UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[ X ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [Fee Required]
For the fiscal year ended March 31, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
Commission file number: 0-7914
BASIC EARTH SCIENCE SYSTEMS, INC.
633 Seventeenth Street, Suite 1670
Denver, Colorado 80202
Telephone (303) 294-9525
Incorporated in Delaware IRS ID#84-0592823
Securities registered under Section 12(b) of the Act: NONE
Securities registered under Section 12(g) of the Act: Common Stock, $.10 par
value at March 31, 1995 and $.001 par value at March 31, 1996
Check whether the issuer (1) 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 registrant was required to file such reports), and (2) has been
subject to the filing requirements for the past 90 days. Yes X No
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant'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. [ ]
Issuer's revenues for its most recent fiscal year: $2,826,000
As of June 7, 1996, 16,580,487 shares of the registrant's common stock were
outstanding and the aggregate market value of such common stock held by non-
affiliates was approximately $350,000.
The proxy statement for the 1996 annual meeting is incorporated by reference
into Part III.
<PAGE>
Basic Earth Science Systems, Inc.
Form 10-KSB Annual Report - 1996
Table of Contents
Part I: Page
----
Item 1. Description of Business 3
Item 2. Description of Property 8
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Part II:
Item 5. Market for Common Equity and Related Stockholder Matters 11
Item 6. Management's Discussion and Analysis or Plan of Operation 12
Item 7. Financial Statements 17
Item 8. Changes In and Disagreements With Accountants On
Accounting and Financial Disclosure 36
Part III:
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act 36
Item 10. Executive Compensation 36
Item 11. Security Ownership of Certain Beneficial Owners and
Management 36
Item 12. Certain Relationships and Related Transactions 36
Part IV:
Item 13. Exhibits and Reports on Form 8-K 37
<PAGE>
Part I
ITEM 1
DESCRIPTION OF BUSINESS
Basic Earth Science Systems, Inc. (Basic or the Company), was originally
organized in July 1969 and became a public company in 1980. The Company is
principally engaged in the acquisition, exploitation, development, operation and
production of crude oil and natural gas. The Company's primary areas of
operation are the Williston basin in North Dakota and Montana, south Texas and
the D-J basin in Colorado.
Business Development
Since 1994, the Company's new management has undertaken a strategy which
redirects the Company's existing capital into productive and economic oil and
gas properties, focuses on increasing reserves through the acquisition and
improvement of producing properties, and re-establishes banking relationships
which may provide debt financing for these purposes. Despite the fact that many
companies are moving away from an acquisition strategy, management believes that
opportunities still exist to increase reserves through the acquisition and
improvement of producing properties. In fact, given the Company's size, its
shortage of external funding and its existing internal staff strengths, this may
be one of the few strategies which the Company may be able to pursue
successfully. The Company's acquisition strategy is based largely on the exodus
of major and large independent oil and gas companies from the United States to
overseas areas. Management believes this exodus or divestiture of producing
properties is particularly intense in the Rocky Mountain region.
In pursuing this plan, in its fiscal year ending March 31, 1995, the Company
reported it successfully established a new banking relationship, the drilling
and recompletion of four wells on its Antenna Federal Prospect, the sale of its
office building and move of its offices from the suburbs to downtown Denver,
Colorado, the sale of deep exploration rights in south Texas and the acquisition
of approximately sixty properties in the Williston basin. Management reported
that these activities resulted in a 41% increase in the discounted present value
of Basic's estimated proved reserves at year end from approximately $3.3 million
to $4.7 million.
As a result of these efforts, in the fiscal year ended March 31, 1996, oil and
gas sales revenue increased 97% from approximately $1.4 million to approximately
$2.8 million and Cash Flows from Operating Activities increased 484% from
$134,000 to $782,000. Production expense was higher than expected and net
income was lower than expected due to the magnitude of unanticipated repair
costs associated with equipment on recently acquired Williston basin properties.
(See further discussion in Results of Operations, Expenses.)
In October 1995, the Company reported it participated with an unrelated third
party in the recompletion of the State #12-16, in Richland County, Montana. The
well was reported to have an initial potential of 147 barrels of oil, 16 barrels
of water and 112 MCF of gas per day from the Bakken formation. The well
previously produced an average of 9 barrels of oil, 11 barrels of water and 4
MCF of gas per day from the Madison formation. Basic owns a fifty percent (50%)
working interest in the well.
Following this success, the Company undertook one other recompletion attempt
which was unsuccessful. Further recompletion attempts were curtailed when the
cash requirements created by these two efforts and the magnitude of
unanticipated repair costs on Williston basin properties resulted in the
Company's inability to satisfy the liquidity covenant in its Loan Agreement.
The Company reported this covenant violation to its bank and, upon request,
received a waiver from the bank for this violation. To rectify the situation,
the Company drew on its line of credit to pay current liabilities as they became
due. As of December 31, 1995, the Company was able to attain a current ratio
acceptable to its bank.
As a result of the inability to satisfy the liquidity covenant and with the
onset of winter in the Williston basin, management curtailed recompletion
activities and thereafter focused on equipment repairs, cash requirements and
bank covenant compliance.
Contemplated Activities
General
The Company has begun implementation of its strategy by virtue of the various
activities described above. Further implementation of its plan of operation is
described herein. However, the Company may alter or vary its plan of operation
based upon changes in circumstances, unforeseen opportunities, inability to
negotiate favorable acquisition or loan terms, lack of funding and other events
which the Company is not able to anticipate.
Repairs
In the fiscal year just ended, the Company has been adversely affected by the
magnitude of unanticipated repair costs associated with equipment on recently
acquired Williston basin properties. Management expects these repair costs to
continue, albeit in decreasing amounts. Indeed, subsequent to year end, the
Company has been required to replace the surface facilities associated with four
wells in McCone County, Montana. The Company cannot predict the magnitude of
future repair activities nor the impact on future costs. However, management
has noted that where it has undertaken the repair and/or replacement of
compromised equipment, operating and/or repair costs have been dramatically
reduced. As a result, it is management's belief that the effect of these
repairs should, in the aggregate, become apparent in the current fiscal year.
However, there can be no assurances that other failures will occur in the future
that would require significant repairs.
Development
The Company holds a number of properties that it believes may have the potential
for increased cash flow and may have additional unproved reserves which could be
exploited. This exploitation may be realized by conventional and unconventional
petroleum engineering techniques and field management practices. Management
expects to pursue these potential opportunities on a number of these properties
in the upcoming fiscal year. However, there can be no assurances that funds
will be available to pursue such opportunities or that such efforts will be
successful.
Drilling
While drilling is no longer the major focus of the Company's strategy, Basic may
participate in high quality development or exploratory prospects which
management believes are capable of increasing reserves and cash flow with
reasonable risk.
In this regard, the Company has agreed to participate with unrelated third
parties for a minority interest (10%) in the development of a small 3-D seismic
prospect in south Texas. The Company's initial commitment is expected to be
$42,000. Management believes the project provides exposure to "high tech"
exploration techniques and, if successful, is capable of increasing reserves and
cash flow with reasonable risk.
Divestitures
The Company continues to hold a number of marginal, non-operated properties in
several states. Management intends to divest itself of a number of these
properties in the current fiscal year.
Segment Information and Major Customers
Industry Segment
The Company is engaged in only one segment of the oil and gas industry: oil and
gas exploration, production, operations and development. The Company has no
gathering, transportation, refining or marketing functions.
Markets
The Company's oil and natural gas is sold to various purchasers in the
geographic area of its properties. Oil and natural gas liquids are hauled by
truck from tanks at or near the wellhead, or collected by pipeline, for
transportation to refineries. Natural gas is collected by a gathering system
and, after processing, is distributed through pipelines to end-users. Basic is
a small company and, as such, has no impact on the market for its goods and
little control over the price received. The market for, and the value of, oil
and natural gas are dependent upon a number of factors including other sources
of production, competitive fuels and proximity and capacity of pipelines or
other means of transportation, all of which are beyond the control of Basic.
The Company believes that substantially all domestic oil which is produced can
be readily sold at prevailing market prices. The oil prices the Company
receives are slightly lower than the benchmark U.S. crude spot price because of
adjustments for location and grade. The price of domestic oil fluctuates due to
supply and demand forces. Since there is strong competition among purchasers,
management does not believe it is dependent on any one purchaser or group of
purchasers.
