and
capitalization activities and did not generate material revenues from
operations. The Company's business is highly capital intensive
requiring continuous development and acquisition of oil and gas
reserves. In addition, capital is required to operate and expand the
Company's oil field operations and purchase equipment. At June 30,
1998, the Company had a working capital of approximately $20,823.
Because of the limited operating history of the Company and the recent
acquisitions of reserves and oil field equipment, the Company's working
capital requirements increased significantly over the last 12 months and
are expected to continue to do so. The Company anticipates, based on
its currently proposed plans and assumptions relating to its operations,
including proceeds from the exercise of outstanding warrants, and
proceeds from the private offerings of debt and equity securities,
together with cash expected to be generated from operations, that it
will be able to meet its cash requirements for at least the next 12
months. However, if such plans or assumptions change or prove to be
inaccurate, the Company could be required to seek additional financing
sooner than currently anticipated. Although the Company is currently
negotiating with private investors and lenders with respect to
additional financing, the Company has no commitments to obtain any
additional debt or equity financing and there can be no assurance that
additional funds will be available, when required, on terms favorable to
the Company. Any future issuances of equity securities would likely
result in dilution to the Company's then existing shareholders while the
incurring of additional indebtedness would result in increased interest
expense and debt service changes. See "Management's Discussion and
Analysis or Plan of Operations".
History of Losses. The Company incurred losses before income tax
benefits of $2,925,868 and $1,276,745 for the fiscal years ended June
30, 1997 and 1998, respectively. The Company's accumulated deficit as
of June 30, 1998 was $3,599,755. The Company does not have a bank line
of credit. The Company has funded its operating losses, acquisitions
and expansion costs primarily through a combination of private offerings
of debt and equity securities, including the issuance of the Convertible
Debentures and proceeds from the exercise of options and warrants.
The success of the Company in obtaining the necessary capital resources
to fund future costs associated with its operations and expansion plans
is dependent upon the Company's ability to: (i) satisfy its registration
obligations to its holders of Convertible Debentures; (ii) increase
revenues through acquisitions and recovery of the Company's proved
producing and proved developed non-producing oil and gas reserves;
(iii) implement stringent cost controls at the corporate administrative
office and in field operations; (iv) convert the Convertible Debentures
to equity; (v) obtain the exercise of outstanding warrants; and (vi)
obtain asset based commercial financing. However, even if the Company
achieves some success with its plans, there can be no assurance that it
will be able to generate sufficient revenues to achieve significant
profitable operations or fund its expansion and acquisition plans. See
"Management's Discussion and Analysis or Plan of Operations".
Possible Contingent Liability for Violation of Securities Act. On
February 9, 1998, the Company effected a Continuance of its domicile
from the Province of Ontario to Yukon Territory (the "Yukon
Continuance") in accordance with applicable Canadian law. The Yukon
Continuance was approved by the shareholders of the Company at a meeting
held on December 10, 1996, for which proxies were solicited in
accordance with applicable Canadian laws, but the transaction was not
registered under the Securities Act. The Staff of the U.S. Securities
and Exchange Commission (the "Commission") has advised the Company that
the registration of the Yukon Continuance was required pursuant to Rule
145 and that the failure to register the Yukon Continuance was a
violation of Section 5 of the Securities Act. As a result, the Company
may have a contingent liability to certain of its shareholders, who may
sue the Company to recover the consideration paid, if any, for shares of
the Company's Common Stock, with interest thereon from the date of the
Yukon Continuance to the date of repayment by the Company, less the
amount of any income received thereon, upon the tender of such
securities, or for damages if the shareholder no longer owns such
securities. The Company intends to vigorously defend any such
shareholder lawsuit and believes that it may have valid
defenses, including the running of applicable statutes of limitations,
against claims by some or all of its shareholders. However, to the
extent any of the Company's shareholders obtain a judgment against the
Company for damages, the Company's net assets and net worth will be
reduced, which in turn could reduce the Company's ability to obtain
financing for its exploration and drilling operations and cause the
Company to curtail operations. There is no assurance that the Company
will have the necessary funds or sufficient assets to pay any such
judgment obtained by any shareholder against the Company. The Company
is unable to quantify the amount of such contingent liability, if any.
See Legal Proceedings -"Yukon Continuance."
Consequences of Default under Convertible Debentures. The Company
has $4,320,000 of outstanding Convertible Debentures, representing
approximately 16.2% of the Company's capitalization at June 30, 1998.
The Convertible Debentures are secured with approximately 29.2% of the
Company's assets and are subject to various operating and financial
covenants. The Company's ability to meet its debt service
obligations will depend on the Company's future operations, which are
subject to prevailing industry conditions and other factors, many of
which are beyond the Company's control. In the event of a violation by
the Company of any of its loan covenants or any other default by the
Company on its obligations relating to its indebtedness, the lenders
could declare such indebtedness to be immediately due and payable and,
in certain cases, foreclose on some of the Company's assets. Moreover,
to the extent that 29.2% of the Company's assets continue to be pledged
to secure outstanding indebtedness under the Convertible Debentures,
such assets will not be available to secure additional indebtedness,
which may adversely affect the Company's ability to borrow in the
future. See "Business--Recent Developments; Sale of Convertible
Debentures."
Significant Capital Expenditures Necessary for Undeveloped
Properties. Almost all of the Company's oil and gas reserves are
classified as Proved Undeveloped Reserves, meaning very little
production currently exists. Recovery of the Company's Proved
Undeveloped Reserves will require significant capital expenditures.
Management estimates that aggregate capital expenditures of
approximately $20 million will be required to fully develop these
reserves, of which $10 million is expected to be incurred during the
next twelve months from its recently negotiated $10 million development
credit facility. No assurance can be given that the Company's estimates
of capital expenditures will prove accurate, that its financing sources
will be sufficient to fully fund its planned development activities or
that development activities will be either successful or in accordance
with the Company's schedule. Additionally, any significant decrease in
oil and gas prices or any significant increase in the cost of
development could result in a significant reduction in the
number of wells drilled and/or reworked. No assurance can be given
that any wells will produce oil or gas in commercially profitable
quantities.
No Assurance of Additional Financing. Development of the Company's
properties will require additional capital resources. Although the
Company is presently negotiating with private lenders and investors with
respect to sources of additional financing to supplement its existing
$10 million credit facility, the Company has no commitments to obtain
any additional debt or equity financing and there can be no assurance
that additional financing will be available, when required, on favorable
terms to the Company. The inability to obtain additional financing
would have a material adverse effect on the Company, including requiring
the Company to curtail significantly its oil and gas acquisition and
development plans or farm-out development of its properties. Any
additional financing may involve substantial dilution to the interests
of the Company's shareholders at that time. See "Management's
Discussion and Analysis or Plan of Operations" and "Business--Recent
Developments; Means Unit Credit Facility."
Exploration and Development Risks; Waterflood Projects. The
Company intends to increase its development and, to a lesser extent,
exploration activities. The Company does not intend to engage in any
significant exploration drilling activities during 1998. Exploration
drilling and, to a lesser extent, development drilling of oil and gas
reserves involve a high degree of risk that no commercial production
will be obtained and/or that production will be insufficient to recover
drilling and completion costs. The cost of drilling, completing and
operating wells is often uncertain. The Company's drilling operations
may be curtailed, delayed or canceled as a result of numerous factors,
including title problems, weather conditions, compliance with
governmental requirements and shortages or delays in the delivery of
equipment. Furthermore, completion of a well does not assure a profit
on the investment or a recovery of drilling, completion and operating
costs.
There are certain risks associated with secondary recovery
operations, especially the use of waterflooding techniques, and
drilling activities in general. Part of the Company's inventory of
development prospects consists of waterflood projects. Waterflooding
involves significant capital expenditures and uncertainty as to the
total amount of secondary reserves that can be recovered. In waterflood
operations, there is generally a delay between the initiation of water
injection into a formation containing hydrocarbons and any increase in
production that may result. The operating cost per unit of production
of waterflood projects is generally higher during the initial phases of
such projects due to the purchase of injection water and related costs,
as well as during the later stages of the life of the project as
production declines. The degree of success, if any, of any secondary
recovery program depends on a large number of factors, including the
porosity of the formation, the technique used and the location of
injector wells.
Volatility of Oil and Gas Prices. The Company's revenues,
profitability and the carrying value of its oil and gas properties
are substantially dependent upon prevailing prices of, and demand for,
oil and gas and the costs of acquiring, finding, developing and
producing reserves. The Company's ability to maintain or increase its
borrowing capacity, to repay current or future indebtedness, and to
obtain additional capital on favorable terms is also substantially
dependent upon oil and gas prices. Historically, the markets for oil
and gas have been volatile and are likely to continue to be volatile in
the future. Prices for oil and gas are subject to wide fluctuations in
response to: (i) relatively minor changes in the supply of, and demand
for, oil and gas; (ii) market uncertainty; and (iii) a variety of
additional factors, all of which are beyond the Company's control.
These factors include domestic and foreign political conditions, the
price and availability of domestic and imported oil and gas, the level
of consumer and industrial demand, weather, domestic and foreign
government relations, the price and availability of alternative fuels
and overall economic conditions. Furthermore, the marketability of the
Company's production depends in part upon the availability, proximity
and capacity of gathering systems, pipelines and processing facilities.
Volatility in oil and gas prices could affect the Company's ability to
market its production through such systems, pipelines or facilities.
Substantially all of the Company's gas production is currently sold to
gas marketing firms or end users either on the spot market on a month-
to-month basis at prevailing spot market prices or under long-term
contracts based on current spot market prices. The Company normally
sells its oil under month-to-month contracts with a variety of
purchasers. Accordingly, the Company's oil and gas sales expose it to
the commodities risks associated with changes in market prices.
Uncertainty of Estimates of Reserves and Future Net Cash Flows.
This Annual Report contains estimates of the Company's oil and gas
reserves and the future net cash flows from those reserves, which
have been prepared or audited by certain independent petroleum
consultants. There are numerous uncertainties inherent in estimating
quantities of reserves of oil and gas and in projecting future rates of
production and the timing of development expenditures, including many
factors beyond the Company's control. The reserve estimates in this
Annual Report are based on various assumptions, including, for example,
constant oil and gas prices, operating expenses, capital expenditures
and the availability of funds, and, therefore, are inherently imprecise
indications of future net cash flows. Actual future production, cash
flows, taxes, operating expenses, development expenditures and
quantities of recoverable oil and gas reserves may vary substantially
from those assumed in the estimates. Any significant variance in these
assumptions could materially affect the estimated quantity and value of
reserves set forth in this Annual Report. Additionally, the Company's
reserves may be subject to downward or upward revision based upon actual
production performance, results of future development and exploration,
prevailing oil and gas prices and other factors, many of which are
beyond the Company's control.
The present value of future net reserves discounted at 10% (the
"PV-10") of Proved Reserves referred to in this Annual Report should
not be construed as the current market value of the estimated Proved
Reserves of oil and gas attributable to the Company's properties. In
accordance with applicable requirements of the Commission, the estimated
discounted future net cash flows from Proved Reserves are generally
based on prices and costs as of the date of the estimate, whereas actual
future prices and costs may be materially higher or lower. Actual
future net cash flows also will be affected by: (i) the timing of both
production and related expenses; (ii) changes in consumption levels; and
(iii) governmental regulations or taxation. In addition, the
calculation of the present value of the future net cash flows using a
10% discount as required by the Commission is not necessarily the most
appropriate discount factor based on interest rates in effect from time
to time and risks associated with the Company's reserves or the oil and
gas industry in general. Furthermore, the Company's reserves may be
subject to downward or upward revision based upon actual production,
results of future development, supply and demand for oil and gas,
prevailing oil and gas prices and other factors. See "Properties -- Oil
and Gas Reserves"
Under full cost accounting, the Company would be required to take a
non-cash charge against earnings to the extent capitalized costs of
acquisition, exploration and development (net of depletion and
depreciation), less deferred income taxes, exceed the PV-10 of its
Proved Reserves and the lower of cost or fair value of unproved
properties after income tax effects. See "Management's Discussion and
Analysis or Plan of Operations."
Operating Hazards and Uninsured Risks; Production Curtailments.
The Company's oil and gas business involves a variety of operating
risks, including, but not limited to, unexpected formations or
pressures, uncontrollable flows of oil, gas, brine or well fluids into
the environment (including groundwater contamination), blowouts, fires,
explosions, pollution and other risks, any of which could result in
personal injuries, loss of life, damage to properties and substantial
losses. Although the Company carries insurance at levels which it
believes are reasonable, it is not fully insured against all risks.
The Company does not carry business interruption insurance. Losses and
liabilities arising from uninsured or under-insured events could have
a material adverse effect on the financial condition and operations of
the Company.
From time to time, due primarily to contract terms, pipeline
interruptions or weather conditions, the producing wells in which the
Company owns an interest have been subject to production
curtailments. The curtailments range from production being partially
restricted to wells being completely shut-in. The duration of
curtailments varies from a few days to several months. In most cases
the Company is provided only limited notice as to when production will
be curtailed and the duration of such curtailments. The Company is not
currently experiencing any material curtailment of its production.
Laws and Regulations. The Company's operations are affected by
extensive regulation pursuant to various federal, state and local
laws and regulations relating to the exploration for and development,
production, gathering and marketing of oil and gas. Matters subject to
regulation include discharge permits for drilling operations, drilling
and abandonment bonds or other financial responsibility requirements,
reports concerning operations, the spacing of wells, unitization and
pooling of properties, and taxation. From time to time, regulatory
agencies have imposed price controls and limitations on production by
restricting the rate of flow of oil and gas wells below actual
production capacity in order to conserve supplies of oil and gas.
Environmental Risks. Operations of the Company are also subject to
numerous environmental laws, including but not limited to, those
governing management of waste, protection of water, air quality, the
discharge of materials into the environment, and preservation of natural
resources. Noncompliance with environmental laws and the discharge of
oil, gas, or other materials into the air, soil or water may give rise
to liabilities to the government and third parties, including civil and
criminal penalties, and may require the Company to incur costs to remedy
the discharge. Laws and regulations protecting the environment have
become more stringent in recent years, and may in certain circumstances
impose retroactive, strict, and joint and several liability rendering
entities liable for environmental damage without regard to negligence or
fault. From time to time the Company has agreed to indemnify sellers of
producing properties from whom the Company has acquired reserves against
certain liabilities for environmental claims associated with such
properties. There can be no assurance that new laws or regulations, or
modifications of or new interpretations of existing laws and
regulations, will not increase substantially the cost of compliance or
otherwise adversely affect the Company's oil and gas operations and
financial condition or that material indemnity claims will not arise
against the Company with respect to properties acquired by or from the
Company. While the Company does not anticipate incurring material costs
in connection with environmental compliance and remediation, it cannot
guarantee that material costs will not be incurred.
Competition. The Company encounters substantial competition in
acquiring properties, marketing oil and gas, securing trained
personnel and operating its properties. Many competitors have financial
and other resources that substantially exceed those of the Company. The
Company's competitors in acquisitions, development, exploration and
production include major oil companies, numerous independents,
individual proprietors and others. Therefore, competitors may be able
to pay more for desirable leases and to evaluate, bid for and purchase a
greater number of properties or prospects than the financial or
personnel resources of the Company will permit.
Dependence on Key Personnel. The Company depends to a large
extent on the services of Eugene A. Soltero, the Company's Chairman of
the Board and Chief Executive Officer, James E. Hogue, the President and
Chief Operating Officer of the Company, and Leon A. Romero, Senior Vice
President and Chief Financial Officer. The loss of the services of
any one of these individuals could have a material adverse effect on the
Company's operations. The Company has not entered into any
employment contracts with any of its executive officers, nor has it
obtained key personnel life insurance. The Company believes that its
success is also dependent on its ability to continue to employ and
retain skilled technical personnel.
Concentration of Voting Power. The Company's executive officers,
directors and their affiliates will continue to vote for directors
approximately 45% of the Company's outstanding 17,233,278 shares of
Common Stock, including rights under certain Voting Agreements to vote
approximately 6 million shares of Common Stock representing
approximately 35% of the outstanding shares of Common Stock. As a
result, officers, directors and their affiliates will have the ability
to exert significant influence over the business affairs of the Company,
including the ability to influence the election of directors and results
of voting on all matters requiring shareholder approval.
Conflicts of Interests. Certain officers, directors and related
parties have engaged in business transactions with the Company which
were not the result of arm's length negotiations between independent
parties. Management believes that the terms of these transactions were
as favorable to the Company as those that could have been obtained from
unaffiliated parties under similar circumstances. All future
transactions between the Company and its affiliates will be on terms no
less favorable than could be obtained from unaffiliated third parties
and will be approved by a majority of the disinterested members of the
Board of Directors of the Company.
Public Market and Possible Volatility of Securities. The Common
Stock is traded on the AMEX and Aover-the-counter" in Canada on the
Canadian Dealing Network CDN"). The trading price of the Common
Stock could be subject to wide fluctuations in response to quarter-to-
quarter variations in operating results, announcements of drilling
results by the Company and other events or factors. In addition, the
U.S. stock market has from time to time experienced extreme price and
volume fluctuations which have particularly affected the market price
for many companies and which often have been unrelated to the operating
performance of these companies. These broad market fluctuations may
adversely affect the market price of the Company's securities.
No Dividends. The Company's board of directors presently intends
to retain all of its earnings for the expansion of its business. The
Company therefore does not anticipate the distribution of cash dividends
in the foreseeable future. Any future decision of the Company's board
of directors to pay cash dividends will depend, among other factors,
upon the Company's earnings, financial position and cash requirements.
Exchange Rate Fluctuations. The Company is exposed to foreign
exchange risks since it has granted stock options and warrants
denominated in Canadian currency while the majority of its expenditures
will be in United States dollars. Any significant reduction in the
value of the Canadian dollar may decrease the value of funds in United
States dollars the Company receives upon exercise of warrants and
options.
Competition
Competition in the oil and gas industry is intense generally.
Cotton Valley believes that price is the determinative factor in
competition for drilling prospects, equipment and labor. Major and
independent oil and gas companies and syndicates actively bid for
desirable oil and gas properties and equipment and labor required to
operate and develop them. Many of Cotton Valley's competitors have
substantially greater financial resources and exploration and
development budgets than those of Cotton Valley. Cotton Valley expects
difficulty in competing for future drilling prospects.
Markets
General. Oil and gas operating revenues are highly dependent upon
prices and demand for oil and gas. Numerous factors beyond Cotton
Valley's control can impact the prices of its oil and gas. Decreases
in oil and gas prices would have an adverse effect on Cotton Valley's
proved reserves, revenues, profitability and cash flow.
Cotton Valley has not engaged in any crude oil and gas price swaps
or other hedging transactions to reduce its exposure to price
fluctuations. Pursuant to the terms of the Means Credit Facility, the
lender may initiate crude oil commodity swaps with the Company for its
production from the Means Unit. The Company may also, however, engage in
other similar transactions from time to time as management deems advisable.
Gas Sales. Gas from its wells in East Texas (Cheneyboro Field) and
Southwest Oklahoma (N.E. Alden Field) are sold at spot prices on
contracts with thirty-day cancellation provisions and are gathered and
delivered to purchasers through pipeline systems owned by the Company.
During fiscal year 1998, the Company sold its gas to eight different
purchasers, no single one of which accounted for more than 10% of the
Company's gross revenues.