In the year ended March 31, 1996, Basic sold 71 percent of its oil and gas
production to a total of three purchasers: 34 percent to Cenex, Inc., 19
percent to Murphy Oil USA, Inc. and 18 percent to Norco Crude Gathering, Inc.
Sales to no other customer of Basic (or group of customers under common control)
were equal to 10 percent or more of oil and gas sales.
Substantially all of Basic's gas production is sold at prevailing wellhead gas
prices, subject to additional charges customary to an area. Basic does not own
or operate any gas gathering or processing plant facilities nor does it possess
sufficient volume on any pipeline to market its product to end-users.
Competition
The oil and gas industry is a highly competitive and speculative business. The
Company encounters strong competition from major and independent oil companies
in all phases of its operations, particularly in the acquisition of economically
desirable producing properties and drilling prospects. Competition is intense
with respect to the acquisition of large producing properties, or large packages
of producing properties. These multiple well packages are particularly
competitive if they include partially developed properties or properties with
natural gas attributes. In this arena, the Company must compete with many
companies having financial resources and technical staffs significantly larger
than its own. However, management believes that the competition for smaller
properties, especially distressed properties, is less intense. Because of the
limited capital resources available to the Company, management has focused on
these smaller and/or distressed properties in its acquisition efforts.
Regulations
General
The operations of the Company are affected in varying degrees by federal, state,
regional and local laws and regulations, including, but not limited to, laws
governing allowable rates of production, well spacing, air emissions, water
discharges, reporting requirements, endangered species, marketing, prices, and
taxes. The Company is further affected by changes in such laws and by
constantly changing administrative regulations. To the best of its knowledge,
the Company is in compliance with all such regulations and is not aware of any
claims which could have a material impact upon the Company's financial
condition, results of operations, or cash flows.
Federal Taxation
During fiscal 1993, The Comprehensive National Energy Policy Act (Act) was
signed into law. The Act provides for various incentives and revenue-raising
provisions. Perhaps most significant to independent oil and gas companies are
the provisions repealing certain intangible drilling cost and statutory
depletion tax preferences for the purposes of calculating the alternative
minimum tax. While provisions are favorable to the oil and gas industry, Basic
will not realize current benefits because of its relatively high, non-cash
depletion expense and a substantial net operating loss carryforward.
Natural Gas Pricing
During fiscal 1992, the Federal Regulatory Commission (FERC) issued FERC Order
636 and subsequent related orders (the Order) which are intended to ensure that
pipelines provide transportation service that is equal in quality for all gas
suppliers, whether the customer purchases gas from the pipeline or from a
different supplier. While the Company views this Order as favorable to natural
gas producers, it is not suspected to have a material impact on Basic in that
the vast majority of the Company's production is crude oil rather than natural
gas.
Environmental Matters
The Company is subject to various federal, state, regional and local laws and
regulations relating to the discharge of materials into, and the protection of,
the environment. These laws and regulations, among other things, may impose
liability on the owner or the lessee for the cost of pollution clean up
resulting from operations, subject the owner or lessee to liability for
pollution damages, require the suspension or cessation of operations in affected
areas and impose restrictions on injection into subsurface aquifers that may
contaminate ground water. Although environmental requirements do have a
substantial impact upon the energy industry, these requirements do not appear to
affect Basic any differently than other companies in this industry who operate
in a given geographic area. The Company is not aware of any environmental claims
which could have a material impact upon the Company's financial condition,
results of operations, or cash flows.
Such regulation has increased the resources required and costs associated with
planning, designing, drilling, operating and both installing and abandoning oil
and natural gas wells and facilities. Indeed, within the fiscal year just
ended, the Company has had to dedicate additional staff resources to the task of
complying with developing, changing and expanding environmental regulations. As
yet, Basic has not had to hire any new employees to comply with these
regulations. The Company will continue to make expenditures in its efforts to
comply with these requirements, which are unavoidable business costs in the oil
and gas industry.
Although the Company is not fully insured against all environmental and other
risks, it maintains insurance coverage which it believes is customary in the
industry.
Other
In the year just ended, the Company was not involved in any research and
development efforts, nor does management anticipate any such efforts in the
coming fiscal year. There are no significant patents, trademarks, licenses,
franchises or concessions held by the Company.
The oil and gas business is not generally seasonal in nature, although unusual
weather extremes for extended periods may increase or decrease demand for oil
and natural gas products temporarily. Additionally, catastrophic events, such
as hurricanes or other supply disruptions, may also temporarily increase the
demand for oil and gas supplies. Such events and their impacts may cause
fluctuations in quarterly or even annual revenues and earnings.
Basic's offices are located at 633 Seventeenth Street, Suite 1670, Denver,
Colorado 80202 (telephone number 303-294-9525). At the end of its fiscal year,
the Company had ten employees: five at its main office in Denver, Colorado and
five at its subsidiary's field office in Bruni, Texas, located forty-five miles
east, southeast of Laredo, Texas.
<PAGE>
ITEM 2
DESCRIPTION OF PROPERTY
Producing Properties: Locations and Impact
As of March 31, 1996, Basic owned an interest in 115 oil wells and 20 gas wells.
Basic currently operates 82 wells in five states: North Dakota, Montana,
Colorado, Texas and Wyoming. These operated wells contributed approximately
75.7 percent of Basic's total liquid hydrocarbon sales and approximately 66.3
percent of total gas sales in the year ended March 31, 1996. The majority of
Basic's operated liquid reserves are located in the Williston basin of North
Dakota and Montana and in south Texas while the majority of Basic's operated gas
reserves are located in Colorado's Denver-Julesburg basin. Substantially all
producing properties are encumbered and used to secure bank debt.
<TABLE>
<CAPTION>
Producing Property
------------------
Gross Wells Net Wells
----------- ---------
Oil Gas Oil Gas
--- --- --- ---
<S> <C> <C> <C> <C>
Colorado 0 4 0.00 2.40
Kansas 3 0 0.53 0.00
Louisiana 4 9 0.77 .38
Montana 18 0 13.55 0.00
New Mexico 0 5 0.00 0.98
North Dakota 50 0 22.36 0.00
Oklahoma 2 1 0.50 0.31
Texas 37 1 28.99 0.23
Wyoming 1 0 0.42 0.00
----- ----- ----- -----
Total 115 20 67.12 4.30
===== ===== ===== =====
</TABLE>
Reserves
At March 31, 1996, the discounted present value of Basic's estimated proved
reserves was approximately $4,725,000 reflecting a 41.2% increase over the
previous year's reserves of $3,347,000. This increase was primarily the result
of an increase in the price of oil over the price at March 31, 1995 and the
reserves added following the successful recompletion of the State #12-16 into
the Bakken formation, in addition to the purchase of numerous small interests in
various wells which Basic operates. The analysis of Basic's oil and gas
reserves and the financial analysis of the oil and gas properties are in Notes 1
and 7 to the Consolidated Financial Statements.
Leasehold Acreage
The Company leases the rights to explore for and produce oil and gas from
mineral owners. Leases (quantified in acres) expire after their primary term
unless oil or gas production is established. Prior to establishing production,
leases are considered undeveloped. After production is established, leases are
considered developed or "held-by-production." Basic's acreage is comprised of
developed and undeveloped acreage. Typically, undeveloped acreage is considered
an indication of the Company's "raw material" and, therefore, its potential to
replace reserves in the future. Basic's strategy is the acquisition of
producing properties. Given this strategy, there is no need for Basic to amass
undeveloped acreage blocks. As a result, Basic has a minimal amount of
undeveloped acreage relative to exploration companies. Management believes this
is a reflection of the Company's strategy rather than its ability to replace
reserves.
<TABLE>
<CAPTION>
Developed Acreage Undeveloped Acreage
----------------- -------------------
Gross Net Gross Net
----- ----- ----- -----
<S> <C> <C> <C> <C>
Colorado 640 344 0 0
Kansas 800 130 0 0
Louisiana 3,349 417 9,478 280
Montana 2,720 2,029 2,600 826
New Mexico 800 156 0 0
North Dakota 8,812 4,579 5,037 2,413
Oklahoma 320 85 0 0
Texas 3,166 2,256 80 64
Wyoming 634 254 1,016 486
----- ----- ----- -----
Total 21,241 10,250 18,211 4,069
====== ====== ====== =====
</TABLE>
Office Building
During the fiscal year ended March 1995, Basic sold its 6,700 square foot office
building which was its corporate headquarters. Following this transaction,
Basic subleased office space and moved its corporate headquarters to downtown
Denver. The building was encumbered by a mortgage. (See Note 2 to the
Consolidated Financial Statements.)
Field Service Equipment
At March 31, 1996, the Company's subsidiary, Basic Petroleum Services, Inc.,
owned a 60' trailer house/field office, a shallow pulling rig, a large winch
truck, a skid-mounted cementing unit, four pickup trucks and six ancillary
service vehicles. None of the vehicles are encumbered.
ITEM 3
LEGAL PROCEEDINGS
None.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS
No matter was submitted to a vote of Basic's shareholders during the fiscal
quarter ended March 31, 1996.
<PAGE>
Part II
ITEM 5
MARKET FOR COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Basic's common stock is traded in the over-the-counter market. The following
table sets forth the range of high and low bid prices for each quarter of the
last two fiscal years. Prices are obtained from National Quotation Bureau, Inc.
<TABLE>
<CAPTION>
High Low
----- -----
Year Ended March 31, 1995
<S> <C> <C>
First Quarter $.0500 $.0200
Second Quarter .0500 .0200
Third Quarter .0300 .0200
Fourth Quarter .0400 .0100
Year Ended March 31, 1996
First Quarter $.0938 $.0312
Second Quarter .0800 .0312
Third Quarter .0800 .0200
Fourth Quarter .0312 .0200
</TABLE>
The bid price on June 17, 1996 was $0.03. Transactions on the over-the-counter
market reflect inter-dealer quotations, without adjustments for retail mark-ups,
mark-downs or commissions to the broker-dealer and may not necessarily represent
actual transactions.
As of March 31, 1996, Basic had approximately 2,546 shareholders of record.
Management estimates there are over 5,000 beneficial owners. Basic has never
paid a cash dividend on its common stock. Any future dividend on common stock
will be at the discretion of the Board of Directors and will be dependent upon
the Company's earnings, financial condition, and other factors. The Company's
Board of Directors presently has no plans to pay any dividends in the
foreseeable future.
ITEM 6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION
Capital Structure and Liquidity
Financing
The Company recognizes the importance of developing its capital resource base in
order to pursue its objectives. However, subsequent to its last public offering
in 1980, debt financing has been the sole source of external funding.
Bank Debt
On September 13, 1995, the Bank and the Company modified its previous loan
agreement to create a "Declining Balance, Revolving Line of Credit" (DBRLOC) and
increased the face amount of the promissory note to $2,500,000. The Company is
now able to draw on the DBRLOC up to $2,500,000 or the borrowing base, whichever
is less. At March 31, 1996 the Company's borrowing base was at $1,020,000, but
declines monthly by the minimum required principal payment. Under the DBRLOC
and note, the Company is required to make monthly principal payments until May
31, 1998. Information concerning the Company's debt appears in Note 2 to the
Consolidated Financial Statements.
Hedging
Hedging techniques are traditionally used to limit exposure to price
fluctuations. Given the financial leverage created by its bank debt and the
magnitude of the near-term principal payments, fluctuations in crude oil prices
may have an impact on the Company's financial affairs. Accordingly, during the
past year the Company entered into futures and/or options contracts in order to
hedge its exposure to any material fluctuations in crude oil prices. The
Company has not hedged any gas production. Information concerning the Company's
hedging activities appears in Note 1 to the Consolidated Financial Statements.
Liquidity
The Company's current ratio increased from .7:1 at March 31, 1995 (1995) to
0.9:1 at March 31, 1996 (1996). A specific Bank covenant requires the
maintenance of a current ratio of 1:1, after adjustment by the removal of the
current portion of long-term debt. At March 31, 1996, the Company was in
compliance with all Bank covenants and the Company's current ratio was 1:1 as
calculated per the provisions of the covenants.
During the fiscal year just ended, current assets decreased 4% from $720,000 at
1995 to $717,000 at 1996 while current liabilities decreased 16% from $986,000
at 1995 to $825,000 at 1996. Cash increased $9,000 (11%) from $83,000 at 1995
to $92,000 at 1996.
Liquidity Outlook
The Company's primary source of funding is the net cash flow from the sale of
its oil and gas production. The profitability and cash flow generated by the
Company's operations in any particular accounting period will be directly
related to: (a) the volume of oil and gas produced and then sold, (b) the
average realized prices for oil and gas sold, and (c) lifting costs. Assuming
that oil prices do not decline significantly from current levels, management
believes the cash generated from operations will enable the Company to meet its
existing obligations as they become due in fiscal year 1997. If the Company is
able to hedge future production, especially through March 1997, then even if oil
prices decline significantly from current levels, management believes the cash
generated from operations and hedging activities will enable the Company to meet
its existing obligations as they become due in fiscal year 1997.
Impact of Inflation
Inflation has not had a great impact on the Company in recent years because of
the relatively low rates of inflation in the United States.
Capital Resources; Requirements and Alternatives
Overview
In addition to its routine and predictable production-related costs, its general
and administrative expenses and its debt repayment requirements, the Company
requires capital to fund the development and enhancement of recently acquired
properties and the capital to fund the acquisition of additional properties.
The Company intends to fund its immediate needs for these efforts with the use
of its internally-generated cash flow from operations, industry and/or
investment partners, and new financing, all of which may or may not be generated
or obtained.
Other Commitments
As of June 17, 1996, the Company has no obligations to purchase or sell any of
its oil and gas properties nor any other commitments beyond its hedging
activities and the 3-D seismic shoot in which it has agreed to participate (See
Item 1, Contemplated Activities, Drilling).
New Debt/Equity Financing
The Company's balance sheet and borrowing base have little capacity for
additional debt. Unless the Company is successful in exploiting undeveloped
potential from recently acquired properties, and thus add to the Company's
borrowing base, management does not believe it can successfully secure
additional bank debt without securing additional equity capital.
Given Basic's size and the current price of the Company's stock, management
believes additional equity would be difficult and expensive to obtain. At the
same time, management is acutely aware of the need for additional equity
financing in order to fund future growth. While addressing the care and
concerns of existing shareholders, management is in the initial stages of
exploring methods of developing a stronger capital base. However, it must be
stressed, there are no assurances that equity financing is available or can be
attained by the Company. Furthermore, pursuit of equity financing may alter or
vary due to changes in circumstances, unforeseen costs or difficulties,
unforeseen opportunities and other events which the Company is not able to
anticipate.
Results of Operations
1996 Compared with 1995
Overview
Operations in fiscal year ended March 31, 1996 (1996) resulted in $6,000 of net
income compared to net income of $90,000 for fiscal year ended March 31, 1995
(1995).
Revenues
Oil and gas sales revenue increased $1,384,000 (97%) from 1995. Of this amount,
$1,319,000 (95%) was attributable to increases in oil production and $23,000
(2%) was attributable to strengthening oil prices. Furthermore, $68,000 (5%)
was attributable to gas volume increases while -$26,000 (-2%) was attributable
to weakening gas prices.
Volumes and Prices
Total liquid production increased 117%, from 69,000 barrels in 1995 to 150,000
barrels in 1996, while the average price per barrel increased slightly from
$16.26 in 1995 to $16.43 in 1996. Total gas production increased 22%, from
175,000 MCF in 1995 to 214,000 MCF in 1996, while the price per MCF dropped 7%,
from $1.75 in 1995 to $1.63 in 1996. The increase in liquid production was due
to the Williston basin acquisition completed near the end of fiscal 1995. The
increase in gas production was primarily due to development drilling and
recompletion on the Company's Antenna Federal prospect in Weld County, Colorado.
Both liquid and gas production increases were partially offset by normal
production declines.
Expenses
Oil and gas production expense and production taxes increased $1,164,000 (137%)
in 1996 from 1995 primarily as a result of the Williston basin acquisition
completed near the end of fiscal 1995. The overall lifting cost per equivalent
barrel increased 25% from $8.67 in 1995 to $10.85 in 1996. This
disproportionate increase in lifting cost is due to a higher percentage of oil
versus gas production following the Williston basin acquisition and high initial
decline rates associated with newly drilled and/or recompleted gas wells.
Compounding this problem are the previously disclosed, unanticipated repair
costs associated with equipmnt on recently acquired Williston basin properties.
These repair costs have two components. First, the costs due to the elevated
level of recurring, but seemingly routine, equipment failures and associated
attempts to repair (keep in service) compromised equipment (a cost which is
expensed). Second, once identified and determined to be economically justified,
the costs to replace and/or refurbish surface and subsurface equipment (a cost
which is capitalized). The Company expects these repair costs to continue,
albeit in decreasing amounts, as the Company discovers, repairs and replaces
compromised equipment and/or abandons or sells wells where replacement of such
equipment cannot be economically justified. While the impact of these costs is
evident on current oil and gas production expense, the Company cannot predict
the magnitude of future repair activities nor the impact on future costs.