Oil Sales. Cotton Valley sells its oil production under short-term
arrangements at prices no less than the purchaser's posted prices for
the respective areas less standard deductions. Management believes that
numerous buyers are available for Cotton Valley's oil. During fiscal year
1998, the Company sold its oil to six different purchasers, one of
which, National Cooperative Refinery Association, accounted (at 11.7%)
for more than 10% of the Company's gross revenues.
Oilfield Equipment Sales. Cotton Valley sells its oilfield equipment
and supplies to numerous retail and wholesale customers located in several
states and Canada. During fiscal year 1998, one Customer, Dunnam Pumping
Units (at 18.1%) accounted for more than 10% of the Company's gross revenues.
Regulation
Oil and gas exploration, production and related operations are
heavily regulated by federal and state authorities. Failure to
comply with applicable law can result in substantial penalties. The
cost of regulatory compliance will increase Cotton Valley's cost of
doing business and affect its profitability. Regulation of oil and gas
activities has changed many times. Consequently, Cotton Valley is
unable to predict the future cost or impact of complying with such laws.
Texas requires drilling permits and bonds and operating reports and
imposes other burdens relating to oil and gas exploration and
production. Texas also requires conservation measures, including
pooling of oil and gas properties, establishing maximum production rates
from oil and gas wells, and spacing, plugging and abandoning wells.
These laws limit the rate at which oil and gas can be produced from
Cotton Valley's properties.
The transportation and sale of gas in interstate commerce is
regulated by United States law and the Federal Energy Regulatory
Commission.
Operating Hazards and Uninsured Risks
The acquisition, development, exploration for, and production,
transportation and storage of, crude oil, gas liquids and gas
involves a high degree of risk, which even a combination of experience,
knowledge and careful evaluation may not be able to overcome. Cotton
Valley's operations are subject to all of the risks normally incident to
drilling gas and oil wells, operating and developing gas and oil
properties, transporting, processing, and storing gas, including
encountering unexpected formations or pressures, premature reservoir
declines, blow-outs, equipment failures and other accidents, craterings,
sour gas releases, uncontrollable flows of oil, gas or well fluids,
adverse weather conditions, pollution, other environmental risks, fires
and spills. Oil production requires high levels of investment and has
particular economic risks, such as retaining wall failure, fires,
explosions, gaseous leaks, spills and migration of harmful substances,
any of which can cause personal injury, damage to property, equipment
and the environment, and result in the interruption of operations.
Cotton Valley is also subject to deliverability uncertainties related to
the proximity of its reserves to pipeline and processing facilities and
the inability to secure space on pipelines that deliver oil and gas to
commercial markets. Although Cotton Valley maintains insurance in
accordance with customary industry practice, it is not fully insured
against all of these risks, nor are all such risks insurable. Losses
resulting from the occurrence of these risks could have a material
adverse impact on Cotton Valley.
Employees
At September 15, 1998, the Company had 20 full-time employees of
which five were management, six were administrative and nine were
field employees. None of the Company's employees are represented by a
union. The Company has experienced no work stoppages and management
considers its relations with employees to be good. The Company uses
contract services in its field operations and employs independent
consultants, as needed, to evaluate Company prospects, reserves and
other oil and gas assets for potential acquisitions.
Facilities
The Company occupies approximately 7,132 square feet of office
space at 6510 Abrams Road, Suite 300, Dallas, Texas 75231 under a five-
year lease that expires on April 30, 2003. Monthly basic rent is
$7,430. The Company leases a field office and an equipment yard in
Odessa, Texas and also leases a warehouse, shop and field office in
Mineral Wells, Texas.
Recent Developments
M&M Acquisition. Effective November 5, 1997, the Company, through
its subsidiary, Mustang Horizontal, acquired certain horizontal
drilling technology and equipment from M&M Directional Drilling
Consultants ("M&M"). In connection with the purchase, the Company issued
warrants to purchase 60,000 shares of Common Stock and warrants to
purchase 100,000 shares of Common Stock (the "Mustang Warrants") to M&M
and Liviakis Financial Communications, Inc. ("Liviakis"), respectively.
Liviakis directed that 25,000 of its Mustang Warrants be issued to
Robert B. Prag, an officer of Liviakis. The Mustang Warrants are
exercisable at any time at an exercise price of $3.50 per share until
December 31, 2000. In addition, the Company paid M&M $550,000 cash for
the horizontal drilling technology and equipment. Subsequent to the
acquisition, the M&M personnel and equipment were used to drill a single
three-lateral horizontal well on one of the Company's properties, which
was completed as a water injection well for a waterflood program. This
well will be tested for injection for a number of months before a
decision would be made to drill additional horizontal wells on the same
property. As a result of the recent downturn in oil and gas prices,
third party service work is not economically available for Mustang
Horizontal and the horizontal drilling of other Company properties has
been delayed pending increases in development capital availability.
Accordingly, the horizontal equipment has been stacked and the
appropriate personnel laid off. The company is currently seeking to
exchange the equipment with a larger horizontal contractor in return for
the horizontal drilling of a test well on the Company's Cheneyboro
property.
Equipment Acquisition. On December 30, 1997, the Company, through
its subsidiary, Mustang Well Servicing, acquired from three
institutional lenders, who had obtained the equipment through a
foreclosure proceeding, two recently rebuilt well servicing rigs and
related transportation and service equipment (the "Equipment") for $1
million in cash and issuance of $220,000 of the Convertible Debentures
described below. The Equipment was tooled out at Mustang Well
Servicing's facilities at Odessa, Texas and began workover and
horizontal drilling re-entry operations on the Company's Means Unit in
Andrews County, Texas and Sears Ranch Prospect in Nolan and Fisher
Counties, Texas.
Sale of Convertible Debentures. On December 30, 1997, the Company
completed the private placement of the Convertible Debentures to a
group of nine institutional investment firms. Approximately $1 million
of the cash proceeds and $220,000 of Convertible Debentures were used to
purchase the Equipment. The remaining funds have been used for the
acquisition and development of oil and gas properties, purchase of oil
field equipment and working capital.
The Convertible Debentures are due December 31, 2001 and are
secured by the Equipment and other assets of the Company. The
Convertible Debentures are convertible into shares of the Company's
Common Stock and Debenture Warrants, subject to adjustment upon certain
events. Under the terms of the Convertible Debentures, the Company was
obligated to obtain on or before May 30, 1998 an effective registration
statement covering the shares of Common Stock to be issued upon
conversion of the Convertible Debentures and exercise of the Debenture
Warrants. The Company was not successful in obtaining the effectiveness
of the registration statement which event, with notice would be an event
of default under the Convertible Debentures. No notice has been given.
As of September 15, 1998, the Company and each Convertible
Debentureholder were in negotiation for certain amendments to the
Convertible Debentures and related documents, including a waiver of
the prospective event of default. As consideration for the waiver, the
Company has agreed to issue a total of 400,000 shares (the "Waiver
Shares") on a pro rata basis to each Convertible Debentureholder.
The Waiver Shares will be valued by the board of directors at $0.425 per
share when issued to the Convertible Debentureholder. Additionally,
the Company expects to issue and deliver to the Convertible
Debentureholders approximately 700,000 shares of common stock in lieu
of accrued interest of approximately $302,000 on the Convertible
Debentures for December 30, 1997 through December 31, 1998.
Zama Lake Property Purchase and Sale. In January 1998, the Company
completed the purchase of substantially all of the oil and gas
interests in the Zama Lake area in Alberta, Canada (the "Zama Property")
owned by two Canadian independent oil and gas producers. The purchase
price was $6.9 million. Shortly after the purchase of the Zama
Property, the Company sold all of its interests to Phillips Petroleum
Resources, Ltd. and certain of its affiliates for $7.5 million.
The Zama Property consists of a total of 23,400 gross acres (11,672
net acres) of oil and gas leases and 42 producing wells in northwest
Alberta approximately 55 miles northeast of Rainbow Lake. At the
time of this transaction, the Zama Property's production net to the
interests acquired averaged approximately 270 Bopd of oil, 6 MMcfd of
gas and 30 Bopd of natural gas liquids.
East Binger Unit, Caddo County, Oklahoma. On January 14, 1998,
CVEI, a subsidiary of the Company, and Phillips Petroleum Company
("Phillips") entered into an agreement for the purchase by CVEI of
all of Phillips' interests in certain oil and gas leases (the "Leases"),
including the wells, equipment and personal property located on the
Leases, in the East Binger Unit, Caddo County, Oklahoma ("East Binger
Unit") for $4,000,000. Closing of the transaction was subject to
CVEI obtaining financing for the purchase by May 31, 1998. As a result
of declining oil and gas prices, the Company was unable to obtain the
necessary financing by the scheduled closing date. The Company did
not incur any liability as a result of the failure of the East Binger
Unit to close.
Means Credit Facility. On June 12, 1998, CV Means entered into a
credit agreement with Triassic Energy Partners, L.P. ("Triassic"),
an affiliate of Cambrian Capital Corporation whereby CV Means could
borrow up to $10,000,000 on a multiple-advance, non-revolving basis (the
"Means Credit Facility"). Repayment of amounts advanced under the Means
Credit Facility is guaranteed by the Company and all its subsidiaries.
Under the Means Credit Facility, up to $1,000,000 may be advanced
for new project development working capital purposes. The remaining
$9,000,000 may be advanced for the development of the Company's Means
(Queen Sand) Unit in Andrews County, Texas (the "Means Unit"). As of
September 15, 1998, the Company had drawn down $350,000 for working
capital and $388,600 for Means Unit property development purposes. A
$10,000,000 promissory note dated June 12, 1998 with interest at the
prime rate of Citibank N.A., New York, New York plus 2% was issued to
Triassic by CV Means in accordance with the terms of the Means Credit
Facility. Until the maturity date, May 31, 2002, the Company will
deliver to Triassic each month a percentage of the revenues from the
Means Unit to be applied to accrued interest and payment of principal of
the note. On the maturity date, the accrued interest and outstanding
principal balance of the note is due and payable. As security for the
Means Credit Facility, CV Means granted a security interest in
substantially all the assets of CV Means, including the Means Unit and
all income generated thereby. As further security for the Means Credit
Facility, Aspen, the sole shareholder of CV Means, pledged all the
outstanding shares of CV Means to Triassic.
As further consideration for the Means Credit Facility, CV Means
assigned a net profits overriding royalty interest in the Means Unit
to Cambrian Capital Partners, L.P. ("Cambrian") and also entered into a
commodities swap agreement with Triassic. The Company also issued a
Unit Purchase Option to Cambrian which allows Cambrian to purchase up to
100,000 units of the Company for $1.75 per unit. Each unit consists
of 1.085 shares of the Company's Common Stock and one warrant, which
grants to the warrantholder the right to purchase two shares of Common
Stock at an exercise price of $2.02 per share. All shares issuable
under this Unit Purchase Option are subject to a registration rights
agreement that requires the Company to register such shares under
certain circumstances.
ITEM 2. PROPERTIES
List of Properties
Cheneyboro Field. Cotton Valley owns approximately 6,700 net acres
of producing and non-producing oil and gas leases (with rights of
first refusal to acquire additional leases) in the Cheneyboro Field of
Navarro County, Texas. Cotton Valley has entered into an Area of Mutual
Interest ("AMI") Agreement with a number of unaffiliated parties
covering approximately 33,000 acres in and around the Cheneyboro Field.
Cotton Valley has the right to acquire up to a 75% working interest in
any new lease acquired by any of the other parties to the AMI Agreement.
The Cheneyboro Field is located 17 miles southeast of Corsicana,
Texas, in Navarro County. This field is productive in the Cotton
Valley Limestone formation (also called the "Cotton Valley Lime") at a
vertical depth of approximately 9,500 feet. Field development continued
following the initial discovery in 1978 into the early 1980s. Between
1978 and 1987, marginal wells were drilled defining the limits of the
field. Approximately 30 interior additional vertical wells in the
Cheneyboro Field produced approximately 2.7 million Bbl of oil,
representing an average of approximately 90,000 Bbl per well. Some of
the vertical wells have produced over 200,000 Bbl, indicating better
drainage where the wells penetrated the fracture system. In 1987, the
Tarrant County Water Authority expropriated approximately 12,000 acres
of this field. Producing wells were plugged and abandoned to permit
construction of the Richland/Chambers Creek Reservoir, a water supply
project for Tarrant County and the City of Fort Worth, Texas.
The Cotton Valley Lime reservoir at Cheneyboro is highly fractured.
The primary objective reservoir rock is an oolitic carbonate
grainstone of Jurassic age that was deposited on a Paleozoic shelf
break. Subsequent pullout of the deeper Louann Salt caused extensive
fracturing. The salt withdrawal left the residual field structure as
simple regional dip. Hydrocarbon trapping occurs as a result of the
high degree of fracture density bounded by areas of non-permeability.
Core and log analysis indicate the presence of 2.5 to 4.5% oil saturated
matrix porosity in the field. Vertical wells in this reservoir produce
42 degree API oil.
Cotton Valley believes that horizontal drilling techniques will
lead to higher initial rates and better recovery efficiencies than
those experienced in the original vertical well completions. Since much
of the field is under water, some directional drilling from the
shoreline is anticipated. Based on analogy to horizontal drilling in
fractured limestone reservoirs in other areas, increased productive
capacity and ultimate reserves are anticipated relative to historical,
vertical per well averages.
The Company is unaware of any regulatory restrictions on drilling
near the reservoir. The Company will build the normal retaining
walls around its drilling and storage sites to prevent oil spills from
spreading. The Company intends drilling to a depth of approximately
9,500 feet while the deepest point in the Richland/Chambers Creek
Reservoir is approximately 100 feet. Consequently, the Company does not
anticipate any special risks associated with drilling near a reservoir.
Means (Queen Sand) Unit. The Cotton Valley Means (Queen Sand) Unit
consists of 2,096 acres on four leases in north central Andrews
County, Texas. Production began in 1954 and development followed
rapidly. By 1960, when a secondary project of water injection was
initiated, there were 41 total wells in the Means Unit. Most wells were
completed in casing, perforated and fractured with a large number
flowing initially. The best wells flowed more than 400 barrels of oil
per day (Bopd") initially and the initial potentials of 32 of the 41
wells (78%) exceeded 100 Bopd.
Primary production peaked in 1957 at 1096 Bopd from 41 wells. By
1960, the production was down to 327 Bopd, a decline of more than
70%. Secondary response was rapid in some wells and peak secondary
production occurred from 1961 through 1964, with almost flat production,
at slightly above 833 Bopd. The original waterflood used 21 injection
wells and 20 producers, for an overall spacing of 50 acres per well, and
an injection to producing well ratio of approximately 1 to 1. However,
during the period of greatest production decline, starting in 1968,
several injection wells were down for extended periods of time because
of severe corrosion of the tubing strings. This was the result of not
using protected tubing (plastic coated, fiberglass or cement lined) in
the injection wells. Also, several of the injection wells had severe
injectivity losses due to plugging problems (scale and iron-sulfide)
partly caused by being at the far end of the Exxon Means Injection
System. As a result, less water than needed to properly flood the
reservoir was used.
Old Aspen purchased the leases in 1996 for the purpose of
instituting a 20-acre infill redevelopment program. Several
redevelopments have been completed since 1988 in other Queen Sand fields
in Andrews County and adjacent Gaines County and all of the
redevelopments designed with adequate injection support have been very
successful. A study of 11 offset redevelopment waterfloods in the
Means, McFarland and Magutex fields indicated that 35.3% of the original
oil in place had been produced on average for these units. The
cumulative production to date (both primary and secondary) in the
Company's initial 2096 acre Means Unit has been 4.136 million barrels of
oil, which is equal to 16.2% of the original oil in place. If the
property produces at the average of the other eleven projects, it will
have 2.5 million barrels of additional reserves.
An engineering report, as of June 30, 1998, prepared by Ryder
Scott Company for Cotton Valley estimates that the Means (Queen Sand)
Unit contains net proved undeveloped reserves of 1.5 million barrels of
oil and 0.5 Bcf of gas. The Company estimates that it will require a
capital investment of approximately $9.2 million to develop this
property.
During March and April of 1998, the Company, using personnel and
tools belonging to its Mustang subsidiaries, re-entered the Spinks #2
well and horizontally drilled three lateral legs of 1,500-2,000 feet
length in the Queens "B", Queen "C" and Queen "D" Sands. The well has
been permitted as a water injection well and the Company has planned an
extensive test program to determine whether a horizontal injection
pattern would provide increased recovery.
The Company, during May and June 1998, acquired two more leases
adjacent to the original 2,096 acre Means Unit and extended it to
approximately 2,600 acres. Accordingly, the pattern has been
increased and the additional property was included in a reserves report
by K&A Energy Consultants Inc., dated as of June 30, 1998 which
estimates that the 2600 acre extended Means Unit contains net proved
reserves of 2.8 million barrels of oil and 0.8 Bcf of gas.
N.E. Alden Field. On March 3, 1997, Cotton Valley purchased all
of the interests held by the Homestake Companies and certain other
parties in the N.E. Alden Field, Caddo County, Oklahoma. The
properties, consisting of approximately 550 net acres of oil and gas
leases, seven producing oil and gas wells, three injection wells and
five shut in wells, contain proved developed and undeveloped net
reserves of approximately 515,515 Bbl of oil and 5,188,326 Mcf of gas,
and probable reserves of 315,436 Bbl of oil and 5,872,940 Mcf of gas.
Working interest in the wells ranges from 50% to 100% and the net
revenue interest is at least 75% of the working interest.
Located approximately 65 miles southwest of Oklahoma City,
Oklahoma, the field was discovered in 1956 and initially tested for
771 barrels of oil and 608 Mcf of gas per day from the Bromide formation
at a depth of approximately 9,300 feet. Since the discovery, the
Bromide has been developed and is now a unitized water flood consisting
of four producing wells and three water injection wells. The remaining
wells have been completed in other zones above and below the Bromide.
Gas from the field is transported through a gathering system and a one-
mile pipeline owned by Cotton Valley.
In addition to the current production, there are also potential
zones either behind existing wells, or reachable by deepening
existing well bores. During 1998, Cotton Valley completed a number of
workovers of the existing wells, which improved production from existing
zones and opened new zones for additional production and reserves.
Sears Ranch Prospect. In October 1997, the Company, through its
subsidiary, CV Energy, completed the acquisition of a 100% working
interest in approximately 6,200 acres in the Sears Ranch area of
Nolan and Fisher Counties, Texas (the "Sears Ranch Prospect") for cash
and other considerations. The assets received by the Company included
pooling rights, existing contracts related to the Sears Ranch Prospect
and all personal property (including equipment) located on or used in
connection with the Sears Ranch Prospect. The primary purpose of this
acquisition was to acquire oil field equipment, including pumpjacks,
tank batteries, injection pumps, separators, tubing and casing.
The Sears Ranch Prospect has been productive in the Odem Lime
formation, with cumulative production of approximately eight million
barrels. Attempts to waterflood this property by predecessor
operators have been unsuccessful. According to reports by the Company's
independent consultants, the Sears Ranch Prospect is an excellent
candidate for redevelopment using horizontal drilling. In February
1998, the Company began testing this prospect as a horizontal drilling
prospect in the Odem Lime formation. During September 1998, the Company
initiated a pilot waterflood project consisting of one injection well
and four producing wells. There can be no assurance that the Company
can economically develop any remaining reserves from the Sears Ranch
Prospect through either horizontal or vertical drilling or a different
waterflood pattern.