Depreciation and depletion expense increased $193,000 (55%) in 1996 from 1995.
This increase was primarily due to increases in produced volumes resulting from
the Williston basin acquisition mentioned above. The effect of the increase in
produced volumes was partially offset by a decrease in the depletion expense per
equivalent barrel. In this regard, the depletion expense per equivalent barrel
decreased 16% from $3.41 in 1995 to $2.87 in 1996, primarily because of the
increase in reserve volumes. However, the depletion rate, as a percent of the
full cost pool, increased from 11% in 1995 to 17% in 1996.
Net general and administrative expense decreased $88,000 (37%) in 1996 from
1995. This decrease is primarily attributable to an increase in the number of
Company-operated properties, and associated administrative overhead fees
following the Williston basin acquisition mentioned above. Administrative
overhead fees are charged to various properties which the Company operates and
serve to reduce gross general and administrative expenses. Such charges are
made in recognition of the cost of office activities incurred in the
administration of Company operated properties. Also contributing to the overall
decrease in general and administrative expense were decreases in building
expenses, bad debt expense and outside professional fees which were partially
offset by increases in salaries and office expenses. As a result of the overall
decrease, and in conjunction with increased production volumes, general and
administrative expense per equivalent barrel decreased from $2.43 in 1995 to
$.81 in 1996.
Other Income/Expense
Other Income/Expense decreased $198,000 (192%), from a positive $103,000 in 1995
to a negative $95,000 in 1996. This decrease was the result of certain
transactions which occurred in 1995 which were not repeated in 1996. They
include sales proceeds being netted against receivables, writing-off dated and
disputed payables and partially offsetting receivables, and proceeds from the
sale of the Company's office building. Additionally, interest expense on the
Company's bank debt increased significantly in 1996 from 1995. See Note 2 to
the Consolidated Financial Statements for further discussion of bank debt.
Liquids and Natural Gas Production, Sales Price and Production Costs
Liquids and natural gas production, average sales prices and average production
costs per equivalent barrel of production are shown in the following table for
each of the three prior years in the period ended March 31.
<TABLE>
<CAPTION>
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Production:
Oil (barrels) 150,000 69,000 67,000
Gas (mcf) 214,000 175,000 109,000
Revenue: (in thousands)
Oil $2,464 $1,122 $1,034
Gas 349 307 207
------ ------ ------
Total 2,813 1,429 1,241
Total production expense
(in thousands)(1) 2,015 851 808
------ ------ ------
Gross profit (in thousands) 798 578 433
====== ====== ======
Average sales price:
Oil (per barrel) $16.43 $16.26 $15.33
Gas (per mcf) 1.63 1.75 1.90
Average production expense(2) 10.85 8.67 9.51
Average gross profit(3) 4.30 5.89 5.08
--------------------------
(1) Operating costs, including production tax
(2) Operating costs, including production tax, per equivalent barrel (6
mcf of gas is equivalent to 1 barrel of oil)
(3) Gross profit per equivalent barrel (6 mcf of gas is equivalent to 1
barrel of oil)
</TABLE>
<PAGE>
ITEM 7
FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Basic Earth Science Systems, Inc.:
We have audited the accompanying consolidated balance sheets of BASIC EARTH
SCIENCE SYSTEMS, INC. (a Delaware corporation) and subsidiaries, as of March 31,
1996 and 1995, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended March 31, 1996.
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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Basic Earth Science Systems,
Inc., and subsidiaries as of March 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
March 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado,
June 7, 1996.
<PAGE>
<TABLE>
Basic Earth Science Systems, Inc.
Consolidated Balance Sheets
Page 1 of 2
<CAPTION>
Assets
------
March 31
--------
1996 1995
-------- --------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $92,000 $83,000
Accounts receivable:
Oil and gas sales 322,000 292,000
Joint interest and other, net 155,000 299,000
Other current assets 148,000 46,000
-------- --------
Total current assets 717,000 720,000
-------- --------
PROPERTY AND EQUIPMENT:
Oil and gas property (full cost method) 31,844,000 31,418,000
Furniture, fixtures and equipment 432,000 435,000
---------- ----------
32,276,000 31,853,000
Accumulated depreciation (356,000) (358,000)
Accumulated depletion - FCP
(includes cumulative ceiling
limitation charges of $14,091,000
in 1996 and 1995) (29,295,000) (28,763,000)
------------ ------------
Net property and equipment 2,625,000 2,732,000
Other noncurrent assets 77,000 56,000
------------ ------------
Total noncurrent assets 2,702,000 2,788,000
------------ ------------
TOTAL ASSETS $3,419,000 $3,508,000
============ ============
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
Basic Earth Science Systems, Inc.
Consolidated Balance Sheets
Page 2 of 2
<CAPTION>
Liabilities and Shareholders' Equity
------------------------------------
March 31
--------
1996 1995
---------- ----------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable & accrued liabilities $699,000 $472,000
Current portion of long-term debt 126,000 514,000
---------- ----------
Total current liabilities 825,000 986,000
---------- ----------
LONG-TERM DEBT 692,000 626,000
---------- ----------
SHAREHOLDERS' EQUITY:
Preferred stock, $.10 par value
at March 31, 1995; $.001 par
value at March 31, 1996
Authorized - 3,000,000 shares
Issued - 0 shares --- ---
Common stock, $.10 par value at
March 31, 1995; $.001 par
value at March 31, 1996
Authorized - 32,000,000 shares
Issued - 16,879,752 shares in
1996 and 1995 17,000 1,688,000
Additional paid-in capital 22,692,000 21,022,000
Employee Stock Ownership Plan
contribution --- 13,000
Treasury stock (299,265 shares at
March 31, 1996; 572,739 shares
at March 31, 1995) at cost (15,000) (29,000)
Accumulated deficit (20,792,000) (20,798,000)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 1,902,000 1,896,000
------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $3,419,000 $3,508,000
============ ============
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
Basic Earth Science Systems, Inc.
Consolidated Statements of Operations
<CAPTION>
Year Ended March 31
-------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
REVENUE:
Oil and gas sales $2,813,000 $1,429,000 $1,241,000
Well service revenue 13,000 7,000 ---
---------- ---------- ----------
Total revenue 2,826,000 1,436,000 1,241,000
---------- ---------- ----------
EXPENSES:
Oil and gas production 1,779,000 762,000 726,000
Production tax 236,000 89,000 82,000
Well servicing expenses 12,000 5,000 ---
Depreciation, depletion and
amortization 547,000 354,000 297,000
General and administrative 151,000 239,000 277,000
--------- --------- ---------
Total expenses 2,725,000 1,449,000 1,382,000
--------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 101,000 (13,000) (141,000)
--------- --------- ---------
OTHER INCOME (EXPENSE):
Interest and other income 9,000 107,000 11,000
Gain on sale of office
building --- 38,000 ---
Interest expense (104,000) (42,000) (44,000)
--------- -------- --------
Total other income (expense) (95,000) 103,000 (33,000)
--------- -------- --------
NET INCOME (LOSS) $6,000 $90,000 $(174,000)
========= ======== ==========
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING 16,478,869 16,593,614 16,739,777
========== ========== ==========
NET INCOME (LOSS) PER SHARE $--- $.005 $(.010)
========== ========== ==========
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
Basic Earth Science Systems, Inc.
Consolidated Statements of Cash Flows
<CAPTION>
Year Ended March 31
-------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss) $6,000 $90,000 $(174,000)
Adjustments to reconcile
net income (loss) to
net cash provided by
operating activities:
Depreciation, depletion
and amortization 547,000 354,000 297,000
Bad debt expense --- --- 60,000
Employee Stock Ownership
Plan contribution --- 7,000 6,000
Change in current assets
and current liabilities:
Accounts receivable, net 114,000 (376,000) 27,000
Other current assets (102,000) (2,000) (5,000)
Accounts payable and
accrued liabilities 227,000 142,000 (10,000)
Changes in other assets (21,000) (56,000) ---
Changes in other
liabilities (3,000) --- ---
(Gain)/loss on sale of
assets 1,000 (38,000) ---
Other 13,000 13,000 6,000
---------- ---------- ----------
Net cash provided by
operating activities 782,000 134,000 207,000
---------- ---------- ----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Capital expenditures:
Oil and gas property (455,000) (1,708,000) (76,000)
Support equipment (28,000) (44,000) (18,000)
Proceeds from sale of oil
and gas property 29,000 186,000 ---
Proceeds from sale of
building --- 382,000 ---
---------- ---------- ----------
Net cash used in
investing activities (454,000) (1,184,000) (94,000)
---------- ---------- ----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Long-term debt payments (564,000) (419,000) (7,000)
Proceeds from borrowing 245,000 1,190,000 ---
Purchase of treasury stock --- (16,000) (48,000)
---------- ---------- ----------
Net cash provided by
(used in) financing
activities (319,000) 755,000 (55,000)
---------- ---------- ----------
CASH AND CASH EQUIVALENTS:
Increase (decrease) in cash
and cash equivalents 9,000 (295,000) 58,000
Balance at beginning of year 83,000 378,000 320,000
---------- ---------- ----------
Balance at end of year $92,000 $83,000 $378,000
---------- ---------- ----------
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
Cash paid for interest $104,000 $42,000 $44,000
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
Basic Earth Science Systems, Inc.
Consolidated Statements of Changes in Shareholders' Equity
Years ended March 31, 1996, 1995 and 1994
<CAPTION>
Common stock Additional
------------ paid-in
Shares Par value capital
------ --------- -------
<S> <C> <C> <C>
Balance, April 1, 1993 16,879,752 $1,688,000 $21,025,000
Purchase of treasury stock --- --- ---
Issuance of treasury stock for
Employee Stock Ownership
Plan contribution --- --- (3,000)
Employee Stock Ownership
Plan contribution
(132,534 shares) --- --- ---
Net Loss --- --- ---
---------- ---------- ----------
Balance, March 31, 1994 16,879,752 1,688,000 21,022,000
Purchase of treasury stock --- --- ---
Employee Stock Ownership
Plan contribution
(140,940 shares) --- --- ---
Net Income --- --- ---
---------- ---------- ----------
Balance, March 31, 1995 16,879,752 1,688,000 21,022,000
Issuance of treasury stock for
Employee Stock Ownership
Plan contribution --- --- (1,000)
Change in par value --- (1,671,000) 1,671,000
Net Income --- --- ---
---------- ---------- ----------
Balance, March 31, 1996 16,879,752 $17,000 $22,692,000
========== ========== ==========
<CAPTION>
Employee Stock Treasury stock
Ownership Plan -------------- Accumulated
contribution Shares Amount deficit
-------------- ------ ------ -----------
<S> <C> <C> <C> <C>
Balance, April 1, 1993 $32,000 --- --- $(20,714,000)
Purchase of treasury
stock --- (468,004) $(48,000) ---
Issuance of treasury stock
for Employee Stock
Ownership Plan
contribution (32,000) 324,757 35,000 ---
Employee Stock Ownership
Plan contribution
(132,534 shares) 6,000 --- --- ---
Net Loss --- --- --- (174,000)
---------- -------- -------- ----------
Balance, March 31, 1994 6,000 (143,247) (13,000) (20,888,000)
Purchase of treasury
stock --- (429,492) (16,000) ---
Employee Stock Ownership
Plan constribution
(140,940 shares) 7,000 --- --- ---
Net Income --- --- --- 90,000
---------- -------- -------- ----------
Balance, March 31, 1995 13,000 (572,739) (29,000) (20,798,000)
Issuance of treasury stock
for Employee Stock
Ownership Plan
contribution (13,000) 273,374 14,000 ---
Change in par value --- --- --- ---
Net Income --- --- --- 6,000
---------- -------- -------- ----------
Balance, March 31, 1996 $0 (299,265) $(15,000) $(20,792,000)
========== ======== ======== ==========
</TABLE>
See accompanying notes.
<PAGE>
Basic Earth Science Systems, Inc.
Table of Contents
Notes to Consolidated Financial Statements
March 31, 1996
Page No.
--------
1. Summary of Significant Accounting Policies 24
2. Debt 27
3. Shareholders' Equity 29
4. Major Customers 29
5. Income Tax 30
6. Related Party Transactions 31
7. Unaudited Oil and Gas Reserve Information 31
<PAGE>
Basic Earth Science Systems, Inc.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Basic Earth
Science Systems, Inc. (Basic or the Company) and its wholly-owned subsidiaries.
All significant intercompany accounts and transactions have been eliminated.
Oil and Gas Producing Activity
Basic follows the full cost method of accounting for its oil and gas activity.
Accordingly, all costs associated with the acquisition, exploration and
development of oil and gas property are capitalized. Should net oil and gas
property cost exceed an amount equal to the present value (using a 10% discount
factor) of estimated future net revenue from proved reserves, considering
related income tax effects, as prescribed by the Securities and Exchange
Commission's ceiling limitation, the excess is charged to expense during the
period in which the excess occurs. Basic did not incur a ceiling limitation
charge during the years ended March 31, 1996, 1995 or 1994.
If a significant portion of Basic's oil and gas reserves are sold, a gain or
loss would be recognized; otherwise, proceeds from sales are credited to oil and
gas property cost. In the years ended March 31, 1996, 1995 and 1994, Basic
credited oil and gas property cost for $29,000, $186,000 and $1,000,
respectively, as a result of the sale of its interest in certain oil and gas
property.
All of Basic's property is located in the United States.
All capitalized cost is depleted on a composite units-of-production method based
on estimated proved reserves attributable to the oil and gas property owned by
Basic. Depletion per equivalent barrel of production was $2.87, $3.41 and $3.08
for the years ended March 31, 1996, 1995 and 1994, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. There
are many factors, including global events, that may influence the production,
processing, marketing, and valuation of crude oil and natural gas. A reduction
in the valuation of oil and gas properties resulting from declining prices or
production could adversely impact depletion rates and ceiling test limitations.
Support Equipment and Other
When property and equipment other than oil and gas property is retired,
abandoned or sold, the related cost and accumulated depreciation are removed
from the accounts and any gain or loss is reflected in operations. Depreciation
of support equipment and other property is computed using various methods over
periods ranging from three to thirty years.
Earnings (Loss) Per Share
Earnings (loss) per share is calculated based on the weighted average number of
shares outstanding for each period. The effect of the assumed exercise of any
outstanding stock options was anti-dilutive and, therefore, was excluded from
the computations. The weighted average number of shares for the years ended
March 31, 1996, 1995 and 1994 was 16,478,869, 16,593,614 and 16,739,777,
respectively.
Reclassifications
Certain prior year amounts have been reclassified to conform to current year
presentation.
Cash and Cash Equivalents
For purposes of the Consolidated Balance Sheets and Statements of Cash Flows,
Basic considers all highly liquid investments with a maturity of ninety days or
less when purchased to be cash equivalents. The carrying amount of cash
equivalents approximates fair value because of the short maturity of those
instruments.
Hedging
Hedging techniques are traditionally used to limit exposure to price
fluctuations. Given the financial leverage created by its bank debt and the
magnitude of the near-term principal payments, fluctuations in crude oil prices
may have an impact on the Company's financial affairs. Accordingly, during the
past year the Company entered into futures and/or options contracts in order to
hedge its exposure to any material fluctuations in crude oil prices. The
Company has not hedged any gas production. Gains or losses attributable to such
contracts that hedge specific future deliveries are deferred and recognized in
income when the corresponding physical sale is recorded.
Under futures contracts, the Company receives or makes payments to the New York
Mercantile Exchange (NYMEX) via a trading account based on the differential
between the price at which any given contract was sold and the price at which it
was bought back (the closing price). Under put option contracts, the Company
would receive payments from NYMEX if the closing price is greater than the floor
price at which the put option was purchased. When a put option contract is
combined with the sale of a call option contract, a "collar" or a floor price
and a ceiling price is created. In this situation the Company would receive
payments from NYMEX if the closing price is greater than the floor price at
which the put option was purchased or would make payments to NYMEX if the
closing price is greater than the ceiling price at which the call option was
sold. If the closing price was between the floor and the ceiling both options
would expire unexercised and the Company would benefit by the amount the closing
price exceeded the floor price, less the cost of the option. When a futures
contract is combined with the purchase of a call option contract, a "synthetic
put" is created. In this situation, the futures contract would cause the
Company to receive or make payments to NYMEX as described above. However, any
payment would be offset by, and to the extent, the closing price is greater than
the price at which the call option was purchased.