Option to Acquire Additional Property. Since 1995, the Company has
owned an option to acquire a 51.8% working interest in the Sword
Unit, Offshore Santa Barbara, California (the "Sword Unit"), containing
significant volumes of heavy crude oil. As a result of lower crude
oil prices during 1998, the Company has been unable to arrange a
syndicate to complete the purchase and re-assigned its option back to
the original holders.
Title of Properties
Cotton Valley follows industry practice when acquiring undeveloped
properties on minimal title investigation. A title opinion is
obtained before drilling begins on the properties. Title opinions cover
more than half of Cotton Valley's properties. Cotton Valley's
properties are subject to royalty interests, liens incident to operating
agreements, liens for current taxes and other burdens that Cotton Valley
believes do not materially interfere with their use or value. Cotton
Valley may incur additional expenses in obtaining titles or doing
remedial work on the titles, but in the opinion of management these
expenses would not be material.
Oil and Gas Reserves
Cotton Valley's reserves consist primarily of proved and probable
reserves located in Texas and Oklahoma. Reserve estimates were made
using industry-accepted methodology including extrapolation of
performance trends, volumetrics, material balance and statistical
analysis of analogs. The evaluator's professional judgment and
experience were used to select the most appropriate method and to
determine the reasonableness of the results. The estimates were made in
accordance with oil and gas reserve definitions promulgated by the U.S.
Securities and Exchange Commission (the "SEC").
The following table summarizes Cotton Valley's estimated net
proved oil and gas reserves as of June 30, 1998 as estimated by K&A
Energy Consultants, Inc.
<TABLE>
Total Reserves(1)
-----------------
Item
Reserves
----------
<S> <C>
Proved producing
Oil (Bbl) 156,657
Gas (Mcf) 161,204
Proved developed non-producing
Oil (Bbl) 198,667
Gas (Mcf) 837,134
Proved undeveloped
Oil (Bbl) 5,414,700
Gas (Mcf) 11,763,141
Total Proved
Oil (Bbl) 5,770,024
Gas (Mcf) 12,761,479
Total Probables
Oil (Bbl) 2,076,754
Gas (Mcf) 11,059,135
Estimated future net revenues before income taxes
Proved producing $ 781,299
Proved developed non-producing $ 2,577,157
Proved undeveloped $51,783,502
-----------
Total $55,141,958
===========
Estimated future net revenues before income taxes
discounted at 10%
Proved producing $ 594,857
Proved developed non-producing $ 1,710,935
Proved undeveloped $28,841,250
-----------
Total $31,147,042
===========
</TABLE>
- ----------------------
- - Prices based on $13.01 per Bbl of oil and $2.04 per Mcf of gas.
The reserve data set forth in this Annual Report is only an
estimate. Numerous uncertainties are inherent in estimating oil and
gas reserves and their values, including many factors beyond the control
of the producer. Reserve engineering is a subjective process of
estimating underground accumulations of oil and gas that cannot be measured in
an exact manner. The accuracy of any reserve estimate is a function of
the quality of available data and of engineering and geological
interpretation and judgment. As a result, estimates of different engineers
often vary. In addition, estimates of reserves are subject to revision by the
results of later drilling, testing and production. Accordingly, reserve
estimates often differ from the quantities of oil and gas ultimately recovered.
The meaningfulness of estimates is highly dependent upon the accuracy of
the assumptions upon which they are based.
In general, oil and gas production declines as reserves are
depleted. Except to the extent that Cotton Valley acquires proven
reserves or succeeds in exploring and developing its own reserves, or
both, Cotton Valley's proven reserves will decline as they are
produced. Cotton Valley's future oil and gas production is, therefore, highly
dependent upon its ability to acquire or develop additional reserves.
Drilling Activity
The Company did not drill any wells during the two fiscal years
ended June 30, 1997. During the year ended June 30, 1998, the
Company participated for a 12.5% working interest in a single exploratory
well which was a dry hole. The Company also successfully completed the
drilling of a horizontal water injection well in which its working interest is
100%.
Oil and Gas Wells
The following table sets forth the number of productive oil and gas
wells in which the Company had a working interest at June 30, 1998. During
fiscal year 1998, the average price received for oil and gas sales
was $14.33 per Boe, and the average cost of production was $10.55 per
Boe, where Boe is defined as the barrel of oil equivalent using 6 Mcf
of gas to one barrel of oil. The full cost pool was amortized at the
rate of $6.26 per Boe.
Productive Wells
Gross(1) Net(2)
-------------------- ----------------------
Location Oil Gas Total Oil Gas Total
----------------- ----- ----- ----- ----- ------ -----
Texas 34 1 35 34 1 35
Oklahoma 10 4 14 9 3 12
----- ----- ----- ----- ------ -----
Total 44 5 49 43 4 47
===== ==== ===== ===== ====== =====
- -------------------
- - The number of gross wells is the total number of wells in which a
working interest is owned.
- - The number of net wells is the sum of fractional working interests
owned in gross wells expressed as whole numbers and fractions thereof.
Oil and Gas Acreage
The following table summarizes the Company's developed and
undeveloped leasehold acreage at June 30, 1998.
Developed Undeveloped
Location Gross(1) Net(2) Gross(1) Net(2)
----------------- -------- ------ -------- -------
Texas 3,729 3,729 13,056 13,056
Oklahoma 1,350 1,181 -0- -0-
------ ------ ------ ------
Total 5,079 4,810 13,056 13,056
====== ====== ====== ======
- ------------------
- - The number of gross acres is the total number of acres in which a
working interest is owned.
- - The number of net acres is the sum of fractional working interests
owned in gross acres expressed as whole numbers and fractions thereof.
ITEM 3. LEGAL PROCEEDINGS
Yukon Continuance
On December 10, 1996, the Company's shareholders of record as of
November 4, 1996, approved the continuance of domicile from the
Province of Ontario to Yukon Territory (the "Continuance"). The Company
mailed proxy solicitation materials to its shareholders on November 8, 1996.
The Company has received an opinion of its Canadian counsel that the
Notice, Information Circular and Proxy delivered to its shareholders complied
in all material respects with applicable corporate and securities laws
of the Province of Ontario. A total of 1,791,195 shares voted for the Yukon
Continuance (19.5% of the 9,204,318 shares then outstanding), with 86
shares voting against. No shareholder exercised his dissenter's
rights under Ontario law. On February 9, 1998, the Company filed Articles
of Continuance with the Registrar of Yukon Territory, changing the
domicile of the Company from the Province of Ontario to the Yukon Territory.
At the time of the December 10, 1996 meeting of shareholders, the
Company believed it to be in the best interest of its shareholders
to continue its domicile into the Yukon Territory because under Yukon
Territory law the Company's Board of Directors need not be comprised
of a majority of Canadian residents as required under Ontario law. The
Company believed that since its principal executive office,
management and principal properties were located in the United States,
it would be advantageous to both its U.S. and Canadian shareholders to
have a majority of its Board of Directors comprised of U.S. residents.
The Company's Charter and bylaws were not changed as a result of the Yukon
Continuance. The Company has been advised by its Canadian counsel that there
are no significant differences in corporate law concerning shareholder
rights between the Province of Ontario and Yukon Territory except for the
allowance of a majority of U.S. residents as directors under Yukon
law. The Company intended to eventually reincorporate into the United
States after completion of the Yukon Continuance since its future business
activities would primarily be in the United States.
On November 27, 1996, the Company filed with the Commission a
Registration Statement on Form SB-2 (the "1996 Registration
Statement") for the purpose of registering securities to be offered in an
underwritten public offering. On or about February 6, 1997, the Staff of the
Commission orally advised the former Chief Financial Officer of the Company
that the Yukon Continuance, as approved by the shareholders on December 10,
1996, involved a transaction which would require registration under the
Securities Act. As a result of the Staff's position, the 1996
Registration Statement was amended to state that the Company would
not proceed with the Yukon Continuance until after the filing of a
registration statement covering the Yukon Continuance under the
Securities Act. The 1996 Registration Statement was never declared effective
and was subsequently withdrawn by the Company.
On February 10, 1997 and as a result of the Staff's advice to the
Company, the Company filed with the Commission a Current Report on
Form 8-K which stated that the Company's continuance from Ontario to the
Yukon Territory would require registration under the Securities Act and
would be delayed until after such registration had been effected and further
shareholder approval had been sought.
During the Staff's review of the Company's 1996 Registration
Statement (November 1996 through June 1997), the Company's principal
officer and liaison with the Staff was the Company's former Chief
Financial Officer and it was with him in February 1997 that the Staff
discussed by telephone the applicability of Rule 145 to the Yukon
Continuance. In October 1997, the Chief Financial Officer resigned
his position as an officer of the Company. Unfortunately, during the
review process of the Company's 1996 Registration Statement by the Staff,
the significance and materiality of the Yukon Continuance registration
issue was not effectively communicated to current management of the
Company.
In December 1997, management of the Company was advised by its
Canadian counsel that the Company should initiate the process of
filing its Articles of Continuance with the Registrar of the Yukon Territory
prior to the end of 1997 or it could be necessary to again seek
shareholder approval of the Yukon Continuance. Current management,
without the knowledge of the significance of the previous discussions
between the Staff of the Commission and the Company's former Chief
Financial Officer regarding the Yukon Continuance issue, decided that
it would be in the Company's best interest to complete the Yukon
Continuance as directed and approved by its shareholders at the December 10,
1996 meeting. The Yukon Continuance was effected in conformity with
applicable Canadian law on February 9, 1998.
Yukon Continuance May Have Violated Securities Act
On March 16, 1998, the Company filed with the Commission a
Registration Statement on Form SB-2 (the "March 1998 Registration
Statement") for the purpose of registering up to 10,891,184 shares of
the Company's Common Stock for sale by certain shareholders of the
Company, including approximately 5.7 million shares to be issued upon exercise
of outstanding warrants and conversion of the Convertible Debentures.
On May 1, 1998, the Company received a letter of comments from the Staff
of the Commission (the May 1998 Staff Comment Letter") relating to the
March 1998 Registration Statement. In the May 1998 Staff Comment Letter,
the Staff advised the Company that it should have registered the Yukon
Continuance under the Securities Act. The Yukon Continuance was not
registered under the Securities Act.
The Company in its supplemental response on May 26, 1998 to the
Staff's May 1998 Comment Letter contended, with the concurrence of
Jackson Walker L.L.P., the Company's U.S. securities counsel, that the Yukon
Continuance was a transaction not subject to the registration
requirements of Section 5 of the Securities Act. The Staff has advised the
Company that is does not agree with the Company and its U.S. securities
counsel's conclusion regarding the Yukon Continuance.
Assuming the Yukon Continuance violated Section 5 of the Securities
Act because it was required to be but was not registered thereunder,
shareholders of the Company would have a cause of action against the
Company for damages under Section 12(a) of the Securities Act.
Section 12(a) of the Securities Act provides in relevant part as
follows:
"Section 12(a) In General. Any person who:
- - Offers or sells a security in violation of Section 5.
- - .shall be liable, subject to subsection (b), to the
person purchasing such security from him, who may sue
either at law or in equity in any court of competent
jurisdiction, to recover the consideration paid for such
security with interest thereon, less the amount of any
income received thereon, upon the tender of such
security, or for damages if he no longer owns the
security."
The Company, therefore, may have a contingent liability to certain
of its shareholders, who may sue the Company to recover the
consideration paid, if any, for shares of the Company's Common Stock, with
interest thereon, from the date of the Yukon Continuance to the date of
repayment by the Company less the amount of any income received thereon, upon
tender of such securities, or for damages if the shareholder no longer owns
such securities. The Company intends to vigorously defend any such
shareholder lawsuit and believes that it may have valid defenses, including the
running of applicable statutes of limitations, against claims by some
or all of its shareholders. However, to the extent that any of the
Company's shareholders obtain a judgment for damages against the Company, the
Company's net assets and net worth will be reduced, which in turn
could reduce the Company's ability to obtain financing for its exploration
and drilling operations and cause the Company to curtail operations. The
Company is unable to quantify the amount of such contingent
liability. Nothing herein should be construed as an admission by the Company
that it has violated any provision of the Securities Act. See "Risk Factors
- --Possible Contingent Liability for Violation of Securities Act."
The Company contends that in the Yukon Continuance transaction, the
"consideration" given by the shareholders was stock in an Ontario
corporation in exchange for stock in a Yukon Territory corporation.
Thus one of the remedies of a shareholder under Section 12(a) would be for
the Company to rescind the Yukon Continuance and offer to exchange with
its shareholders shares of common stock of an Ontario corporation. Under
Canadian law such action would require a vote of the present
shareholders and would give them dissenters' rights under Yukon law. If Rule
145 were deemed applicable, the continuance back to Ontario would require
registration under the Securities Act with the attendant costs and
delays. The Company believes this would be an impractical and expensive
solution, and would be inconsistent with the Company's shareholders' approval
of the Yukon Continuance at the December 10, 1996 meeting. The Company does
not intend to make such a rescission offer or any other rescission offer to
its shareholders regarding the Yukon Continuance. Further, the Company
does not believe that its shareholders suffered any monetary loss or other
damages as a result of the Yukon Continuance.
Other Legal Proceedings.
The Company is not currently party to any other legal
proceedings which would have material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company had no matters requiring a vote of security holders
during the fourth quarter of fiscal 1998 nor the first quarter of
fiscal 1999, through September 15, 1998.
_____________________________________________________________________________
PART II
_____________________________________________________________________________
ITEM 5. MARKET FOR THE COMPANY's COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
Market Investments.
The Common Stock began trading through the Canadian Dealing
Network ("CDN") on June 24, 1996, under the symbol "CVZC". From June 24,
1996, through June 30, 1998, the following table sets forth the high and
low bid information for the Company's Common Stock in Canadian dollars as
reported on the Canadian Dealing Network. The information in the
table reflects inter-dealer prices, without retail mark-up, mark-down or
commission, and may not necessarily represent actual transactions.
During this period, the Canadian dollar traded in the $.69 to $.74 range.
On December 31, 1998, one Canadian dollar was worth $0.72 U.S. Since
December 31, 1997, there have been no significant trades on the Canadian
Dealing Network.
High Low
June 21-30, 1996 C$2.80 C$2.50
July 1 - September 30, 1996 C$2.60 C$1.20
October 1 - December 31, 1996 C$1.90 C$0.75
January 1 - March 31, 1997 C$3.45 C$1.45
April 1 - June 30, 1997 C$2.55 C$1.50
July 1 - September 30, 1997 C$6.50 C$1.95
October 1 - December 31, 1997 C$4.17 C$3.91
The Company's Common Stock began trading through the NASD Electronic
Bulletin Board on January 14, 1997 under the symbol "CTVYF". On July
1, 1997, the Company's symbol was changed to "CTVY". The following
table sets forth the high and low bid information for the Company's Common
Stock in U.S. currency as reported on the NASD Electronic Bulletin Board
since January 14, 1997. The table reflects inter-dealer prices, without
retail mark-up, mark-down or commission, and may not necessarily represent
actual transactions. The Company's Common Stock was not traded through the
NASD Electronic Bulletin Board after October 17, 1997.
High Low
January 14 - March 31. 1997 $2.20 $1.00
April 1- June 30, 1997 $1.81 $1.12
July 1- September 30, 1997 $4.81 $1.38
October 1-17, 1997 $3.45 $3.12
On October 17, 1997, the Common Stock was listed on the American
Stock Exchange under the symbol "KTN". The following table sets
forth the high and low sales prices for the Common Stock since October 17,
1997.
High Low
October 17 to December 31, 1997 $6.00 $2.12
January 1 - March 31, 1998 $2.94 $1.38
April 1 - June 30, 1998 $1.75 $0.88
July 1 - September 15, 1998 $1.19 $0.50
Holders. As of June 30, 1998, there were approximately 1,065 record
holders of the Company's Common Stock.
Dividends.
The Company has not previously paid any cash dividends on its
Common Stock and does not anticipate or contemplate paying dividends on the
Common Stock in the foreseeable future. It is the present intention
of management to utilize all available funds for the development of the
Company's business. In addition, the Company may not pay any
dividends on common equity unless and until all dividend rights on outstanding
preferred stock, if any, have been satisfied. The only other
restrictions that limit the ability to pay dividends on common equity
or that are likely to do so in the future, are those restrictions
imposed by law or by certain credit agreements.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Fiscal Year 1998 as Compared to Fiscal Year 1997
During the fiscal year ended June 30, 1998, the Company had a net
loss of $830,600 on revenues of $1,825,852 as compared with a net
loss of $2,006,878 on revenues of $272,243 for the fiscal year ended June 30,
1997. The improvement results from the first used equipment sales by
the Company's subsidiary, Mustang Oilfield Equipment Company, oil and gas
production beginning March 1997 from the N.E. Alden Field and August
1997 from the Aspen properties, oil and gas production beginning November
1997 from the Sears Ranch Prospect, and continued production from the
Company's Cheneyboro properties, as well as reductions in general and
administrative costs, and gain from the purchase and sale of a Canadian
property, which were offset by costs associated with the financing and
development of the Company.
Oil and gas sales increased 207% from $272,243 for the fiscal year
ended June 30, 1997 to $835,684 for the fiscal year ended June 30,
1998, reflecting the addition of the Aspen, N.E. Alden and Sears Ranch
acquisitions. Oil and gas production costs increased 144% for the
fiscal year ended June 30, 1998, reflecting the addition of oil and gas
properties and continued remedial work required at the N.E. Alden
Field. The Company did not have any significant oil and gas production
costs for the fiscal year ended June 30, 1997.
Equipment sales for the fiscal year ended June 30, 1998 were
$987,811 as compared to no sales for the fiscal year ended June 30,
1997. Equipment purchase and refurbishing expenses were $660,373 for the
fiscal year ended June 30, 1998 as compared to zero expenses for the
comparable period ended June 30, 1997.
General and administrative costs were $1,330,361 for the fiscal year
ended June 30, 1998, a decrease of $1,495,317 or 53% less than the
$2,825,678 incurred for the fiscal year ended June 30, 1997. A
substantial portion of the decrease was due to the expiration of the
investor relations contract with LFC and an administrative cost
reduction program instituted by management in mid-June 1997. In
addition, the Company allocated that portion of its general and
administrative expenses that were directly associated with oil and gas
acquisition and development activities during the fiscal year ended
June 30, 1998 to oil and gas properties. No such costs were allocated
during the fiscal year ended June 30, 1997 because the Company was
primarily involved in fund raising activities during that time period.
The Company purchased and sold a Canadian oil and gas property
during January 1998 that resulted in a gain of $629,660.
The Company will recognize an income tax benefit of $467,678 for the
fiscal year ended June 30, 1998 as compared to recognition of an income
tax benefit of $919,000 for the fiscal year ended June 30, 1997.
This is directly related to the size of the profit or loss before income
taxes during such periods.
Fiscal Year 1997 As Compared to Fiscal Year 1996
During the fiscal year ended June 30, 1997, the Company incurred a
net loss of $2,006,878 as compared to a loss of $712,360 for fiscal
1996. This 181% increase in net loss is primarily attributable to increases
in general and administrative expenses.
General and administrative costs were $2,825,678 in fiscal 1997, an
increase of $1,859,902 or 193% over the $965,776 incurred in fiscal
1996. Included in 1997 general and administrative expenses is a
compensation expense of $1,286,800, (approximately 46% of total general
and administrative expenses) representing the value of shares and
warrants issued to LFC for certain investor relations services, and
approximately $212,000 representing costs incurred with respect to a public
offering of securities which did not materialize. The remaining increase in
general and administrative expense can be attributed to the addition of staff
and technical personnel during 1997 as compared to a relatively small
staff which was in place for only a part of 1996.