At March 31, 1996, the Company had forty-two open futures and/or options
contracts to hedge future deliveries with maturities ranging from May 1996
through January 1997 at prices ranging from $18.08 to $21.47 per barrel.
Cash flows from hedging activities are classified as operating activities in the
Statement of Cash Flows. The Company realized a $38,350 loss on its hedging
activities in 1996. These losses were offset by receiving higher prices for
physical crude oil sales in 1996. No hedging activities were undertaken in
1995. The fair market value of the open futures and options contracts at March
31, 1996, using commodity prices in effect at March 31, 1996, would, if such
prices were to remain constant in the future, create an approximate loss of
$45,930. If such a loss, or a portion thereof, were to occur, such loss
theoretically would be offset by receiving higher prices for physical crude oil
sales.
For each futures contract and each call option contract that is sold, the
Company is required to furnish an initial cash margin. In addition, to the
extent that the price of oil moves above the price each futures or call option
contract was sold, the Company is required to furnish an additional cash margin,
an event known as a margin call. The purchase of put or call options does not
require a cash margin to be maintained. If a margin call is not funded, NYMEX
will close the contracts and any unrealized loss would become a realized loss.
The Company has executed a tri-party agreement to fund the initial margin
requirement and any margin calls up to $900,000 (See further information under
Debt). Because of the volatility of oil prices, it is possible for this credit
limit to be exceeded. One example of how this credit limit could be exceeded
would occur if the Company were to execute one hundred (100) contracts and the
price of oil were to increase nine dollars per barrel ($9/ Bbl) in each future
month in which the Company had a contract (other variations of this example
could result in credit limit exposure). By loan covenant and Board of Director
direction, the Company is precluded from exceeding 75% of the average monthly
production demonstrated over the three preceding months. At March 31, 1996,
approximately $150,000 of the $900,000 credit limit was being utilized. During
the past year, the maximum credit utilization never exceeded $150,000.
The Company is not exposed to credit risk in the event of nonperformance by a
counterparty in that such risk is borne by NYMEX. Since each trader in each
future contract and put or call option sold is required to furnish an initial
cash margin and is subject to margin calls, nonperformance by NYMEX is
considered unlikely.
Continuation of hedging activities, at this level of coverage or at higher or
lower levels of coverage, may vary or change, due to change of circumstances,
unforeseen opportunities, inability to fund margin requirements, lending
institution requirements and other events which the Company is not able to
anticipate.
2. Debt
Outstanding debt of Basic as of March 31, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
March 31
-----------------------
1996 1995
-------- --------
<S> <C> <C>
Bank note under loan
agreement (see below) $801,000 $1,120,000
Other long-term liabilities 17,000 20,000
-------- ----------
818,000 1,140,000
Less current portion 126,000 514,000
-------- ----------
Total long-term debt $692,000 $626,000
======== ==========
</TABLE>
Bank Debt
On August 1, 1994, the Company entered into a loan agreement with Norwest Bank
Colorado N.A. (the Bank) whereby the Company borrowed $500,000 and executed a
$500,000 promissory note payable to the Bank.
On March 30, 1995, the Bank and the Company modified this loan agreement to
provide the Company with an additional $690,000 and increased the face amount of
the promissory note to $1,120,000. The loan was modified to accommodate the
acquisition of approximately sixty properties in the Williston basin of North
Dakota and Montana.
On September 13, 1995, the Bank and the Company modified its previous loan
agreement to create a "Declining Balance, Revolving Line of Credit" (DBRLOC) and
increased the face amount of the promissory note to $2,500,000. The Company is
now able to draw on the DBRLOC up to $2,500,000 or the borrowing base, whichever
is less. At March 31, 1996 the Company's borrowing base was at $1,020,000, but
declines monthly by the minimum required principal payment. Under the DBRLOC
and note, the Company is required to make monthly principal payments until May
31, 1998 in the following minimum amounts:
April 30, 1996 through December 31, 1996 $30,000 per month
January 31, 1997 through December 31, 1997 $25,000 per month
January 31, 1998 through April 30, 1998 $20,000 per month
May 31, 1998 Balance of remaining
principal
The Company's borrowing base will be reviewed biannually and may be adjusted up
or down due to reevaluation of previously collateralized properties, addition of
newly acquired properties, increased reserves created by enhancements or
exploitation and rising or declining oil or gas prices. At May 31, 1998, unless
the DBRLOC is again modified or the borrowing base is adjusted, the outstanding
principal balance potentially could be as high as $151,000.
In addition to the above described principal payments, monthly interest payments
are due on the unpaid principal balance at the Bank's fluctuating prime lending
rate plus two percent (2%). In addition, quarterly, the Company is required to
pay a 1/2% commitment fee on the unused portion of the adjusted and declined
borrowing base. As of March 31, 1996, the Company's effective annual interest
rate was 10.25%.
As a result of the foregoing loan modification, the Company now has the ability
to draw additional funds from the DBRLOC up to the then effective borrowing
base. In addition, the Company may reduce the loan balance ahead of schedule
and be able to re-borrow up to the declined and/or adjusted borrowing base.
Because of this flexibility, the current portion of long term debt has been
reduced by the difference between the borrowing base ($1,020,000) and the
outstanding debt ($801,000) or $219,000. Had this adjustment not been made,
the current portion of long term debt would be $345,000.
In addition to the above described DBRLOC, on September 13, 1995, the Bank and
the Company executed the collateral documents necessary to create a second
Revolving Line of Credit (RLOC) and make an additional $900,000 available for
the Company's hedging activities. The terms of the RLOC were finalized in
December 1995 and funds under this second facility were made available. In
addition to other requirements and restrictions, the funds from the RLOC can
only be used to fund margin requirements associated with the Company's hedging
activities. At March 31, 1996 the Company had drawn approximately $150,000 from
this facility to fund the margin requirements associated with the hedging
activities described above under Note 1.
Under the modified loan agreement, the Company must maintain certain covenants
with regard to various financial ratios, net worth, liens and other criteria.
Failure to maintain any covenant, after a curative period, creates a default
under the loan agreement and requires the repayment of the then-existing
principal balance. In addition to the foregoing, a specific event of default
occurs with the death, resignation or replacement of greater than fifty percent
(50%) of the current board of directors. At March 31, 1996, the Company was in
compliance with all Bank covenants, including those regarding financial ratios,
net worth, liens, encumbrances and other criteria.
The DBRLOC and RLOC are collateralized and secured by mortgages on substantially
all of the Company's producing oil and gas properties and the Company's
hedging/margin account associated with the Company's hedging activities.
Statements of Financial Accounting Standards No. 107 and 119 require a
disclosure comparing the fair value of long-term debt relative to the carrying
value. The Company's lines of credit require interest payments to be adjusted
by fluctuations in the Bank's prime lending rate. Based on this, management
believes the fair value of long-term debt approximates the carrying value.
Mortgage Debt
On September 1, 1994, the Company closed on the sale of its office building to
an unrelated third party for $382,000. The transaction generated approximately
$38,000 in net sales proceeds after extinguishing the mortgage debt and paying
all penalties, commissions and fees.
3. Shareholders' Equity
Employee Stock Ownership Plan
Basic's Employee Stock Ownership Plan covers substantially all employees who
have worked for Basic for at least six months and are employed at the end of the
Company's fiscal year. The annual contribution is determined by the board of
directors based upon eligible employees' base salaries. For the years ended
March 31, 1994 and 1995, the annual contribution was made using treasury stock.
There was no contribution made for the year ended March 31, 1996.
As previously disclosed, subsequent to the year ended March 31, 1995, the
Company filed an application with the Internal Revenue Service to terminate the
Employee Stock Ownership Plan (the Plan) effective April 1, 1995. This
application was made because of the high administrative costs associated with
maintenance of the Plan, the low percentage of proceeds which are received by
employees relative to total Plan costs, and the belief that alternative methods
of compensation will more effectively benefit the Company's employees. The
application was approved by the Internal Revenue Service and the process for
final termination is under way. The Company is reviewing several alternatives
in deciding how to replace the Plan.
4. Major Customers
Significant purchasers of 10% or more of Basic's oil and gas production are as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Cenex, Inc. 34% --- ---
Norco Crude Gathering, Inc. 18% 30% ---
Murphy Oil USA, Inc. 19% 28% 22%
Associated Natural Gas, Inc. --- 13% ---
Conoco, Inc. --- 10% 12%
Mobil Oil Corporation --- --- 34%
</TABLE>
It is not expected that the loss of any of these customers would cause a
material adverse impact on operations since alternative markets for the
Company's products are available.