Oil and gas production costs were $252,272 in 1997 as compared to
none in 1996. These costs primarily relate to the N.E. Alden Field
and particularly to rehabilitation costs which were not capitalized. The
Company initially acquired its interest in the N.E. Alden Field in
December 1996 for $390,000 of which $35,000 was paid in December 1996
and $355,000 was paid upon closing on March 3, 1997. Oil and gas sales
from the N.E. Alden Field in fiscal 1997 were approximately $200,000.
Rehabilitation work on two wells in the Cheneyboro Field in the
fourth quarter of fiscal 1996 resulted in oil and gas sales of $74,473
during fiscal 1997.
The Company recognized an income tax benefit of $919,000 in fiscal
1997 compared to $387,000 in fiscal 1996. This is directly related
to the size of the loss before income taxes during such periods.
During fiscal 1996, the Company issued 300,000 shares to two former
officers of the Company for services which was recorded at $446,950.
Other expenses during this period were $657,796 which includes
$138,970 in interest expense and officers and staff compensation. The loss
before income tax benefit of $387,000 was $1,099,360 during fiscal 1996.
Fiscal Year 1996 As Compared to Fiscal Period 1995
From February 15, 1995 (inception), to June 30, 1996, the Company
accumulated a deficit of $762,277 after an income tax benefit of
$412,000. During this period, the Company acquired certain oil and gas
properties, completed the amalgamation with Arjon, issued debentures and notes
and sold stock for cash.
Legal, audit and accounting fees were $190,053, which represents 17%
of the net loss before tax through June 30, 1996.
Management fees of $82,840 and salaries of $163,309, for a total of
$246,149, represent 22% of the net loss before tax through June 30,
1996. The Company paid management fees of $10,000 per month from its
inception to July 31, 1995, and $20,000 per month from August 1, 1995 to March
31, 1996, for the full-time services of Eugene A. Soltero, Chairman of
the Board and Chief Executive Officer, and James E. Hogue, President and
Chief Operating Officer. Effective April 1, 1996, each of these officers
received a salary of $10,000 per month. A third officer earned
$10,000 per month from August 1, 1995. A fourth officer earned $10,000 per
month from May 1, 1996.
Management fees and salaries totaling $194, 951 from inception
through June 30, 1996, were capitalized into oil and gas properties
and are not included in the accumulated deficit as of that date. These
costs represent the estimated portion of the compensation directly
attributable to acquisition of the properties in the Cheneyboro Field and
related development activities.
Liquidity and Capital Resources
As of June 30, 1998, the Company had a net working capital of
$20,823, before adjustments of $396,411 for non-cash accrued
liabilities, leaving an effective working capital of $417,234. For
fiscal year 1999, the Company anticipates a capital budget of
approximately $10 million, of which $8 million would be spent
developing the Means Unit, $0.5 million is allocated to workovers at
N.E. Alden and $1.5 million will be used at Cheneyboro. The Means Unit
and N.E. Alden funding is scheduled to be provided by the $10 million
Triassic line of credit. The Company plans to obtain the capital for its
initial Cheneyboro drilling from a combination of reduction of its oilfield
equipment inventory, vendor financing, exchange of horizontal tools for
services and private placements. No assurance can be given that the Company
will be successful in these efforts.
During the fiscal year ended June 30, 1998, the Company used
$714,969 net cash for its operating activities, of which $891,359 was
used for increases in materials and supplies inventory for its used
equipment resale business and $196,966 was loss before non-cash charges,
offset by $373,356 net increases in cash from net changes to receivables and
payables. Cash of $11,286,846 was used in investing activities,
primarily in oil and gas properties, and well service and horizontal
drilling equipment. Net cash from investing activities was $11,444,965,
consisting of: (i) $13,122,331 generated from the issuance of long
term notes, sale of common stock, exercise of warrants, exchange of stock
for oil and gas properties, and the issuance of the Convertible
Debentures; less (ii) $1,677,366 used for payment of liability related to the
Aspen acquisition, costs related to sale of stock and notes, and repayments
of advances payable, notes payable and long-term debt.
The Company did not obtain effectiveness of a registration statement
by May 31, 1998 for the securities underlying the Convertible Debentures,
which event would, with notice, be an event of default under the
relevant financing agreements. No notice has been given. As of
September 15, 1998, the Company and each Convertible Debentureholder
were in negotiation for certain amendments to the Convertible
Debentures and related documents, including a waiver of the prospective
event of default. As consideration for the waiver, the Company has
agreed to issue a total of 400,000 shares (the "Waiver Shares") on a
pro rata basis to the Convertible Debentureholders. The Waiver Shares
will be valued by the board of directors at $0.425 per share when issued
to the Convertible Debentureholder. Additionally, the Company expects
to issue and deliver to the Convertible Debentureholders approximately
700,000 shares of common stock in lieu of accrued interest of
approximately $302,000 on the Convertible Debentures for December
30, 1997 through December 31, 1998. If the amendments are not
completed, and the Debentureholders give notice of default,
the Company's liquidity and activities could be severely adversely
affected.
During the first quarter of fiscal year 1999, through September 15,
1998, the Company has raised $145,000 through the sale of 290,000
shares of its Common Stock and warrants to purchase 290,000 shares,
exercisable at $0.60 per share until December 31, 1001, in a private placement,
and signed a subscription agreement for an additional $430,00 to be
subscribed during the second quarter of fiscal 1999.
For the remainder of fiscal year 1999, the Company expects that its
cash for operations and capital expenditure requirements will be met
in the aggregate as follows:
- - through the proceeds received from the exercise of outstanding
warrants;
- - institutional reserves based development mezzanine loans;
- - traditional commercial bank asset lending;
- - private sales of securities;
- - conversion of debt to equity;
- - reduction of oilfield equipment inventory;
- - exchange of drilling and well servicing equipment for drilling
services;
- - farmout and/or sale of oil and gas property interests; and
- - revenues from operations.
Management believes a combination of the above sources of capital
will provide the necessary liquidity to operate the Company over the
next 12 months. No assurance can be given that any additional financing
will be available to the Company on acceptable terms, if at all. The
inability to obtain additional financing would have a material adverse effect
on the Company, including requiring the Company to curtail significantly
development of its properties. Any financing may involve substantial
dilution to the interests of the Company's then existing shareholders.
Year 2000 Modifications
The Company is currently reviewing its computer systems in order to
evaluate necessary modifications for the year 2000. The Company does
not currently anticipate that it will incur material expenditures to
complete any such modifications. Many of the companies with whom the Company
has material transactions have responded to the Company's inquiring and
stated that they are Year 2000 compliant, or are currently examining Year
2000 compliance issues.
Other Matters
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per
Share ("SFAS 128"). SFAS 128 requires companies with complex capital
structures that have publicly held common stock or common stock equivalents
to present both basic and diluted earnings per share ("EPS") on the face
of the income statement. The presentation of basic EPS replaces the
presentation of primary EPS currently required by Accounting Principles
Board Opinion No. 15 ("APB No. 15"). Basic EPS is calculated as
income available to common shareholders divided by the weighted average
number of common shares outstanding during the period. Diluted EPS is
calculated using the "if converted" method for convertible securities and
the treasury stock method for options and warrants as prescribed by APB
No. 15. This statement is effective for financial statements issued
for interim and annual periods ending after December 15, 1997. The
Company adopted SFAS 128 as of December 31, 1997 for the period ended
December 31, 1997 and all prior periods. The adoption of SFAS 128 has
not had a significant impact on the Company's reported EPS to date.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 129, Disclosures of
Information About Capital Structure ("SFAS 129") which establishes
standards for disclosing information about an entity's capital
structure. The disclosures are not expected to have a significant
impact on the consolidated financial statements of the Company.
SFAS 129 is effective for financial statements ending after
December 15, 1997.
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income ("SFAS 130") which established standards for
reporting and displaying comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general
purpose financial statements. SFAS 130 requires that all items that
are required to be recognized under accounting standards as components
of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
SFAS 130 is effective for years beginning after December 15, 1997.
The Company does not anticipate a material impact to its consolidated
financial statements upon adoption of this standard.
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, Disclosures
About Segments of an Enterprise and Related Information ("SFAS 131")
which establishes standards for the way public business enterprises
are to report information about operating segments in annual financial
statements and requires those enterprises to report selected information
about operating segments in interim financial reports issued to
shareholders. It also establishes the related disclosures about products
and services, geographic areas and major customers. SFAS 131 replaces the
"industry segment" concept of Financial Accounting Standard No. 14 with a
"management approach" concept as the basis for identifying reportable
segments. SFAS 131 is effective for financial statements for periods
beginning after December 15, 1997. The Company expects additional
disclosures will be required, but otherwise does not anticipate a
material impact to its consolidated financial statements upon adoption
of this standard.
In 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, Employers' Disclosures
about Pensions and Other Postretirement Benefits ("SFAS 132"), and SFAS
133, Accounting for Derivative Instruments and Hedging Activities." SFAS
132 is effective for fiscal years beginning after December 15, 1997, and
SFAS 133 is effective for fiscal years beginning after June 15, 1999. The
Company does not anticipate a material impact to its consolidated
financial statements upon adoption of these standards.
Estimated Reserves
The carrying value of Cotton Valley's oil and gas properties is
supported almost entirely by proved undeveloped reserves. Cotton
Valley emphasizes that reserve estimates of new discoveries or undeveloped
properties are more imprecise than those of producing oil and gas
properties. Accordingly, these estimates are expected to change
materially as future information becomes available.
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS AND UNAUDITED
SUPPLEMENTARY DATA
Index to Financial Statements and Financial Statement Schedule
Page
Independent Auditor's Reports 24
Financial Statements
Consolidated Balance Sheet 26
Consolidated Statements of Operations 27
Consolidated Statement of Changes in Stockholders' 28
Consolidated Statements of Cash Flows 27
Notes to Consolidated Financial Statements 29
Supplemental Information (Unaudited) 38
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Cotton Valley Resources Corporation
Dallas, Texas
We have audited the accompanying consolidated balance sheet of Cotton
Valley Resources Corporation and subsidiaries (a development stage
company) as of June 30, 1998, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for the
year then ended and the period from February 15, 1995 (date of
incorporation) to June 30, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial
position of Cotton Valley Resources Corporation and subsidiaries
as of June 30, 1998 and the results of their operations and their cash
flows for the year then ended and the period from February 15, 1995
(date of incorporation) to June 30, 1998, in conformity with generally
accepted accounting principles.
The carrying value of the Company's oil and gas properties is
supported primarily by proved undeveloped reserves.
LANE GORMAN TRUBITT L.L.P.
Dallas, Texas
September 11, 1998
<PAGE>
Board of Directors
Cotton Valley Resources Corporation
Dallas, Texas
We have audited the accompanying of consolidated statements of
operations, stockholders' equity and cash flows
Cotton Valley Resources Corporation and subsidiaries (a development stage
company) for the year ended June 30, 1997, and the period from
February 15, 1995 (date of incorporation) to June 30, 1995 and the
period from February 15, 1995 to June 30, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, results of the Company
its operations and its cash flows for the year ended June 30, 1997,
the period from February 15, 1995 (date of incorporation) to June 30, 1995
and the period from February 15, 1995 to June 30, 1997 in accordance with
generally accepted accounting principles.
The carrying value of the Company's oil and gas properties is
supported primarily by proved undeveloped reserves.
HEIN + ASSOCIATES, L.L.C.
Dallas, Texas
September 15, 1997
<PAGE>
<TABLE>
COTTON VALLEY RESOURCES CORPORATION
(a development stage company)
ASSETS
<S> <C>
CURRENT ASSETS:
Cash $ 85,762
Accounts receivable 396,390
Materials and supplies inventory 891,359
Prepaid expenses 219,119
-----------
Total current assets 1,592,630
Proved Oil & Gas Properties (full cost method) 24,331,189
net of accumulated depletion of $396,008
Office Furniture and Equipment 92,412
net of accumulated depreciation of $24,724
Debenture Financing Costs and Other Assets 521,625
-----------
Total Assets $26,537,856
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,175,396
Accrued expenses 51,288
Accrued interest 158,483
Accrued well plugging costs 186,640
-----------
Total current liabilities 1,571,807
Long Term Debt, net of discount of $53,962 4,654,638
Advances from Related Parties 122,989
Deferred Income Taxes 1,845,000
Stockholders' Equity
Preferred stock, no par value, authorized-unlimited,- issued, none -
Common Stock, no par value, authorized-unlimited:
issued: - 17,273,278 21,119,482
Warrants and beneficial conversion feature 823,695
Deficit accumulated in development state (3,599,755)
-----------
Total liabilities and stockholders equity $26,537,856
===========
See accompanying notes to these financial statements.
</TABLE>
<TABLE>
COTTON VALLEY RESOURCES CORPORATION
(a development stage company)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Expressed in U.S. Dollars)
Period from
February 15, 1995
Year Ended June 30, to
1998 1997 June 30, 1998
----- ----- --------------
<S> <C> <C> <C>
REVENUE:
Oil and gas sales $ 835,684 $ 272,243 $ 1,107,927
Equipment sales 987,811 987,811
Other income 2,357 - 2,357
---------- ------------ -------------
Total Revenue 1,825,852 272,243 2,098,098
EXPENSES:
Oil and gas production 615,162 252,272 867,434
Cost of equipment sold 542,864 - 542,864
Operating expenses 117,509 - 117,509
General and administrative 1,330,361 2,825,678 5,196,732
Depreciation and depletion 378,920 27,000 405,920
Other expenses 1,566 - 1,566
----------- ----------- --------------
Total Expenses 2,986,382 3,104,950 7,132,025
----------- ----------- --------------
LOSS FROM OPERATIONS (1,160,530) (2,832,707) (5,033,930)
OTHER INCOME (EXPENSES):
Interest and financing expense (814,845) (97,158) (1,050,973)
Gain on sale of assets 629,660 - 629,660
Interest income 47,437 3,987 56,810
----------- ----------- --------------
Total Other (137,747) (93,171) (364,503)
----------- ----------- --------------
LOSS BEFORE INCOME TAX (1,298,278) (2,925,878) (5,398,433)
INCOME TAX BENEFIT 467,678 919,000 1,798,678
----------- ----------- --------------
NET LOSS $ (830,600) $(2,006,878) $(3,599,755)
NET LOSS PER SHARE $ (0.05) $ (0.18) $ (0.30)
WEIGHTED AVERAGE SHARES 16,301,723 11,403,000 11,868,140
See accompanying notes to these financial statements.
</TABLE>
<TABLE>
COTTON VALLEY RESOURCES CORPORATION
(a development stage company)
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM FEBRUARY 15, 1995 TO JUNE 30, 1998
(Expressed in U.S. Dollars)
COMMON STOCK
COMMON STOCK SUBSCRIBED
SHARES AMOUNT SHARES AMOUNT
------ ------ ------- ------
<S> <C> <C> <C> <C>
Issued upon incorporation to
Officers ($.003 per share) 560,001 $ 1,401 - -
Issued March 10, 1995 for the
acquisition of
subsequently abandoned oil and gas
properties (621,600 shares issued
and 310,800 shares canceled $.003
per share) 310,800 777 - -
Issued March 10, 1995 for the acquisition
of oil and gas properties
($1.82 per share) 3,875,957 7,072,914 - -
Issued June 1, 1995 for cash
($1.00 per share) 10,000 10,000 - -
Net Loss - - - -
--------- --------- ----- ----
BALANCES, June 30, 1995 4,756,758 7,085,092 - -
Issued July - December 1995 in
connection with notes payable
($1.49 per share) 107,258 160,008 - -
Repayment and conversion to equity
of notes payable, net of
amortized discount - (72,000) - -
Issued December 29, 1995 to officers
upon conversion of special shares
($.004 per share) 1,440,000 5,840 - -
Issued December 29, 1995 as advance
for stock offering costs
($1.49 per share) 340,000 506,409 - -
Issued December 29, 1995 to officers
for services ($1.49 per share) 300,000 446,950 - -
Sale of shares for cash during April - June
1996 ($1.64 per share) 1,272,500 2,089,872 - -
Issued June 14, 1996 upon conversion
of debentures ($1.48 per share) 288,529 426,474 - -
Issued June 14, 1996 to former Arjon
shareholders ($.21 per share) 686,551 146,300 - -
Share issuance costs - (915,785) - -
Net loss - - - -
--------- ---------- ---- ----
BALANCES, June 30, 1996 9,191,596 9,879,160 - -
- --Continued--
</TABLE>
<TABLE>
WARRANTS
AND
BENEFICAL
SPECIAL SHARES CONVERSION
SHARES AMOUNT DISCOUNT
------- ------ ----------
<S> <C> <C> <C>
Issued upon incorporation to officers
($.003 per share) 2,100,000 $ 8 -
Issued March 10, 1995 for the
acquisition of
subsequently abandoned oil and gas
properties (621,600 shares issued
and 310,800 shares canceled $.003
per share) - - -
Issued March 10, 1995 for the acquisition
of oil and gas properties
($1.82 per share) - - -
Issued June 1, 1995 for cash
($1.00 per share) - - -
Net Loss - - -
--------- --------- --------
BALANCES, June 30, 1995 2,100,000 8 -
Issued July - December 1995 in
connection with notes payable
($1.49 per share) - - -
Repayment and conversion to equity
of notes payable, net of
amortized discount - - -
Issued December 29, 1995 to officers
upon conversion of special shares
($.004 per share) (2,100,000) (8) -
Issued December 29, 1995 as advance
for stock offering costs
($1.49 per share) - - -
Issued December 29, 1995 to officers
for services ($1.49 per share) - - -
Sale of shares for cash during April - June
1996 ($1.64 per share) - - -
Issued June 14, 1996 upon conversion
of debentures ($1.48 per share) - - -
Issued June 14, 1996 to former Arjon
shareholders ($.21 per share) - - -
Share issuance costs - - -
Net loss - - -
--------- ---------- -----
BALANCES, June 30, 1996 - - -
- --Continued-
</TABLE>
<TABLE>
DEFICT
ACCUMULATED
IN DEVELOPMENT
STAGE TOTAL
-------------- -----------
<S> <C> <C>
Issued upon incorporation to officers
($.003 per share) - $ 1,409
Issued March 10, 1995 for the
acquisition of
subsequently abandoned oil and gas
properties (621,600 shares issued
and 310,800 shares canceled $.003
per share) - 777
Issued March 10, 1995 for the acquisition
of oil and gas properties
($1.82 per share) - 7,072,914
Issued June 1, 1995 for cash
($1.00 per share) - 10,000
Net Loss (49,917) (49,917)
------------- ------------
BALANCES, June 30, 1995 (49,917) 7,035,183
Issued July - December 1995 in
connection with notes payable
($1.49 per share) - 160,008
Repayment and conversion to equity
of notes payable, net of
amortized discount - (72,000)
Issued December 29, 1995 to officers
upon conversion of special shares
($.004 per share) - 5,832
Issued December 29, 1995 as advance
for stock offering costs
($1.49 per share) - 506,409
Issued December 29, 1995 to officers
for services ($1.49 per share) - 446,950
Sale of shares for cash during April - June
1996 ($1.64 per share) - 2,089,872
Issued June 14, 1996 upon conversion
of debentures ($1.48 per share) - 426,474
Issued June 14, 1996 to former Arjon
shareholders ($.21 per share) - 146,300
Share issuance costs - (915,785)
Net loss - (712,360)
------------- -------------
BALANCES, June 30, 1996 - 9,116,883
- --Continued--
</TABLE>
<TABLE>
COMMON STOCK
COMMON STOCK SUBSCRIBED
SHARES AMOUNT SHARES AMOUNT
------ ------ ------- ------
<S> <C> <C> <C> <C>
- --Continued--
Issued August 13, 1996 for exercise
of warrants ($1.64 per share) 6,667 10,950 - -
Issued in August and November 1996 for
exercise of warrants ($.48 per share) 175,001 84,315 - -
Sales of shares for cash during November 1996
($.73 per share) 100,000 73,365 - -
Issued primarily in December 1996 for
services ($.78 per share) 86,888 67,432 - -
Issued in December 1996 to settle
liabilities ($.73 per share) 53,750 39,238 - -
Issued in December 1996 for investor relations
services ($.73 per share) 1,490,000 1,087,700 - -
Issued in December 1996 for investor relations
services ($.73 per share) 1,490,000 1,087,700 - -
Sale of shares for cash on January 7, 1997
($.82 per share), less commission of
$16,400 200,000 147,825 - -
Issued during January 1997 for exercise of
warrants ($.48 per share) 241,666 116,434 - -
Issued February 5, 1997 for exercise of
warrants ($2.00 per share) 11,239 22,562 - -
Issued February 5, 1997 for exercise of
warrants ($1.47 per share) 37,741 55,791 - -
Issued during March 1997 for exercise of
warrants ($1.64 per share) 31,667 52,014 - -
Sale of shares from December 1996 through
March 1997 for cash, including shares
subscribed but not issued
($.75 per share) 375,000 281,250 125,000 93,750
Sale of shares for cash during February -
June 1997 ($1.51 per share) 266,667 402,527 - -
- --Continued--
</TABLE>
<TABLE> WARRANTS
AND
BENEFICAL
SPECIAL SHARES CONVERSION
SHARES AMOUNT DISCOUNT
------- ------ ------------
<S> <C> <C> <C>
- --Continued--
Issued August 13, 1996 for exercise
of warrants ($1.64 per share) - - -
Issued in August and November 1996 for
exercise of warrants ($.48 per share) - - -
Sales of shares for cash during November 1996
($.73 per share) - - -
Issued primarily in December 1996 for
services ($.78 per share) - - -
Issued in December 1996 to settle
liabilities ($.73 per share) - - -
Issued in December 1996 for investor relations
services ($.73 per share) - - -
Sale of shares for cash on January 7, 1997
($.82 per share), less commission of
$16,400 - - -
Issued during January 1997 for exercise of
warrants ($.48 per share) - - -
Issued February 5, 1997 for exercise of
warrants ($2.00 per share) - - -
Issued February 5, 1997 for exercise of
warrants ($1.47 per share) - - -
Issued during March 1997 for exercise of
warrants ($1.64 per share) - - -
Sale of shares from December 1996 through
March 1997 for cash, including shares
subscribed but not issued
($.75 per share) - - -
Sale of shares for cash during February -
June 1997 ($1.51 per share) - - -
- --Continued-
</TABLE>
<TABLE>
DEFICT
ACCUMULATED
IN DEVELOPMENT
STAGE TOTAL
-------------- -----------
<S> <C> <C>
- --Continued--
Issued August 13, 1996 for exercise
of warrants ($1.64 per share) - 10,950
Issued in August and November 1996 for
exercise of warrants ($.48 per share) - 84,315
Sales of shares for cash during November 1996
($.73 per share) - 73,365
Issued primarily in December 1996 for
services ($.78 per share) - 67,432
Issued in December 1996 to settle
liabilities ($.73 per share) - 39,238
Issued in December 1996 for investor relations
services ($.73 per share) - 1,087,700
Sale of shares for cash on January 7, 1997
($.82 per share), less commission of
$16,400 - 147,825
Issued during January 1997 for exercise of
warrants ($.48 per share) - 116,434
Issued February 5, 1997 for exercise of
warrants ($2.00 per share) - 22,562
Issued February 5, 1997 for exercise of
warrants ($1.47 per share) - 55,791
Issued during March 1997 for exercise of
warrants ($1.64 per share) - 52,014
Sale of shares from December 1996 through
March 1997 for cash, including shares
subscribed but not issued
($.75 per share) - 375,000
Sale of shares for cash during February -
June 1997 ($1.51 per share) - 402,527
- --Continued-
</TABLE>
<TABLE>
COMMON STOCK
COMMON STOCK SUBSCRIBED
SHARES AMOUNT SHARES AMOUNT
------ ------ ------- ------
<C> <C> <C> <C>
- --Continued--
Issuance of shares in May 1997 for
services (1.84 per share) 20,400 37,500 - -
Cash received in June 1997 as
prepayment for subsequent exercise of
warrants ($2.00 per share) - - 52,000 104,000
Issuance of shares in June 1997 for
conversion of notes payable
($1.16 per share) 302,191 349,000 - -
Estimated fair value of warrants issued for
services in November 1996 and as
discount on note payable in
June 1997 - - - -
Net loss - - - -
---------- ------- ------ --------
BALANCES, June 30, 1997 12,590,473 12,707,063 177,000 197,750
=========== ========== ======= ========
Issuance of shares in July for Aspen Energy
acquisition ($1.87 per share) 2,511,287 4,700,000 - -
WPM Group private placement
in August 1997 ($1.667 per share) 272,700 454,500 - -
Share issued in July 1997 against prior
subscription agreement 177,000 197,750 (177,000) (197,750)
Shares issued for employee bonuses
in August 1997 ($1.06 per share) 45,000 47,813 - -
Shares issued in September 1997 for
purchase of property
($3.70 per share) 9,447 35,000 - -
- --Continued-
Warrants issued in connection with
$125,000 note placement in September
1997 - - - -
Warrants exercised July-October
1997 ($1.85 per share) 1,610,674 3,017,812 - -
Exercise of warrants in December 1997
($1.22 per share) 66,667 81,419 - -
Discount for beneficial conversion feature of
$4,320,000 of convertible debentures
issued in December, 1998 - - - -
Issuance of shares in February 1998 for
conversion of convertible note 60,000 100,000 - -
Cancellation of shares in March 1998
for debt in Aspen acquisition (269,970) (425,000) - -
Issuance of shares for services in May 1998
($1.1875 per share) 150,000 178,125 - -
Issuance of shares for property option
($.50 per share) 50,000 25,000 - -
Net loss - - - -
----------- ----------- -------- -------
BALANCES, June 30, 1998 17,273,278 $21,119,482 - $ -
=========== =========== ======== ========
See accompanying notes to these financial statements.
</TABLE>
<TABLE>
WARRANTS
AND
BENEFICAL
SPECIAL SHARES CONVERSION
SHARES AMOUNT DISCOUNT
------- ------ ----------
<S> <C> <C> <C>
- --Continued--
Issuance of shares in May 1997 for
services (1.84 per share) - - -
Cash received in June 1997 as
prepayment for subsequent exercise of
warrants ($2.00 per share) - - -
Issuance of shares in June 1997 for
conversion of notes payable
($1.16 per share) - - -
Estimated fair value of warrants issued for
services in November 1996 and as
discount on note payable in
June 1997 - - 323,000
---------- ------- ---------
Net loss - - -
BALANCES, June 30, 1997 - - 323,000
=========== ========== ==========
Issuance of shares in July for Aspen Energy
acquisition ($1.87 per share)
- - -
WPM Group private placement
in August 1997 ($1.667 per share) - - -
Share issued in July 1997 against prior
subscription agreement - - -
Shares issued for employee bonuses
in August 1997 ($1.06 per share) - - -
Shares issued in September 1997 for
purchase of property
($3.70 per share) - - -
- --Continued-
Warrants issued in connection with
$125,000 note placement in September
1997 - - 21,533
Warrants exercised July-October
1997 ($1.85 per share) - - -
Exercise of warrants in December 1997
($1.22 per share) - - -
Discount for beneficial conversion feature of
$4,320,000 of convertible debentures
issued in December, 1998 - - 479,162
Issuance of shares in February 1998 for
conversion of convertible note - - -
Cancellation of shares in March 1998
for debt in Aspen acquisition - - -
Issuance of shares for services in May 1998
($1.1875 per share) - - -
Issuance of shares for property option
($.50 per share) - - -
Net loss - - -
---------- -------- ---------
BALANCES, June 30, 1998 - $ - $823,695
=========== ======== =========
See accompanying notes to these financial statements.
</TABLE>
<TABLE>
DEFICT
ACCUMULATED
IN DEVELOPMENT
STAGE TOTAL
-------------- -----------
<S> <C> <C>
- --Continued--
Issuance of shares in May 1997 for
services (1.84 per share) - 37,500
Cash received in June 1997 as
prepayment for subsequent exercise of
warrants ($2.00 per share) - 104,000
Issuance of shares in June 1997 for
conversion of notes payable
($1.16 per share) - 349,000
Estimated fair value of warrants issued for
services in November 1996 and as
discount on note payable in
June 1997 - 323,000
Net loss (2,006,878) (2,006,878)
--------------- ------------
BALANCES, June 30, 1997 (2,769,155) 10,458,658
=============== ============
Issuance of shares in July for Aspen Energy
acquisition ($1.87 per share) - 4,700,000
WPM Group private placement
in August 1997 ($1.667 per share) - 454,500
Share issued in July 1997 against prior
subscription agreement -
Shares issued for employee bonuses
in August 1997 ($1.06 per share) - 47,813
Shares issued in September 1997 for
purchase of property
($3.70 per share) - 35,000
- --Continued-
Warrants issued in connection with
$125,000 note placement in September
1997 - 21,533
Warrants exercised July-October
1997 ($1.85 per share) - 3,017,812
Exercise of warrants in December 1997
($1.22 per share) - 81,419
Discount for beneficial conversion feature of
$4,320,000 of convertible debentures
issued in December, 1998 - 479,162
Issuance of shares in February 1998 for
conversion of convertible note - 100,000
Cancellation of shares in March 1998
for debt in Aspen acquisition - (425,000)
Issuance of shares for services in May 1998
($1.1875 per share) - 178,125
Issuance of shares for property option
($.50 per share) - 25,000
Net loss (830,600) (830,600)
---------- -----------
BALANCES, June 30, 1998 $(3,599,755) $18,343,422
=========== ===========
See accompanying notes to these financial statements.
</TABLE>
<TABLE>
COTTON VALLEY RESOURCES CORPORATION
(a development stage company)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. Dollars)
Year Ended June 30,
1998 1997
---------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (830,600) $ (2,006,878)
Adjustments to reconcile net loss
to net cash used by operating activities:
Deferred income tax benefit (467,678) (919,000)
Depreciation and depletion 378,920 40,128
Amortization 633,632 -
Common stock and warrants issued
for services 69,346 1,391,632
Change in accounts receivable
and prepaid expenses (341,430) (110,797)
Change in accounts payable and
accrued liabilities 878,770 406,348
Change in materials and supplies
inventory (891,359) -
Other (33,685) 2,189
------------- -------------
Net cash used by
operating activities (604,084) (1,196,378)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties (6,600,175) (937,621)
Acquisition of office furniture
and equipment (61,673) (18,242)
------------ --------------
Net cash used by
investing activities (6,661,848) (955,863)
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock and exercise
of warrants 3,553,731 1,444,783
Issuance of convertible debentures 4,320,000 -
Issuance of note payable subsequently
converted into convertible debentures - -
Payment of liability related to
oil and gas property - -
Costs related to sale of stock
and notes (557,528) -
Issuance of notes payable 513,600 579,000
Repayment of notes payable
and long-term debt (1,104,000)
Advances from (repayments to)
related parties (16,721) (32,000)
------------- -------------
Net cash provided by
financing activities 6,709,082 1,991,783
NET INCREASE (DECREASE) IN CASH (556,850) (160,458)
CASH - Beginning of period 642,612 803,070
------------- -------------
CASH - End of period $ 85,762 $ 642,612
SUPPLEMENT INFORMATION:
Cash paid for interest 169,973 38,059
Conversion of debt and other
liabilities to common stock 100,000 388,238
Liabilities incurred in acquisition
of oil and gas properties 300,000 -
Retirement of debenture upon merger
with Arjon - -
Oil and gas property option acquired
with payable - -
Oil and gas properties acquired with
common stock 4,335,000 -
Issuance of common stock for stock
offering costs - -
Transfer of accounts payable and
related property option - 230,000
Prepaid expenses acquired with
common stock 178,125 -
Beneficial conversion feature on
convertible debentures 479,162 -
See accompanying notes to these financial statements.
</TABLE>
<TABLE>
COTTON VALLEY RESOURCES CORPORATION
(a development stage company)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. Dollars)
Period From
February 15, 1995
to
June 30, 1998
-----------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net profit (loss) $(3,599,755)
Adjustments to reconcile net loss to net cash
used by operating activities:
Deferred income tax benefit (1,798,678)
Depreciation and depletion 420,731
Amortization 721,632
Common stock and warrants issued
for services 1,910,109
Change in accounts receivable
and prepaid expenses (452,227)
Change in accounts payable and
accrued liabilities 1,571,807
Change in materials and supplies
inventory (891,359)
Other (25,653)
-------------
Net cash used by
operating activities (2,143,393)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties (8,289,555)
Acquisition of office furniture
and equipment (117,135)
------------
Net cash used by
investing activities (8,406,690)
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock and exercise
of warrants 7,098,386
Issuance of convertible debentures 4,746,474
Issuance of note payable subsequently
converted into convertible debentures 146,300
Payment of liability related to
oil and gas property (500,000)
Costs related to sale of stock
and notes (966,904)
Issuance of notes payable 1,342,600
Repayment of notes payable
and long-term debt (1,354,000)
Advances from (repayments to)
related parties 122,989
-------------
Net cash provided by
financing activities 10,635,845
NET INCREASE (DECREASE) IN CASH 85,762
CASH - Beginning of period -
-------------
CASH - End of period $ 85,762
SUPPLEMENT INFORMATION:
Cash paid for interest 245,042
Conversion of debt and other
liabilities to common stock 914,712
Liabilities incurred in acquisition
of oil and gas properties 1,386,049
Retirement of debenture upon merger
with Arjon 146,300
Oil and gas property option acquired
with payable 230,000
Oil and gas properties acquired with
common stock 11,407,914
Issuance of common stock for stock
offering costs 506,409
Transfer of accounts payable and
related property option 230,000
Prepaid expenses acquired with
common stock 178,125
Beneficial conversion feature on
convertible debentures 479,162
See accompanying notes to these financial statements.
</TABLE>
COTTON VALLEY RESOURCES CORPORATION
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
The Company was incorporated under the laws of Ontario as Cotton
Valley Energy Limited (CVEL) on February 15, 1995. It acquired all of the
shares of Cotton Valley Energy Corporation (CVEC), a Nevada
corporation, on June 30, 1995 in a one-for-one share and warrant
exchange. CVEC was also incorporated in February 1995. CVEL had no
substantive activity, so the acquisition of CVEC was accounted for as
a recapitalization of CVEL with the net assets of CVEC. These
consolidated financial statements have been prepared as if the
Company had acquired CVEC at the Company's inception.
On June 14, 1996, the Company merged with Arjon Enterprises, Inc.
("Arjon"), an Ontario corporation and reporting issuer in Ontario.
As a result of that merger the Company's name was changed to Cotton
Valley Resources Corporation and a new capital structure was established.
Transactions in the accompanying financial statements are reflected
as if the resulting capital structure was in existence since inception.
Arjon had no business activities and its only asset consisted of
convertible debentures of the Company in the principal amount of
$146,300. The Company accounted for the transaction as an issuance
of stock for the net monetary assets of Arjon accompanied by a
recapitalization. Former Arjon shareholders received 686,551 common
shares (representing approximately 7.5% of the then outstanding
common shares) of the Company.
On April 30, 1996, the Company organized Cotton Valley Operating
Company, a Texas corporation ("CV Operating") to operate the
Company's oil and gas properties. The Company on February 25, 1997,
organized Cotton Valley Energy, Inc., an Oklahoma corporation ("CVEI") to
acquire and operate the N.E. Alden Field properties in Caddo County,
Oklahoma. CVEI commenced operations on March 3, 1997. Aspen Energy
Corporation, a Nevada corporation ("Aspen"), was an inactive subsidiary
of the Company, formed on May 1, 1996, which was used to accommodate the
merger of Aspen Energy Corporation, a New Mexico corporation ("Old
Aspen") into Aspen on July 31, 1997. The principal asset of Old
Aspen was its interest in the Means Unit in Andrews County, Texas (the
"Means Unit"). On May 27, 1998, Aspen organized Cotton Valley Means, Inc.
as a Texas corporation ("CV Means") and transferred all of its interest
in the Means Unit to CV Means to facilitate a $10 million financing
relating to the development of this property.
In addition to CV Energy, CV Operating, CVEI, Aspen and CV Means, the
Company recently organized Mustang Well Servicing Company, a Nevada
corporation ("Mustang Well Servicing"), Mustang Oilfield Equipment
Company, a Nevada corporation ("Mustang Equipment"), and Mustang
Horizontal Services, Inc., a Nevada corporation ("Mustang
Horizontal") (collectively, the "Mustang Service Companies"). All of the
Company's subsidiaries are wholly owned by the Company, except for CV Means
which is a wholly-owned subsidiary of Aspen.
The Company is in the development stage and has not had material
revenues from operations through June 30, 1997. Although it
commenced sales during the year ended June 30, 1998, the Company incurred
losses due to its efforts to raise capital for its development. The
Company's planned principal business activity is to acquire, explore, and
develop oil and gas properties, including trading in used oil field
equipment.
The recoverability of amounts capitalized for oil and gas properties
is dependent upon the identification of economically recoverable
reserves, together with obtaining the necessary financing to exploit such
reserves and the achievement of profitable operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Oil and Gas Properties
The Company follows the full-cost method of accounting for oil and
gas properties. Accordingly, all costs associated with acquisition,
exploration and development of oil and gas reserves, including
directly related overhead costs, are capitalized into a "full-cost pool". A
separate full cost pool is established for U.S. and non-U.S.
properties.
All capitalized costs of oil and gas properties, including the
estimated future costs to develop proved reserves, are amortized on
the unit-of-production method using estimates of proved reserves. Costs
directly associated with the acquisition and evaluation of unproved
properties are excluded from the amortization base until the related
properties are evaluated. Such unproved properties are assessed
periodically and a provision for impairment is made to the full-cost
amortization base when appropriate. Sales of oil and gas properties
are credited to the full-cost pool unless the sale would have a
significant effect on the amortization rate. See Note 9.
Abandonments of properties are accounted for as adjustments to capitalized
costs with no loss recognized. Oil and gas drilling and workover equipment
used primarily on the Company's properties are included in the full
cost pool.
The net capitalized costs are subject to a "ceiling test" which
limits such costs to the aggregate of the estimated present value of future
net revenues from proved reserves discounted at ten percent based on
current economic and operating conditions.
Revenue Recognition
Revenue is accrued and recognized in the month the oil and gas is
produced and sold.
Office Furniture and Equipment
Office equipment is recorded at cost and depreciated on a straight-
line basis over the estimated useful lives of the assets, which range from
three to ten years.