5. Income Tax
Basic and its subsidiaries file a consolidated income tax return.
As of March 31, 1996, Basic had available, to reduce future taxable income, tax
net operating loss carryforwards of approximately $15,083,000 which approximates
alternative minimum tax net operating loss carryforwards, and which expire in
1997 through 2011. The net operating loss carryforward for tax purposes is
different from the net operating loss carryforward for financial reporting
purposes primarily because of the expensing of intangible drilling and
development costs for tax purposes and the ceiling limitation charges for
financial reporting purposes. For income tax purposes, investment tax credit
and excess statutory depletion carryforwards as of March 31, 1996 are
approximately $146,000 and $3,534,000, respectively. Investment tax credits are
accounted for using the flow-through method and expire in the year ended March
31, 2001.
In the first quarter of fiscal 1994, Basic implemented Statement of Financial
Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes,"
effective as of April 1, 1993. SFAS 109 requires recognition of deferred income
tax assets and liabilities based on enacted tax laws for all temporary
differences between financial reporting and tax bases of assets, liabilities and
carryforwards under SFAS 109. Deferred tax assets are then reduced, if deemed
necessary (i.e., more likely than not), by a valuation allowance for the amount
of any tax benefits which, based on current circumstances, are not expected to
be realized. The Company's adoption of SFAS 109 had no cumulative effect on
operations for the year ended March 31, 1996 since the net deferred tax asset of
$5,994,000 was offset by a valuation allowance of an equal amount.
The Company's deferred tax liabilities and assets are comprised of the following
components at March 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
----- -----
<S> <C> <C>
Deferred tax liabilities
Depreciation and depletion $(522,000) $(377,000)
Deferred tax assets
Net operating loss carryforwards 5,279,000 5,716,000
Statutory depletion carryforward 1,237,000 1,186,000
Valuation allowance (5,994,000) (6,525,000)
----------- -----------
Net deferred tax asset $0 $0
=========== ===========
</TABLE>
Basic has established a valuation allowance due to the uncertainty that the full
amount of the operating loss carryforwards will be utilized due to expiration
and other factors. Although management expects improvement in the future
results of operations, it emphasizes past performance rather than income
projections when determining the valuation allowance. Any subsequent
adjustments to the valuation allowance, if deemed appropriate due to changed
circumstances, will be recognized as a separate component of the provision for
income taxes.
6. Related Party Transactions
It is the policy of Basic that officers or directors may assign to or receive
assignments from Basic in oil and gas prospects only on the same terms and
conditions as accepted by independent third parties. It is also the policy of
Basic that officers or directors and Basic may participate together in oil and
gas prospects generated by independent third parties only on the same terms and
conditions as accepted by each other.
In the years ended March 31, 1996, 1995 and 1994, there were no significant
related party transactions.
7. Unaudited Oil and Gas Reserve Information
Approximately ninety-six percent (96%) of the reserve estimates presented
herein, for the year ended March 31, 1996, were derived from reports prepared by
the independent petroleum engineering firm, Heinle & Associates, Inc (Heinle).
The remaining four percent (4%) were prepared by Basic and were not audited by
Heinle. For the year ended March 31, 1995, approximately ninety-four percent
(94%) of the reserve estimates presented herein were derived from reports
prepared by Heinle. The remaining six percent (6%) were prepared by Basic and
were not audited by Heinle. For the year ended March 31, 1994, approximately
ninety percent (90%) of the reserve estimates presented herein were derived from
reports prepared by Heinle. The remaining ten percent (10%) were prepared by
Basic and were not audited by Heinle. The Company cautions that there are many
inherent uncertainties in estimating proved reserve quantities and in projecting
future production rates and the timing of development expenditures.
Accordingly, these estimates are likely to change as future information becomes
available.
Proved oil and gas reserves are the estimated quantities of crude oil,
condensate, natural gas and natural gas liquids 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 reserves are those reserves expected to be recovered through
existing wells with existing equipment and operating methods.
Analysis of Changes in Proved Reserves
Estimated quantities of proved reserves (all of which are located within the
United States), as well as the changes in proved reserves during the periods
indicated, are presented in the following two tables:
<TABLE>
Proved Developed and Undeveloped Reserves
<CAPTION>
Natural
Oil gas
(bbl) (mcf)
----------- -------
<S> <C> <C>
Proved developed and undeveloped
reserves at March 31, 1993 539,000 976,000
Revisions of previous estimates (226,000) (106,000)
Extensions and discoveries 14,000 392,000
Improved recovery 8,000 49,000
Production (67,000) (109,000)
Purchase of reserves 8,000 ---
Sale of reserves --- ---
---------- ----------
Proved developed and undeveloped
reserves at March 31, 1994 276,000 1,202,000
Revisions of previous estimates 87,000 (801,000)
Extensions and discoveries 29,000 862,000
Improved recovery 25,000 3,000
Production (69,000) (175,000)
Purchase of reserves 262,000 ---
Sale of reserves --- ---
---------- ----------
Proved developed and undeveloped
reserves at March 31, 1995 610,000 1,091,000
Revisions of previous estimates 108,000 228,000
Extensions and discoveries 68,000 ---
Improved recovery 70,000 ---
Production (150,000) (214,000)
Purchase of reserves 15,000 2,000
Sale of reserves --- ---
---------- ----------
Proved developed and undeveloped
reserves at March 31, 1996 721,000 1,107,000
========== ==========
</TABLE>
<TABLE>
Proved Developed Reserves
-------------------------
<CAPTION>
Natural
Oil gas
(bbl) (mcf)
---------- ---------
<S> <C> <C>
March 31, 1996 721,000 1,107,000
March 31, 1995 610,000 1,091,000
March 31, 1994 258,000 790,000
</TABLE>
<TABLE>
Aggregate Capitalized Oil and Gas Property Cost
-----------------------------------------------
<CAPTION>
March 31
--------
1996 1995
----------- -----------
<S> <C> <C>
Capitalized cost
Proved property $31,823,000 $31,397,000
Unproved property 21,000 21,000
----------- -----------
31,844,000 31,418,000
Accumulated depreciation and
depletion (15,204,000) (14,672,000)
Oil and gas property cost
in excess of ceiling
limitation (cumulative) (14,091,000) (14,091,000)
------------ ------------
Net capitalized cost $2,549,000 $2,655,000
============ ============
</TABLE>
<TABLE>
Costs Incurred
--------------
<CAPTION>
Year Ended March 31
-------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Property acquisition
Proved property $215,000 $1,063,000 $36,000
Unproved property (15,000) (186,000) ---
Exploration 11,000 --- ---
Development 276,000 589,000 ---
</TABLE>
In the year ended March 31, 1996, Basic received approximately $29,000 from an
unrelated third party for undeveloped acreage in Stark County, North Dakota.
This $29,000 payment is reflected as a credit to unproved property acquisition
cost in the table above.
In the year ended March 31, 1995, Basic received approximately $186,000 from an
unrelated third party for an assignment of deep rights underlying its West Cole
Unit in Webb County, Texas. This $186,000 payment is reflected as a credit to
unproved property acquisition cost in the table above.
The following table sets forth a standardized measure of the estimated
discounted future net cash flows attributable to Basic's proved oil and gas
reserves. Estimated future cash inflows were computed by applying year end
prices of oil and gas (with consideration of price changes only to the extent
provided by contractual arrangements) to the estimated future production of
proved oil and gas reserves at March 31, 1996, 1995 and 1994. The future
production and development cost represents the estimated future expenditures to
be incurred in developing and producing the proved reserves, assuming
continuation of existing economic conditions. Future income tax expense was
computed by applying statutory income tax rates to the difference between
pre-tax net cash flows relating to Basic's proved oil and gas reserves and the
tax basis of proved oil and gas properties and available operating loss and
excess statutory depletion carryovers, reduced by investment tax credits in
accordance with the Tax Reform Act of 1986. Discounting the annual net cash
flows at 10% illustrates the impact of timing on these future cash flows.
<TABLE>
Standardized Measure of Estimated Discounted Future Net Cash Flows
------------------------------------------------------------------
<CAPTION>
March 31
--------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Future cash inflows $16,392,000 $12,195,000 $5,824,000
Future cash outflows
Production cost (9,532,000) (7,414,000) (2,837,000)
Development cost (45,000) (45,000) (489,000)
----------- ----------- -----------
Future net cash flows
before future income tax 6,815,000 4,736,000 2,498,000
Future income tax --- --- ---
----------- ----------- -----------
Future net cash flows 6,815,000 4,736,000 2,498,000
Adjustment to discount
future annual net
cash flows at 10% (2,090,000) (1,299,000) (891,000)
----------- ----------- -----------
Standardized measure of
discounted future
net cash flows $4,725,000 $3,347,000 $1,607,000
=========== =========== ===========
</TABLE>
The following table summarizes the principal factors comprising the changes in
the standardized measure of estimated discounted net cash flows for the years
ended March 31, 1996, 1995 and 1994.