Foreign Currency Translation
The Company's assets and principal activities are in the United
States and its functional currency is the U.S. dollar. The effects of
exchange rate changes on transactions denominated in Canadian dollars or
other currencies are charged to operations. Foreign exchange gains or
losses were insignificant for all periods presented.
Income Taxes
Income taxes are provided for the tax effects of transactions
reported in the financial statements and consist of taxes currently due, if
any, plus net deferred taxes related primarily to differences between the
bases of assets and liabilities for financial and income tax reporting.
Deferred tax assets and liabilities represent the future tax return
consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.
Deferred tax assets include recognition of operating losses that are
available to offset future taxable income and tax credits that are
available to offset future income taxes. Valuation allowances are
recognized to limit recognition of deferred tax assets where
appropriate. Such allowances may be reversed when circumstances
provide evidence that the deferred tax assets will more likely than
not be realized.
Deferred Site Restoration
A provision is established for estimated future costs of site
restoration of oil and gas production interests, including the
removal of production facilities at the end of their useful life.
Costs are based on management's estimates of the anticipated method
and extent of site restoration. The annual charge is determined on
the same basis as the depletion and amortization of the underlying asset.
Net Loss Per Share
Per share information is based on the weighted average number of
common stock and common stock equivalent shares outstanding. As
required by the Securities and Exchange Commission rules, all warrants,
options, and shares issued within a year prior to the initial filing of a
registration statement are assumed to be outstanding for each year
presented for purposes of the loss per share calculation.
Cash Flow Statement
For purposes of the statements of cash flows, the Company considers
all highly liquid debt instruments purchased with an original maturity of
three months or less to be cash equivalents.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123 - Accounting for
Stock-Based Compensation (SFAS 123), which was effective for the
Company beginning with its 1997 fiscal year, requires recognition of
compensation expense for grants of stock, stock options, and other
equity instruments based on fair value. If the grants are to
employees, companies may elect to disclose only the pro forma effect
of such grants on net income and earnings per share in the notes to
financial statements and continue to account for the grants pursuant
to APB Opinion No. 25, "Accounting for Stock Issued to Employees". The
Company has elected the pro forma disclosure alternative for employee
grants.
Use of Estimates
The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires the
Company to make estimates and assumptions that affect the amounts
reported in these financial statements and accompanying notes.
Actual results could differ from those estimates. Significant assumptions
are required in the valuation of proved oil and gas reserves, which as
described above may affect the amount at which oil and gas properties
are recorded. It is at least reasonably possible those estimates
could be revised in the near term and those revisions could be material.
Inventories
Inventories, which consist primarily of oilfield equipment and
supplies held for resale, are stated at the lower of cost or market
using the first-in, first-out (FIFO) method.
Debenture Financing Costs
Debenture financing costs are being amortized ratably over the life
of the related debenture.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All material intercompany
accounts and transactions of consolidated subsidiaries have been
eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to the prior years financial
statements to conform to the current year presentation.
Accounting Pronouncements
In 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits
("SFAS 132"), and SFAS 133, Accounting for Derivative Instruments and
Hedging Activities." SFAS 132 is effective for fiscal years beginning
after December 15, 1997, and SFAS 133 is effective for fiscal years
beginning after June 15, 1999. Also in June 1997 the FASB issued
SFAS 130, Reporting Comprehensive Income effective for years beginning
after December 15, 1997. The Company does not anticipate a material
impact to its consolidated financial statements upon adoption
of these standards.
3. OIL AND GAS PROPERTIES
Cheneyboro Field
The Company acquired approximately 5,000 net acres of oil and gas
leases in the Cheneyboro Field of Navarro County, Texas during fiscal
years 1995 and 1996. The Company issued 3,252,533 common shares,
granted 406,567 Class A warrants (see Note 5), and paid $500,000 in
cash and a promissory note of $586,049 as consideration. The stock
was recorded at $5,935,281, based on the estimated fair value of the
properties. The Company determined fair value by reference to an
independent engineering firm's reserve report. Since inception, the
Company has invested approximately $9,512,000 on this property,
including the aforementioned acquisition costs.
Sword Unit, Offshore Santa Barbara, California
The Company has entered into option agreements to acquire a working
interest in the Sword Unit, Offshore Santa Barbara, California. The
Company paid $400,000 in fiscal year 1996 to acquire the option. In
addition, the Company paid an additional $125,000 in fiscal year 1997
to settle a contingent liability of up to $1,000,000 due upon closing
the acquisition. To complete the option and acquire the working
interest, the Company was initially required to pay $12,000,000 in
cash and marketable securities (including the $1,000,000 referred to
above) on closing sometime in 1997. In June 1997, in connection with the
transfer of one of the Company's properties, the requirement was
reduced to $8,000,000, of which $2,000,000 may be in the Company's
stock at the election of the other party. The Company is also
required to participate in a $4,000,000 letter of credit related to the
abandonment of two existing wells if it acquires the working
interest. Subsequent to June 30, 1998, the Company determined that it would be
unable to raise the necessary capital to exercise the option and
reassigned the option back to its original holder.
Alden Properties, Caddo County, Oklahoma
In fiscal year 1997, the Company acquired an interest in the Alden
properties for $390,000. In fiscal year 1998, the company acquired
additional interests in the Alden properties for cash and common
stock.
Aspen Energy Corporation
On July 31, 1997, effective June 30, 1997, the Company acquired 100%
of Aspen Energy Corporation, an oil and gas company, for $200,000 in
cash, a $300,000 promissory note which was paid in two installments through
January 1998 and 2,511,317 shares of the Company's common stock. The
transaction was recorded for as a purchase. The stock was recorded at
$4,700,000. In March 1998 the shareholders of Aspen to delivered 269,870
of the Shares they received in the transaction back to Aspen in
satisfaction of obligations owed by such shareholders to Aspen in the
amount of $425,000.
Well Servicing and Drilling Equipment
During fiscal year 1998, the Company purchased $2,756,296 of well
servicing and horizontal drilling equipment. Most of this equipment
was "tooled out" and put into service during January, February and March
1998, and has for the remainder of fiscal year 1998 worked only on
development of the Company's properties. All the costs associated
with purchase, tooling out and operations have been capitalized in the
full cost pool. Subsequent to June 30, 1998 some of the equipment has
been rented to third parties and the proceeds therefore have been treated
as a credit to the full cost pool. On June 30, 1998, the full cost pool
of $24,331,189 includes $3,197,877 of drilling and well service
equipment.
4. NOTES PAYABLE AND LONG-TERM DEBT
The Company had a $579,000 convertible 9% note payable at June 30, 1997
to a company that provided investor relations services to the Company
and owns stock in the Company. Warrants to purchase 161,351 shares at
$2.08 through April 30, 2002 were also granted in connection with this
transaction. The estimated fair value of the warrants at the time of
grant of $124,000 was accounted for as a discount to the note. During
November 1997, $100,000 of the note was converted into 60,000 shares
of common stock and the remaining principal and accrued interest was
paid.
The Company had a 12% promissory note payable totaling $200,000 at June
30, 1997, for the unpaid purchase price of the Cheneyboro oil and gas
properties (see Note 3). The note was paid in November 1997.
Sale of Convertible Debentures. On December 30, 1997, the Company
completed the private placement of the $4,320,000 Convertible Debentures
to a group of nine institutional investment firms. Approximately $1
million of the cash proceeds and $220,000 of Convertible Debentures were
used to purchase the Equipment. The remaining funds have been used for
the acquisition and development of oil and gas properties, purchase of
oil field equipment and working capital.
The Convertible Debentures are due December 31, 2001 and are secured
by the Equipment and other assets of the Company. Interest is payable
annually at 7%. The Convertible Debentures are convertible into shares
of the Company's Common Stock and Debenture Warrants, subject to
adjustment upon certain events. Under the terms of the Convertible
Debentures, the Company was obligated to obtain on or before May 30,
1998 an effective registration statement covering the shares of
Common Stock to be issued upon conversion of the Convertible
Debentures and exercise of the Debenture Warrants. The Company was
not successful in obtaining the effectiveness of the registration
statement which event, with notice, would have been an event of default
under the Convertible Debentures.
A beneficial conversion feature was recognized and measure by
allocating a portion of the proceeds equal to the intrinsic value of that
feature to stockholders' equity. The estimated fair value of $479,162
has been recorded as a discount to the note and is being amortized
from the issue date to the date the debenture first becomes convertible.
As of September 15, 1998, the Company and each Convertible
Debentureholder were in negotiation for certain amendments to the
Convertible Debentures and related documents, including a waiver of
the event of default. As consideration for the waiver, the Company has
agreed to issue a total of 400,000 shares (the "Waiver Shares") on a
pro rata basis to each Convertible Debentureholder. The Waiver
Shares will be valued by the board of directors at $0.425 per share when
issued to the Convertible Debentureholder. Additionally, the Company
expects to issue and deliver to the Convertible Debentureholders
approximately 700,000 shares of common stock in lieu of accrued
interest of approximately $302,000 on the Convertible Debentures
for December 30, 1997 through December 31, 1998.
Means Credit Facility. On June 12, 1998, CV Means entered into a
credit agreement with Triassic Energy Partners, L.P. ("Triassic"),
an affiliate of Cambrian Capital Corporation whereby CV Means could
borrow up to $10,000,000 on a multiple-advance, non-revolving basis (the
"Means Credit Facility"). Repayment of amounts advanced under the
Means Credit Facility is guaranteed by the Company and all its
subsidiaries.
Under the Means Credit Facility, up to $1,000,000 may be advanced for
new project development working capital purposes. The remaining
$9,000,000 may be advanced for the development of the Company's Means
(Queen Sand) Unit in Andrews County, Texas (the "Means Unit"). As of
September 15, 1998, the Company had drawn down $350,000 for working
capital and $388,600 for Means Unit property development purposes. A
$10 million promissory note dated June 12, 1998 with interest payable
monthly at the prime rate of Citibank N.A., New York, New York plus
2% was issued to Triassic by CV Means in accordance with the terms of
the Means Credit Facility. Until the maturity date, May 31, 2002,
the Company will deliver to Triassic each month a percentage of the
revenues from the Means Unit to be applied to accrued interest and
payment of principal of the note. On the maturity date, the accrued
interest and outstanding principal balance of the note is due and
payable. As security for the Means Credit Facility, CV Means
granted a security interest in substantially all the assets of CV
Means, including the Means Unit and all income generated thereby.
As further security for the Means Credit Facility, Aspen, the sole
shareholder of CV Means, pledged all the outstanding shares of CV
Means to Triassic.
As further consideration for the Means Credit Facility, CV Means
assigned a net profits overriding royalty interest in the Means Unit
to Cambrian Capital Partners, L.P. ("Cambrian") and also entered into a
crude oil commodities swap agreement with Triassic. The Company also
issued a Unit Purchase Option to Cambrian which allows Cambrian to
purchase up to 100,000 units of the Company for $1.75 per unit. Each
unit consists of 1.085 shares of the Company's Common Stock and one
warrant, which grants to the warrant holder the right to purchase two
shares of Common Stock at an exercise price of $2.02 per share. All shares
issuable under this Unit Purchase Option are subject to a registration
rights agreement that requires the Company to register such shares under
certain circumstances.
5. STOCKHOLDERS' EQUITY
The Company has an unlimited number of preferred shares authorized,
which may be issued in series and include such rights and preferences
as authorized by the board of directors. The board of directors has
authorized the issuance of up to 2,000,000 shares of 8% Cumulative
Convertible Preferred Stock. No such shares have been issued as of
June 30, 1998. If the shares were to be issued, holders of the
Preferred Stock would be entitled to two votes per share on all
matters submitted to a vote of the Company's shareholders.
In addition, such holders would be entitled to receive cumulative
dividends at the rate of 8% per annum, payable at the election of the
Company in cash or in shares of common stock. Holders of the
Preferred Stock would have a liquidation preference, limited to $6.00 per share
of Preferred Stock; and each outstanding share of Preferred Stock
would be convertible at any time by the holder into two shares of common
stock.
Shortly after incorporation, the Company issued 2,100,000 special
shares for total cash consideration of $8.00 to officers, which were
subsequently exchanged for 1,440,000 common shares of the Company.
The special shares were issued in exchange for preferred stock which had
been issued upon incorporation of CVEC and subsequently canceled.
In connection with the acquisition of oil and gas properties,
including a property abandoned following its acquisition, the Company granted
518,345 Class A warrants. In connection with the issuance of notes
payable and debentures, the Company granted 112,390 Class A warrants.
The Company also issued 636,250 Class A warrants in conjunction with
a private placement of common shares. Each Class A warrant is a right
to purchase one common share for $2.00 until December 31, 1997, which
was extended to June 30, 1998. During fiscal year 1998 all Class A
warrants, except for approximately 32,000 had been exercised. The remaining
32,000 Class A Warrants expired on June 30, 1998.
Effective January 31, 1996, each 2.5 outstanding shares of the
Company's common stock were consolidated into one share and the
previously authorized unlimited number of special shares were
canceled. The financial statements reflect the consolidation of common shares
as if it occurred on inception of the Company.
In December 1995, the Company issued a total of 300,000 shares of
common stock to three officers in exchange for services performed
from June 1995 through December 1995. The shares were recorded at
$446,950, which represented the estimated value of the services.
During the year ended June 30, 1996, the Company granted to senior
employees options that enable the employees to purchase 800,000
shares of the Company's common stock for $1.83 per share until July 1, 2000.
In fiscal year 1997, options to purchase an additional 330,000 shares
were granted directors and employees under substantially the same
terms. The Company is authorized to issue shares of common stock
under its employee stock option plan to employees, officers, directors,
consultants and other service providers, provided that insiders must
not in the aggregate hold options exceeding 10% of the outstanding
shares. 280,000 of the director and employee options were exercised
during fiscal year 1998.
The Company has granted to the placement agent of the debenture and
private placement offerings that occurred in fiscal year 1996 three-
year options to purchase up to 10% of the common shares issued upon
conversion of the debentures at a price equal to the conversion
price. As a result, the agent has the right to buy 37,741 common shares at
$1.48 per share until August 31, 1998; 73,739 common shares at $2.00
per share until December 31, 1997; and 125,000 common shares at $1.64
per share until April 30, 1998. Certain of these options were
exercised in fiscal year 1997, and the remainder during fiscal year
1998.
In conjunction with the merger with Arjon, a total of 431,755 common
shares are issuable to former Arjon shareholders for Arjon warrants
in existence prior to the merger. These shares are issuable as follows:
333,334 common shares until December 31, 1998 at an exercise price of
$0.48 per share and 98,421 common shares at an exercise price of
$1.64 per share until December 31, 1997. Certain of these warrants were
exercised in fiscal year 1997, and the remainder during fiscal year
1998.
In November 1996, the Company entered into an agreement to obtain
certain investor relations services. The other party was granted
1,490,000 shares of the Company's common stock as non-forfeitable
compensation. The stock was recorded at $1,087,700, based on the
Company's stock price at the date of the agreement. The other party
was required to acquire 500,000 units, with each unit consisting of
one share of the Company's common stock and a warrant to purchase one
share for $0.80 through November 2001, for $375,000. As of June 30, 1997,
the Company had received payment for the units, but 140,000 of the
shares remained unissued. This has been recorded as common stock
subscribed in the June 30, 1997 financial statement. The shares were
issued in October 1997. None of the warrants had been exercised as
of June 30, 1998. The estimated fair value of the warrants at the time
of grant of $199,000 was recorded in fiscal year 1997 as general and
administrative expense.
In fiscal year 1998, additional warrants were granted as set forth
below. None of these warrants had been exercised as of June 30,
1998.
X Warrants to acquire 160,000 shares for $3.50 per share through
December 31, 2000 were granted in connection with an acquisition;
X Warrants to acquire 260,000 shares for $1.75 per share through July
7, 2000 were granted as compensation for assisting in exercise of
the Company's Class A Warrants outstanding;
X Warrants to acquire 355,200 shares for $2.08 per share through
April 3, 2002 were issued in connection with a private placement;
In fiscal year 1997, additional warrants were granted as set forth below.
X Warrants to acquire 266,667 shares for $1.68 per share through
January 2002 were granted in connection with a private placement;
X Warrants to acquire 200,000 shares at $.73 per share through
December 31, 1999 were granted in connection with another private
placement;
X Warrants to acquire 302,191 shares at $1.28 through June 30, 2002
were granted in connection with conversion of a note payable to
common stock as described in Note 4;
X Warrants to acquire 161,351 shares as described in Note 4;
X Warrants to acquire 166,666 shares at $.73 per share through
December 31, 1999 were granted officers.
The following table summarizes the option and warrant activity for
the years ended June 30, 1998 and 1997:
<TABLE>
June 30, 1998 June 30, 1997
---------------- -----------------
Weighted Weighted
Average Average
Number Exercise Number Exercise
of Shares Price of Shares Price
--------- --------- ---------- --------
<S> <C> <C> <C> <C>
Outstanding,
beginning of year 4,248,114 $ 1.83 2,735,220 $1.73
Granted to:
Employees, officers
and directors 674,000 1.65 496,666 1.46
Others 775,200 2.33 1,430,209 1.20
Expired 177,665 1.75 -
Exercised (1,610,674) 1.87 (413,981) .70
----------- ----------
Outstanding, end of year 3,908,975 1.87 4,248,114 1.83
</TABLE>
All outstanding warrants and options were exercisable at June 30, 1998.
If not previously exercised, warrants and options outstanding at June 30, 1998,
will expire as follows:
<TABLE>
Weighted
Average
Number Exercise
Year Ending June 30, of Shares Price
-------------------- --------- --------
<S> <C> <C>
2000 566,666 .76
2001 1,014,000 2.03
2002 1,728,309 1.48
2003 600,000 1.65
---------
Total 3,908,975
Presented below is a comparison of the weighted average exercise
prices and market price of the Company's common stock on the measurement
date for all warrants and stock options granted during fiscal years 1998
and 1997:
1998 1997
--------------------------- --------------------------
Number Exercise Market Number Exercise Market
of Shares Price Price of Shares Price Price
Fair value equal to
exercise price 934,000 $1.69 $1.69 935,524 $1.18 $1.18
Fair value greater
than exercise price - $ - $ - - $ - $ -
Exercise price greater
than fair value 515,200 $2.52 $2.10 991,351 $1.35 $1.02
Fair value of warrants granted in connection with short term debt
transactions during the year ended June 30, 1998 was determined using
the Black-Scholes option pricing model. Significant assumptions
included a risk-free interest rate of 5.5%, expected volatility of
87%, and that no dividends would be declared during the expected term of
the options. The weighted average contractual term of the warrants was
approximately 4.5 years compared to a weighted average expected term
of 2 years. The estimated fair value of warrants described above
amounted to $21,533 which is recorded as an expense in the statement of
operations.
Fair value of warrants granted to non-employees for services or in connection
with debt transactions during the year ended June 30, 1997 was determined
using the Black-Scholes option pricing model. Significant assumptions
included a risk-free interest rate of 5.9%, expected volatility of 102%, and
that no dividends would be declared during the expected term of the options.
The weighted average contractual term of the warrants was approximately 5.0
years compared to a weighted average expected term of 2.0 years. The
estimated fair value of warrants described above amounted to $323,000 of
which $124,000 is recorded as a debt issuance cost in the balance sheet and
$199,000 is recorded as general and administrative expense in the statement
of operations.
Pro Forma Stock-Based Compensation Disclosures - The Company applies
APB Opinion 25 and related interpretations in accounting for its
stock options and warrants which are granted to employees. Accordingly,
compensation cost has not been recognized for grants of options and
warrants to employees and directors unless the exercise prices were
less than the fair value of the Company's common stock on the grant
dates. Had compensation cost been determined based on the fair value
at the grant dates for awards under those plans consistent with the
method of FASB 123, the Company's net loss and loss per share would have
been increased to the pro forma amounts indicated below.
Year Ended June 30,
------------------------------
1998 1997
----------- -------------
Net loss applicable to common stockholders:
As reported $ (830,600) $ (2,006,878)
Pro forma $ (1,337,440) $ (2,408,000)
Net loss per common share:
As reported $ (.05) $ (.18)
Pro forma $ (.08) $ (.21)
The fair value of each employee option and warrant granted in 1998
and 1997 was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:
Year ended June 30,
------------------------------
1998 1997
------------ ------------
Expected volatility 87% 102%
Risk-free interest rate 5.5% 5.9%
Expected dividends - -
Expected terms (in years) 5.0 4.5
6. RELATED PARTY TRANSACTIONS
During the year ended June 30, 1996 and the period from February 15,
1995 to June 30, 1995, the Company paid management fees in lieu of
salaries to two corporations controlled by senior officers of the
Company, aggregating $160,000 and $50,000, respectively. In
addition, the Company has received advances from these two companies,
net of repayments, totaling. The advances are unsecured, without
interest and are due after June 30, 1999. See Note 5 for other
transactions with related parties.
7. INCOME TAXES
The Company's deferred tax assets (liabilities) consist of the
following:
JUNE 30,
-------------------------------
1998 1997
----------- -------------
Deferred tax liabilities:
Difference in bases of oil and
gas properties acquired $ (3,643,000) $ (2,000,000)
Costs capitalized for books and
deducted for tax (397,000) (84,000)
------------- --------------
Total deferred tax liabilities (4,040,000) (2,084,000)
------------- --------------
Deferred tax asset (net operating
loss carryforwards) 2,195,000 1,415,000
------------- --------------
Net deferred tax liability $ (1,845,000) $ (669,000)
------------- --------------
The difference from the expected income tax benefit for the year
ended June 30, 1998 at the statutory federal tax rated of 34% and the
actual income tax benefit is primarily the result of payroll tax penalties
and entertainment expenses, which are not deductible for income tax
purposes. The difference for the year ended June 30, 1997 is
primarily the result of amounts related to the estimated value of warrants that
were expensed for purposes of the financial statements, but are not
deductible for income tax purposes.
At June 30, 1998, the Company has available net operating loss
carryforwards of approximately $6,455,000 to reduce future taxable
income. These carryforwards expire from 2002 to 2013.
8. CONCENTRATION OF CREDIT RISK AND FAIR VALUE OF FINANCIAL
INSTRUMENTS
Financial instruments that potentially subject the Company to concentrations
of credit risk consis principally of cash and accounts receivable. The
Company maintains its cash with banks primarily in Dallas, Texas. The term
of these deposits are on demand to minimize risk. The Company has not
experienced any losses related to these cash deposits and believes it is not
exposed to any significant credit risk.
Accounts receivable consist of uncollateralized receivables from domestic and
international customers primarily in the oil and gas industry. To minimize
risk associated with international transactions, all sales are denominated in
U.S. currency. The Company routinely assesses the financial strength of it
sutomers. The Company consider accounts receivable to be fully collectible;
accordingly, no allowance for doubtful accounts is required. If amounts
become uncollectible, they will be charged to operations when that
determination is made.
Fair value of financial instruments ar estimated to approximate the related
book value, unless otherwise indicated, base on market information available
to the Company.
9. ZAMA LAKE PROPERTY SALE.
In January 1998, the Company completed the purchase of
substantially all of the oil and gas interests in the Zama Lake area in Alberta,
Canada (the "Zama Property") owned by two Canadian independent oil
and gas producers. The purchase price was approximately $6.9 million.
Shortly after the purchase of the Zama Property, the Company sold all
of its interests to Phillips Petroleum Resources, Ltd. and certain of its
affiliates for approximately $7.5 million. The Zama property was the only
property in the non-U.S. full cost pool. Proceeds of the sale exceeding
the basis in the full cost pool were $629,660 and were accounted for as
a gain on sale of assets.
10. SUBSEQUENT EVENTS
In September 1998, the Company initiated a private placement of its
common stock, with warrants attached. Through September 15, 1998, the
Company had sold 285,000 shares and 285,000 warrants exercisable for
$0.60 per share until December 31, 2001 for net proceeds of $142,500.
A subscription agreement for 860,000 shares and 860,000 warrants has
been executed by one of the Company's significant shareholders. The
net proceeds of approximately $430,000 is expected to be received by the
Company during October, November and December 1998.
11. COMMITMENTS AND CONTINGENCIES
Leases. The Company leases office space that requires monthly
payments aggregating $95,160, $89,160, $90,050, $95,392, and $83,210
for fiscal years ending June 30, 1999, 2000, 2001,2002 and 2003,
respectively. Rent expense for fiscal 1998 for office space was
approximately $54,000. One facility lease contains an option to
allow the Company to purchase the facility for $115,900.
The Company also leases equipment. Rent expense for equipment for
fiscal 1998 was approximately $52,000. Future commitments for
equipment leases run through fiscal 1999 and aggregate approximately
$24,000.
Potential Securities Act Violation. On March 16, 1998, the Company
filed with the Commission a Registration Statement on Form SB-2 (the
"March 1998 Registration Statement") for the purpose of registering
up to 10,891,184 shares of the Company's Common Stock for sale by
certain shareholders of the Company, including approximately 5.7 million
shares to be issued upon exercise of outstanding warrants and conversion of
the Convertible Debentures. On May 1, 1998, the Company received a
letter of comments from the Staff of the Commission (the "May 1998
Staff Comment Letter") relating to the March 1998 Registration Statement.
In the May 1998 Staff Comment Letter, the Staff advised the Company that
it should have registered the Yukon Continuance under the Securities
Act. The Yukon Continuance was not registered under the Securities
Act.
The Company in its supplemental response on May 26, 1998 to the
Staff's May 1998 Comment Letter contended, with the concurrence of, the
Company's U.S. securities counsel, that the Yukon
Continuance was a transaction not subject to the registration
requirements of Section 5 of the Securities Act. The Staff has
advised the Company that is does not agree with the Company and its U.S.
securities counsel's conclusion regarding the Yukon Continuance.
The Company, therefore, may have a contingent liability to certain of
its shareholders, who may sue the Company to recover the
consideration paid, if any, for shares of the Company's Common Stock, with
interest thereon, from the date of the Yukon Continuance to the date of
repayment by the Company less the amount of any income received
thereon, upon tender of such securities, or for damages if the
shareholder no longer owns such securities. The Company intends to
vigorously defend any such shareholder lawsuit and believes that it
may have valid defenses, including the running of applicable statutes of
limitations, against claims by some or all of its shareholders.
However, to the extent that any of the Company's shareholders obtain
a judgment for damages against the Company, the Company's net assets
and net worth will be reduced, which in turn could reduce the Company's
ability to obtain financing for its exploration and drilling
operations and cause the Company to curtail operations. The Company is unable
to quantify the amount of such contingent liability.
Litigation. The Company, in the normal course of business, is a party to a
number of lawsuits and other proceedings. The Company's management does not
expect that the results in these lawsuits and proceedings will have a
material adverse effect on the financial position or results of operations of
the Company.
Liquidity and Capital Resources. The statement of operations presented in
the financial statements reflect net losses for 1998 and 1997. However, the
Company has been able to improve its financial position through stock
offerings and has obtained financing for development of its oil and gas
properties.
Successful development of the Company's oil and gas properties and,
ultimately, the attainment of profitable operations is dependent upon future
events, including adequate financing to fulfill its development activities
and achieving a level of revenue adequate to support the Company's cost
structure. Management believes that the Company's future success will be
achieved by the development of its oil and gas properties. While management
believes the Company is well positioned for future profitability, there can
be no assurance of future success. Management is aware of the need for
additional cash resources to be obtained for the continuance of operations
and anticipates such financial resources will primarily come the financing
described in Note 4, placements of the Company's stock and revenues generated
from its oil and gas properties. Management believes that the cash provided
by operations and financing activities will be sufficient for its needs.
Potential Convertible Debenture Default. The Company did not obtain
effectiveness of a registration statement by May 31, 1998 for the securities
underlying the Convertible Debentures, which event would, with notice, be an
event of default under the relevant financing agreements. No notice has been
given. As of September 15, 1998, the Company and each Convertible
Debentureholder were in negotiation for certain amendments to the Convertible
Debentures and related documents, including a waiver of the prospective event
of default. As consideration for the waiver, the Company has agreed to issue
a total of 400,000 shares (the "Waiver Shares") on a pro rata basis to each
Convertible Debentureholder. The Waiver Shares will be valued by the board
of directors at $0.425 per share when issued to the Convertible
Debentureholder. Additionally, the Company expects to issue and deliver to
the Convertible Debentureholders approximately 700,000 shares of common stock
in lieu of accrued interest of approximately $302,000 on the Convertible
Debentures for December 30, 1997 through December 31, 1998. If the
amendments are not completed, and the Debentureholders give notice of
default, the Company's liquidity and activities could be severely adversely
affected.
12. EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution 401(k) Plan to which both the
Company and eligible employees may contribute. Company contributions are
voluntary and at the discretion of the board of directors. There were no
Company contributions for the periods presented.
13. SUPPLEMENTAL INFORMATION (UNAUDITED)
Costs incurred by the Company with respect to its oil and gas
producing activities are set forth below.
FOR THE PERIODS ENDED
JUNE 30,
1998 1997
------------- --------------
Exploration Activities $ 85,000 $ -
Proved property acquisition cost 8,093,083 515,000
Development costs 1,012,012 422,621
Drilling & Well Service Equipment
Acquisition Cost 2,756,296 -
Drilling & Well Service Equipment
Tooling Out Cost 441,581 -
------------ ---------------
Total $12,387,972 $ 937,621
------------ ---------------
14. OIL AND GAS RESERVE INFORMATION (UNAUDITED)
Proved oil and gas reserves are the estimated quantities of crude
oil, condensate and natural gas which geological and engineering data
demonstrate with reasonable certainty to be recoverable in future
years from known reservoirs under existing economic and operating
conditions. Proved developed oil and gas reserves are reserves that can be
expected to be recovered through existing wells with existing
equipment and operating methods. The following estimated net interests in
proved reserves are based upon subjective engineering judgments and may be
affected by the limitations inherent in such estimation. The process
of estimating reserves is subject to continual revision as additional
information becomes available as a result of drilling, testing,
reservoir studies and production history. There can be no assurance
that such estimates will not be materially revised in subsequent periods.
The Company emphasizes that reserve estimates of new discoveries or
undeveloped properties are more imprecise than those of producing oil
and gas properties. The Company's reserves are substantially from
undeveloped properties. Accordingly, these estimates are expected to
change materially as future information becomes available. The
Company's reserves were estimated by independent petroleum engineers.
All of the Company's reserves are located onshore in the continental
United States. The recoverability of the proved undeveloped reserves
is dependent upon obtaining financing to exploit the reserves.
The following table sets forth proved oil and gas reserves at June
30, 1998, 1997, 1996 and 1995 together with changes therein:
OIL AND NATURAL
CONDENSATE GAS
(BBLS) (MCF)
------------ -------------
Balance at February 15, 1995 - -
Purchase of minerals in place 4,294,000 12,882,000
Balance at June 30, 1995 4,294,000 12,882,000
Balance at June 30, 1996 4,294,000 12,882,000
Purchase of minerals in place 523,000 5,222,000
Production (12,000) (34,000)
Revision of prior estimates (19,000) (8,000)
------------- -------------
Balance at June 30, 1997 4,786,000 18,062,000
============= =============
Purchase of minerals in place 1,560,000 468,000
Production (28,000) (181,000)
Revision of prior estimates (548,000) (5,588,000)
------------- -------------
Balance at June 30, 1998 5,770,000 12,761,000
============= =============
Proved developed reserves at June 30:
1995 - -
============= =============
1996 93,000 280,000
============= =============
1997 423,000 1,787,000
============= =============
1998 355,000 998,000
============= =============
The standardized measure of discounted future net cash flows at June
30, 1998, 1997 and 1996 relating to proved oil and gas reserves is
set forth below. The assumptions used to compute the standardized
measure are those prescribed by the Financial Accounting Standards Board and
as such, do not necessarily reflect the Company's expectations of actual
revenues to be derived from those reserves nor their present worth.
The limitations inherent in the reserve quantity estimation process
described above are equally applicable to the standardized measure
computations since these estimates are the basis for the valuation
process.
Standardized measure of discounted future net cash flows relating to
proved reserves:
AT JUNE 30,
1998 1997 1996
------------- -------------- ------------
Future cash inflows $ 101,128,000 $ 129,610,000 $ 118,003,000
Future production costs (19,923,000) (18,826,000) (15,013,000)
Future development costs (26,064,000) (13,915,000) (12,446,000)
------------- ------------- -------------
Future net cash flows,
before income tax 55,141,000 96,869,000 90,544,000
Future income tax expenses (16,542,000) (31,526,000) (30,785,000)
------------- ------------- -------------
Future net cash flows 38,599,000 65,343,000 59,759,000
10% discount to reflect timing of net
cash flows (12,866,000) (22,543,000) (19,315,000)
------------- ------------- -------------
Standardized measure of
discounted future
net cash flows $ 25,733,000 $ 42,800,000 $ 40,444,000
------------- ------------- -------------
Changes in standardized measure of discounted future net cash flows
relating to proved reserves:
FOR THE PERIOD ENDED JUNE 30,
1998 1997 1996
Standardized measure,
beginning of period $ 42,800,000 $ 40,444,000 $ 29,800,000
Net change in sales price,
net of production costs (17,591,000) (5,288,000) 11,762,000
Accretion of discount ( 9,677,000) 4,044,000 2,980,000
Purchases of reserves in-place 432,000 6,687,000 -
Production (221,000) (21,000) -
Change in timing of
production and other - (2,581,000) -
Net changes in income taxes 9,990,000 (485,000) (4,098,000)
------------- ------------- --------------
Standardized measure, end of
period $ 25,733,000 $42,800,000 $ 40,444,000
------------- ------------- --------------
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
There are not and have not been any disagreements between the
Company and its accountants on any matter of accounting principles or
practices or financial statement disclosure. The Company's
accountants for fiscal 1997, Hein & Associates LLP declined to stand for re-
election for fiscal 1998. They were replaced with Lane Gorman Trubitt, L.L.P.
Form 8-K was filed on August 5, 1998 which described the transition.
_____________________________________________________________________________
PART III
_____________________________________________________________________________
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS OF THE ISSUER; COMPLIANCE WITH SECTION 16(a)
OF THE EXCHANGE ACT
Directors and Executive Officers
The following is a list of the names and ages of each of the
Company's directors and executive officers:
Name Age Position
Eugene A. Soltero 55 Chairman of the Board and Chief
Executive Officer
James E. Hogue 62 Director, President and
Chief Operating Officer
Leon A. Romero 46 Senior Vice President and
Chief Financial Officer
Patricia A. Dickerson 52 Vice President, Corporate
Affairs/Investor Relations
and Secretary
Wayne T. Egan(1) 33 Director
(1) Member, Audit Committee, Compensation Committee
Eugene A. Soltero has served Cotton Valley as a director since
February 1995. He was President from February 1995 to July 1996 and
has been Chairman and Chief Executive Officer since January 1996. He has
been Chairman and Chief Executive Officer of CV Trading since May 1995.
From March 1994 to February 1995, Mr. Soltero was President and Chief
Executive Officer of Cimarron Resources, Inc., an independent gas production
company. From August 1991 to March 1994, he was Chairman of the
Board, President and Chief Executive Officer of Aztec Energy Corporation, a
publicly-held independent oil and gas production company. In June
1994, Aztec Energy Corporation entered into bankruptcy proceedings. Mr.
Soltero has served as Chief Operating Officer and/or Chief Executive Officer
for private and public oil and gas companies for more than 20 years,
including directing the formation and growth of start-up companies. Early in
his career, he was trained at Sinclair Oil Corporation in exploration and
production management, served as Manager of Planning for Texas
International Petroleum Corporation, and Petroleum Economist for
DeGolyer and MacNaughton, petroleum consultants. Mr. Soltero is a member of
the Society of Petroleum Engineers, a member and former director of the
Independent Petroleum Association of America and the Texas
Independent Producers and Royalty Owners. He has also served, on two separate
terms, as a director of the Independent Petroleum Refiners Association of
America. He is a master's graduate of the Massachusetts Institute of
Technology in business (where he was awarded the Sinclair Fellowship
in Petroleum Economics) with an undergraduate engineering degree from
The Cooper Union. Mr. Soltero is a registered professional engineer in
the State of Texas.
James E. Hogue became President, Chief Operating Officer and a
director of Cotton Valley in July 1996 and he served as Chairman of
CV Energy from February 1995 to January 1996 and Chairman of CV Trading
from May 1995 to January 1996. He became President of CV Energy and CV
Operating in January 1996. Mr. Hogue also has been director,
President and major shareholder of Third Coast Capital, Inc., a venture capital
company, since 1988. Since 1991, Mr. Hogue has served as President
of Martex Oil and Gas, Inc. In 1983, Mr. Hogue formed Mayco Petroleum,
Inc., for which he served as President until 1988. Early in his career,
Mr. Hogue served as a driller for Leatherwood Company and as a core
engineer for Sargent Diamond Bit, Inc. Subsequently, Mr. Hogue
became President and major shareholder of a diamond bit manufacturing
company. In the late 1970s, Mr. Hogue served for four years as President of
Union Crude Oil Company, an exploration and drilling company, and for two
years as Vice President of Independent Producers Marketing Company, a crude
oil supply and transportation company. Mr. Hogue has participated in
drilling or furnishing services for over 3,000 wells in Texas, Oklahoma, New
Mexico, Louisiana and Colorado.
Leon A. Romero has served as a director, and, on an interim basis,
as Senior Vice President and Chief Financial Officer of the Company
since February 1998. From August 1997 through February 1998, Mr. Romero
was an Advisory Director of the Company. From 1992 to August 1997, Mr.
Romero was the President and co-founder of Old Aspen. Mr. Romero is
President of MAR Oil and Gas Corporation. Mr. Romero is a former Director of the
Independent Petroleum Association of New Mexico and member of the
New Mexico Oil and Gas Association. Mr. Romero received his Bachelor of
Science in Accounting from the University of Albuquerque. He also
holds a Master of Business Administration degree from New Mexico Highlands
University. He completed a program in Entrepreneurial Development
from the University of California at Los Angeles.
Patricia A. Dickerson has served as Director of Investor Relations
of the Company since March, 1997. In February 1998, she was elected
as Vice President, Corporate Affairs/Investors Relations. She was
formerly employed with Box Energy Corporation, a Dallas, Texas based and
Nasdaq listed independent oil and gas exploration company, from 1985 to 1997
where she served as Senior Assistant to the Chairman of the Board.
She also served as Director of Investor Relations for Box Energy
Corporation. Ms. Dickerson holds a B.A. degree in Government from Texas Woman's
University, Denton, Texas and a Juris Doctorate degree from Texas
Tech University, Lubbock, Texas. She is a member of the National
Association of Investor Relations Professionals and the Texas Investor Relations
Association for the Petroleum Industry.
Wayne T. Egan is a partner in the law firm of Weir and Foulds and
serves in the securities law section of said firm. He holds an
L.L.B. from Queen's University and a Bachelor of Commerce from the
University of Toronto, and is a member of the Canadian Bar Association. Weir
and Foulds serves as Cotton Valley's corporate counsel.
Director Compensation
Directors who are not Cotton Valley employees receive $500 per
meeting of the board and $500 per committee meeting not held on the
same date as a board meeting. Directors are permitted to accept stock in
lieu of cash. Employee directors receive no extra compensation for
service on the board.
Family Relationships
There are no family relationships among the Company's directors or
executive officers.
Involvement in Certain Legal Proceedings
None of the Company's directors or executive officers have been
involved during the past five years in any legal proceedings material
to an evaluation of such persons ability or integrity.
Compliance with Section 16(a) of the Exchange Act
In the Company's Annual Report on Form 10-KSB for the fiscal year
ended June 30, 1997, the Company reported that all persons or
entities subject to the reporting requirements of Section 16(a) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), timely filed
all reports required under the rules and regulations promulgated
thereunder. Subsequent to the filing of the Annual Report with the Commission,
the Company became aware that both Wayne T. Egan and Richard J. Lachcik,
each a director of the Company, failed to file a Form 3 C Initial
Statement of Beneficial Ownership of Securities, which filing was due in
December 1996, and Form 4's C Statement of Changes in Beneficial Ownership of
Securities for the months ended September and October 1997. On December 19,
1997, Messrs. Egan and Lachcik filed with the Commission appropriate forms
promulgated under Section 16(a) of the Exchange Act for the purpose
of reporting their respective ownership interests and related
transactions in the Company's Common Stock for the noted periods.
Except for the events described in the foregoing paragraph, the
Company is not aware of any transactions in its outstanding
securities by or on behalf of any director, executive officer or 10% holder of
the Common Stock, which would require the filing of any report pursuant
to Section 16(a) that was not filed with the Company.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or to be paid
to Cotton Valley's executive officers, directly or indirectly, for
services rendered in all capacities for the period from inception to
June 30, 1995, fiscal 1996, fiscal 1997, and fiscal 1998:
SUMMARY COMPENSATION TABLE
Long-Term
Annual Compensation(1) Compensation
Name and Principal Position Year Other Annual Restricted
Salary Compensation Stock
Awards(2)
Eugene A. Soltero, Chairman
of the Board, Chief
Executive Officer 1998 $160,000 $0 $ 0
1997 $120,000 $ 60,000
1996 $115,000 $0
1995 $ 25,000 $0
James E. Hogue, President
and Chief Operating Officer 1998 $160,000 $0
1997 $120,000 $ 60,000
1996 $115,000 $0
1995 $ 25,000 $0
Leon A. Romero, Senior Vice
President and Chief
Financial Officer 1998 $ 40,000 $0
Patty Dickerson, Vice Prsident,
Corporate Affairs/Investor
Relations and Secretary 1998 $ 50,000 $0 $ 50,000
1997 $ 37,000 $0
- -----------------
(1) Certain of Cotton Valley's executive officers receive personal
benefits in addition to salary. The aggregate amounts of these
benefits, however, do not exceed the lesser of $50,000 or 10% of the
total annual salary reported for the executives.
(2) During fiscal 1997 each of Messrs. Soltero and Hogue received
warrants to purchase 83,333 shares of Common Stock at a per warrant
exercise price of $.72. The warrants expire December 31, 1999. Ms.
Dickerson received a stock bonus award during fiscal year 1998 of
25,000 common shares.
Employment Agreements
Cotton Valley does not have employment contracts with any of its
executive officers.
Options
The following table sets forth information regarding options
granted to executive officers under Cotton Valley's employee stock option
plan in fiscal 1997:
Option Grants in Last Fiscal Year
(Individual Grants)
Number of Percent of Total
Securities(1) Options Granted to
Underlying Employees in Exercise or Expiration
Name Options Granted Fiscal Year Base Price Date
- ---------------- --------------- ------------------ ----------- ---------
Eugene A. Soltero 300,000 48% 1.65 2/28/03
James E. Hogue 300,000 48% 1.65 2/28/03
Patricia A. Dickerson 25,000 4% 1.67 7/01/00
______________________
(1) Shares of Common Stock
The following table sets forth information regarding the value of
unexercised options held by executive officers as of June 30, 1998.
During fiscal 1998 a former executive officer (Peter Lucas) exercised
200,000 options, a former director (Richard Lachick) exercised 50,000
options, and a current director (Wayne Egan) exercised 30,000 options.
Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
Name Exercisable/Unexercisable Exercisable/Unexercisable
- ----------------- ------------------------- -------------------------
Eugene A. Soltero 500,000/0 $0/$0
James E. Hogue 500,000/0 $0/$0
Patricia A. Dickerson 25,000/0 $0/$0
Wayne Egan 20,000/0 $0/$0
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth certain information regarding
beneficial ownership of the Company's Common Stock as of September
15, 1998, by (i) each person who "beneficially" owns more than 5% of all
outstanding shares of Common Stock, (ii) each director and executive
officer, and (iii) all directors and executive officers as a group.
Except as otherwise indicated, all persons listed below have (") sole
voting power and investment power with respect to their Common Stock
except to the extent that authority is shared by spouses under
applicable law, and (b) record and beneficial ownership of their shares.
Name Amount and
Nature of Percentage
Beneficial of
Name Ownership Ownership
Eugene A. Soltero (1) 4,394,333(5) 24.61
James E. Hogue (1) 4,594,333(6) 25.73
Leon A. Romero(1) (2) 973,571 5.64
Wayne T. Egan (3) 28,000(7) *
Patricia A. Dickerson (4) 50,000(8) *
Liviakis Financial Communications, Inc. 3,041,851(9) 17.01
All directors and executive
officers as a group (five persons) 9,066,666(10) 49.05
*Less than 1%.
(1) Mr. Soltero is a director, Chairman of the Board and Chief
Executive Officer of the Company and Mr. Hogue is a director,
President and Chief Operating Officer of the Company. Messrs.
Soltero and Hogue may be deemed promoters of the Company.
The address of Messrs. Soltero, Hogue and Romero is 6510 Abrams Road,
Suite 300, Dallas, Texas 75231.
(2) Mr. Romero is the Senior Vice President, Chief Financial
Officer and a director of the Company.
(3) Mr. Egan is a director of the Company. The address of Mr.
Egan is Weir & Foulds, Exchange Tower, Suite 1600, 130 King Street West,
Toronto, Ontario, Canada M5X 1J5
(4) Ms. Dickerson is Vice President, Corporate Affairs/Investor
Relations and Secretary of the Company.
(5) Includes 583,333 shares of Common Stock subject to employee
stock options and the following shares, beneficial ownership of
which is disclaimed: 710,000 shares of Common Stock owned by the Soltero
Family Limited Partnership, 36,000 shares of Common Stock held by Mr.
Soltero's wife and approximately 3,000,000 shares of Common Stock,
which represents 50% of the 6,000,000 shares owned by others subject
to a voting trust agreement and voting covenants under certain
agreements. See "Voting Agreements," below.
(6) Includes 583,333 shares of Common Stock subject to employee
stock options and warrants and the following shares, beneficial
ownership of which is disclaimed: 740,000 shares of Common Stock
owned by the Hogue Family Limited Partnership, 231,000 shares of
Common Stock held by Mr. Hogue's wife and approximately 3,000,000
shares of Common Stock, which represents 50% of the 6,000,000 shares
owned by others subject to a voting trust agreement and voting covenants
under certain agreements. See "Voting Agreements," below.
(7) Includes 20,000 shares of Common Stock subject to employee
stock options.
(8) Includes 25,000 shares of Common Stock issuable upon exercise
of stock options.
(9) Includes 611,351 shares issuable upon exercise of LFC,
Liviakis and LFC Mustang Warrants held by LFC and does not
include 150,000 shares of Common Stock issuable upon exercise of
125,000 LFC Warrants and 25,000 LFC Mustang Warrants, or 125,000 shares
owned by Robert B. Prag, an officer of LFC. The address of LFC is 2420
>K= Street, Sacramento, California 95816. See "Certain Relationships
and Related Transactions".
(10) Includes 6,000,000 shares subject to a voting trust agreement
and voting covenants under certain agreements, of which 973,571 are
owned by Mr. Romero.
Voting Agreements
Under the terms of a Voting Trust Agreement (the "Voting
Agreement"), unaffiliated parties that transferred their interests in
certain properties to the Company in 1995 in exchange for securities
provided a power of attorney to Eugene A. Soltero and James E. Hogue
to vote approximately 3.28 million shares of Common Stock held by such
property contributors until January 1, 2001. The Voting Agreement
expires with respect to any of the shares of Common Stock transferred to an
unaffiliated third party by such shareholder. The Company believes
that as of June 30, 1998, approximately 2 million shares of Common Stock
were subject to the Voting Agreement. See "Principal Shareholders."
Liviakis Financial Communications, Inc. ("LFC") and its affiliates
have agreed that, with respect to any shares of Common Stock acquired
by them pursuant to the LFC Consulting Agreement with the Company, they
will vote such shares of Common Stock until January 1, 2001 for directors
nominated by Messrs. Hogue and Soltero and certain other matters.
Approximately 2,000,000 shares are currently subject to this voting
rights covenant. See "Certain Relationships and Related Transactions" and
"Principal Shareholders."
Pursuant to the terms of the definitive acquisition agreement, the
four previous shareholders of Old Aspen agreed, for a period of five
years, to vote their shares of Common Stock for directors nominated
by Messrs. Hogue and Soltero. Messrs. Hogue and Soltero were obligated,
upon the Company's continuance into the Yukon Territory, a jurisdiction
which allows a majority of the directors to be U.S. citizens, to nominate
and vote for Mr. Leon A. Romero, former President of Old Aspen, as a
director of the Company. In February 1998, Mr. Romero was elected as a
director, Senior Vice President and Chief Financial Officer of the Company.
Approximately 2,000,000 shares are currently subject to this voting
covenant.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In February 1995, the Company issued a total of 560,001 shares of
Common Stock to the wives of Eugene A. Soltero, Chairman of the Board
and Chief Executive Officer, and James E. Hogue, President and Chief
Operating Officer, for pre-incorporation services valued at $1,401. Shortly
after incorporation, the Company issued 2,100,000 special shares to family
partnerships of Messrs. Soltero and Hogue which were subsequently
exchanged for 1,440,000 shares of Common Stock of the Company valued
at $5,832.
In December 1995, the Company issued 80,000 shares of Common Stock
to each of Messrs. Soltero and Hogue for pre-incorporation services
valued at $0.04 per share. Additionally, since June 14, 1996, the Company
has granted to each of Messrs. Soltero and Hogue warrants to purchase
83,333 shares of Common Stock at $0.73 per share and employee options to
purchase 500,000 shares at prices ranging from $1.65 to $1.83 per share.
During the fiscal years ended June 30, 1996 and 1995, the Company
paid management fees to two family corporations controlled by Messrs.
Soltero and Hogue aggregating $160,000 and $50,000, respectively, in
lieu of salaries. In addition, the Company has received advances from
these two companies which totaled $139,710 at June 30, 1997. As of June
30, 1998, $119,710 of the advances remained outstanding. The advances
are unsecured and without interest and are payable after January 1, 1999.
During each of the years ended June 30, 1998 and 1997, the Company
paid to Weir and Foulds approximately $50,000 in legal fees. Most of
the legal services were provided by Richard J. Lachcik and Wayne T. Egan,
respectively, former director and director of the Company, who both
at the time were members of Weir and Foulds. Messrs. Lachcik and Egan each
received in fiscal year 1997 options to purchase 50,000 shares of
Common Stock at $1.83 per share. The Company believes that the legal fees
it pays to Weir & Foulds are comparable to legal fees charged by
unaffiliated law firms.
In November 1996, the Company entered into a consulting agreement
(the "LFC Consulting Agreement") with Liviakis Financial
Communications, Inc., a California corporation ("LFC"). Under the terms of the
LFC Consulting Agreement, LFC was retained to assist and consult with the
Company in matters concerning corporate finance and to represent the
Company in investor communications and public relations with existing
shareholders, brokers and other investment professionals. As
consideration for LFC undertaking the engagement, the Company issued
and delivered to LFC an aggregate of 1,490,000 shares of Company's Common
Stock as non-forfeitable compensation. The stock issuance was
recorded at $1,087,800 based on the Company's stock price at the date of the LFC
Consulting Agreement.
In connection with LFC undertaking the consulting engagement, the
Company sold to LFC and Robert B. Prag, an affiliate of LFC, an
aggregate of 500,000 units (the "Units") for $375,000 or $0.75 per Unit. Each
Unit consisted of one share of the Common Stock and one stock purchase
warrant ("LFC Warrant") which entitled the holder thereof to purchase a share
of Common Stock at an exercise price of $0.80 through November 7, 2001.
The estimated value of the LFC Warrants of $199,000 was recorded as an
expense. The LFC Consulting Agreement provided that any shares of
Common Stock received by LFC and its affiliate under the LFC Consulting
Agreement, either directly or indirectly through the exercise of
warrants, shall be voted in accordance with the terms and conditions of the
voting rights covenant contained therein. The LFC Consulting Agreement
expired on January 2, 1998.
As further compensation to LFC, the Company agreed to pay LFC a fee
in the event that LFC introduces the Company, or its nominees, to a
lender or equity purchaser, not already having a pre-existing relationship
with the Company and such financing is ultimately consummated. In
connection with the sale by the Company of its Convertible Debentures in
December 1997, LFC received a cash fee of $108,000. Additionally, in December
1997, the Company agreed to issue to LFC warrants to purchase 100,000
shares of Common Stock exercisable at $3.50 per share until December
31, 2000 (the "LFC Mustang Warrants") as additional compensation for
LFC's assistance to the Company in completing acquisitions and other
financings during calendar 1997. LFC directed the Company to issue 25,000 of
the Mustang Warrants to Robert B. Prag, an officer of LFC.
On June 24, 1997, the Company issued to LFC a 9% Convertible Secured
Promissory Note (the "LFC Note") for a $579,000 loan. On December 3,
1997, the Company repaid $479,000 of the principal amount of the LFC
Note and accrued interest. LFC converted the remaining principal amount
of $100,000 into 60,000 shares of Common Stock ($1.67 per share). As
additional consideration for the loan, the Company issued to LFC
warrants (the "Liviakis Warrants") expiring April 3, 2002 to purchase 161,351
shares of Common Stock at an exercise price of $2.08 per share.
Leon A. Romero, Senior Vice President, Chief Financial Officer and
a director of the Company received 977,771 net shares of Common
Stock from the Company in July 1997 as a result of the Aspen Acquisition.
Mr. Romero was one of the selling shareholders of Old Aspen.
The transactions described in this section were ratified by a
majority of the Company's independent directors who did not have an
interest in the transactions and who had access, at the Company's
expense, to available material information and to the Company's independent
counsel.
Any future transactions between the Company and its affiliates will
be approved by a majority of disinterested directors and will be on
terms no less favorable to the Company than those which could be obtained
from unrelated third parties. Any forgiveness of loans must be approved
by a majority of the Company's independent directors who do not have an
interest in the transactions and who have access, at the Company's
expense, to either the Company's or their own independent legal
counsel.
PART IV
ITEM 13. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-KSB
(a)(1) Financial Statements: See Index to Consolidated Financial
Statements on page 19.
(a)(2) Exhibits: See Exhibit Index on page 49.
(b) Reports on Form 8-KSB: No reports on Form 8-KSB were filed
during the last quarter of fiscal 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized, on September 29, 1998.
COTTON VALLEY RESOURCES CORPORATION
(Registrant)
By: /s/ Eugene A. Soltero
______________________________
Eugene A. Soltero
Chairman of the Board and
Chief Executive Officer
(Principal Executive
Officer)
By: /s/ Leon Romero
______________________________
Leon Romero
Senior Vice President
and Chief Financial
Officer
(Principal Financial and
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the
capacities and on the dates indicated:
Signature Title Date
/s/ Eugene A. Soltero Chairman of the Board
Eugene A. Soltero and Chief Executive Officer September 29, 1998
/s/ James E. Hogue President, Chief Operating
James E. Hogue Officer and Director September 29, 1998
/s/ Leon Romero Senior Vice President
Leon Romero and Chief Financial Officer September 29, 1998
/s/ Wayne T. Egan Director September 29, 1998
Wayne T. Egan
COTTON VALLEY RESOURCES CORPORATION
EXHIBITS INDEX
Exhibit
Number Description
________ _________________________
3(a)* Articles of Amalgamation
3(b)* Bylaws
4* Description of the Common Stock
11 Statement regarding computation of per share loss
21 Subsidiaries
23(a) Consent of K&A Energy Consultants, Inc.
23(b) Consent of Ryder Scott Company
27 Financial Data Schedule
*Previously filed and incorporated by reference herein.
EXHIBIT 4
DESCRIPTION OF COMMON STOCK
Cotton Valley is authorized to issue an unlimited number of shares
of common stock, without par value (the ACommon Stock"). Holders of
Common Stock are entitled to one vote per share on all matters
submitted to a vote of stockholders. They are entitled to receive dividends
when and as declared by the board of directors out of legally available
funds and to share ratably in the assets of Cotton Valley legally available
for distribution upon liquidation, dissolution or winding up.
Holders of Common Stock do not have subscription, redemption or
conversion rights, nor do they have any preemptive rights. Holders
of Common Stock do not have cumulative voting rights. All stockholder
action is taken by vote of a majority of voting shares of the capital
stock of Cotton Valley present at a meeting of stockholders at which a
quorum existing of a majority of the issued and outstanding shares of
the voting capital stock is present in person or by proxy. Directors
are elected by a plurality vote.
For certain fundamental changes, the corporate legislation under
which Cotton Valley was formed may require each class of outstanding
stock to vote separately.
EXHIBIT 21
SUBSIDIARIES
(i) Cotton Valley Energy Corporation, a Nevada corporation.
(ii) Cotton Valley Operating Company, a Texas corporation.
(iii) Mustang Oil Field Equipment Company, a Nevada corporation.
(iv) Cotton Valley Energy, Inc., an Oklahoma corporation.
(v) Aspen Energy Corporation, a Nevada corporation.
(vi) Mustang Well Service Company, a Nevada Corporation.
(vii) Mustang Horizontal Company, a Nevada Corporation.
(viii) Cotton Valley Means, Inc., a Texas Corporation, which is a
subsidiary of Aspen Energy Corporation
</TABLE>
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 85,762
<SECURITIES> 0
<RECEIVABLES> 396,390
<ALLOWANCES> 0
<INVENTORY> 891,359
<CURRENT-ASSETS> 1,592,630
<PP&E> 24,819,609
<DEPRECIATION> 396,008
<TOTAL-ASSETS> 26,537,856
<CURRENT-LIABILITIES> 1,571,807
<BONDS> 0
0
0
<COMMON> 21,119,482
<OTHER-SE> 823,695
<TOTAL-LIABILITY-AND-EQUITY> 26,537,856
<SALES> 1,823,495
<TOTAL-REVENUES> 1,825,852
<CGS> 542,864
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