<TABLE>
Changes in Standardized Measure of Estimated Discounted Net Cash Flows
----------------------------------------------------------------------
<CAPTION>
Year Ended March 31
-------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Standardized measure,
beginning of period $3,437,000 $1,607,000 $2,273,000
Sales of oil and gas, net
of production cost (835,000) (527,000) (406,000)
Net change in sales prices,
net of production cost 498,000 (338,000) 126,000
Discoveries, extensions and
improved recoveries, net
of future development cost 840,000 1,240,000 225,000
Sale of reserves --- --- ---
Purchase of reserves 71,000 1,022,000 14,000
Development costs incurred
that reduced future
development cost --- 489,000 18,000
Changes in estimated future
development cost --- (43,000) (82,000)
Revisions of quantity
estimates 792,000 (155,000) (860,000)
Accretion of discount 344,000 161,000 227,000
Net change in income tax --- --- ---
Changes in rates of
production and other (422,000) (19,000) 72,000
----------- ----------- -----------
Standardized measure,
end of period $4,725,000 $3,437,000 $1,607,000
=========== =========== ===========
</TABLE>
In the year ended March 31, 1996, Basic realized an increase from the prior year
in the standardized measure of estimated discounted net cash flows. This
increase in the standardized measure was primarily the result of (1) the
reserves added following the successful recompletion of the State #12-16 into
the Bakken formation, (2) the purchase of numerous small interests in various
wells which Basic operates, and (3) higher oil prices.
ITEM 8
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Part III
ITEM 9
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a)
OF THE EXCHANGE ACT
Information concerning this item will be in Basic's 1996 Proxy Statement, which
is incorporated herein by reference.
ITEM 10
EXECUTIVE COMPENSATION
Information concerning this item will be in Basic's 1996 Proxy Statement, which
is incorporated herein by reference.
ITEM 11
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
Information concerning this item will be in Basic's 1996 Proxy Statement, which
is incorporated herein by reference.
ITEM 12
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning this item will be in Basic's 1996 Proxy Statement, which
is incorporated herein by reference.
Part IV
ITEM 13
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Document
- -------- --------------------
3i Restated Certificate of Incorporation included in Basic's Form 10-K
for the year ended March 31, 1981 (1)
3i By-laws included in Basic's Form S-1 filed October 24, 1980 (1)
3i Certificate of Amendment to Basic's Restated Certificate of
Incorporation dated March 31, 1996 (*)
10(i)a Division Orders with NORCO, Inc. for oil produced from the West Cole
and West Cole North Units, Webb County, Texas (1)
10(i)a Commercial Contract pertaining to the sale of Company-owned office
building, dated April 15, 1994 (1)
10(i)a Office Lease, dated August 17, 1994 (1)
10(i)a Loan Agreement between Norwest Bank Denver, N.A. and Basic, dated
August 1, 1994 (1)
10(i)a Sales Agreement between Basic and TransTexas, dated March 3, 1995,
pertaining to the sale of deep exploration rights (1)
10(i)a Purchase & Sale Agreement between Basic and MCM, dated March 6, 1995,
pertaining to Williston basin acquisition (1)
10(i)a Amended Loan Agreement between Norwest Bank Denver, N.A. and Basic,
dated March 30, 1995 (1)
10(i)a Amended Loan Agreement between Norwest Bank Denver, N.A. and Basic,
dated September 13, 1995 (1)
10(ii) Oil and Gas Incentive Compensation Plan included in Basic's Form 10-K
for the year ended March 31, 1985 (1)
22 Subsidiaries of Basic included in Basic's Form 10-K for the year ended
March 31, 1987 (1)
- ---------------------------
(1) Previously filed and incorporated herein by reference
(*) Filed herein
Other exhibits and schedules are omitted because they are not applicable, not
required or the information is included in the financial statements or notes
thereto.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended March 31, 1996.
<PAGE>
Signatures
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
BASIC EARTH SCIENCE SYSTEMS, INC.
/s/Ray Singleton /s/Karen E. Morris
- ------------------------ ------------------------
Ray Singleton, President Karen Morris, Controller
Principal Accounting Officer
June 27, 1996 June 27, 1996
- ------------------------ ------------------------
Date: Date:
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Name and Capacity: Date:
- -------------------- ---------
- ------------------------------ --------------------
G. W. Breuer, Director
/s/David J. Flake June 27, 1996
- ------------------------------ --------------------
David J. Flake, Director
/s/Edgar J. Huffman June 27, 1996
- ------------------------------ --------------------
Edgar J. Huffman, Director
/s/Ray Singleton June 27, 1996
- ------------------------------ --------------------
Ray Singleton, Director
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheets, statements of operations, statements of cash flows,
and statements of changes in shareholders' equity on pages 18, 19, 20, 21 and 22
of the Company's Form 10-KSB for the fiscal year ended March 31, 1996 and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-END> MAR-31-1996
<CASH> 92
<SECURITIES> 0
<RECEIVABLES> 512
<ALLOWANCES> (35)
<INVENTORY> 0
<CURRENT-ASSETS> 717
<PP&E> 32,276
<DEPRECIATION> (29,651)
<TOTAL-ASSETS> 3,419
<CURRENT-LIABILITIES> 825
<BONDS> 0
<COMMON> 17
0
0
<OTHER-SE> 17
<TOTAL-LIABILITY-AND-EQUITY> 3,419
<SALES> 2,813
<TOTAL-REVENUES> 2,826
<CGS> 2,725
<TOTAL-COSTS> 2,725
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 15
<INTEREST-EXPENSE> 104
<INCOME-PRETAX> 6
<INCOME-TAX> 0
<INCOME-CONTINUING> 6
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
CERTIFICATE OF AMENDMENT
TO THE
RESTATED CERTIFICATE OF INCORPORATION
OF
BASIC EARTH SCIENCE SYSTEMS, INC.
PURSUANT TO the General Corporation Law of the State of Delaware the undersigned
corporation adopts the following Certificate of Amendment to the Restated
Certificate of Incorporation:
ARTICLE I
- ----------
Name
- -----
The name of the corporation is BASIC EARTH SCIENCE SYSTEMS, INC. (the "Corpora-
tion").
ARTICLE II
- -----------
Amendment Adopted
- ------------------
Pursuant to approval of the holders of the majority of the Corporation's out-
standing stock obtained at a meeting of the shareholders of the Corporation held
on October 6, 1995, the Fourth Article of the Restated Certificate of Incorpora-
tion of the Corporation was amended and restated in its entirety as follows:
"FOURTH
The total number of shares of stock which the corporation is authorized to
issue is Thirty-five Million Shares (35,000,000) of a par value of $0.001
each, consisting of Three Million Shares (3,000,000) of preferred stock and
Thirty-two Million Shares (32,000,000) of common stock and the Board of
Directors is authorized to issue such shares without further authorization
from the shareholders and, as to the preferred shares, the Board of
Directors is granted the authority to provide for the issuance of preferred
shares in series, the designation, voting powers, full, limited or no
voting powers, and such designations, preferences, conversion rights, re-
demption rights, dividend rights, preemptive rights, participating rights,
optional rights, or other special rights, qualifications, limitations, or
restrictions."
ARTICLE III
- ------------
Stated Capital
- ---------------
As a result of the change in par value of the Corporation's capital, the stated
capital of the Corporation shall be reduced by the re-allocation of capital from
the stated capital account to the capital surplus account.
CERTIFICATE
Pursuant to the General Corporation Law of the State of Delaware, the under-
signed corporation does hereby certify that this Certificate of Amendment to the
Restated Certificate of Incorporation of Basic Earth Science Systems, Inc. has
been duly adopted pursuant to the approval and vote of the holders of the
majority of said corporation's outstanding stock in accordance with Section 242
of the General Corporation Law of the State of Delaware.
Dated: March 31, 1996
BASIC EARTH SCIENCE SYSTEMS, INC.
By /s/Ray Singleton
------------------------
Ray Singleton, President
ATTEST:
By /s/David J. Flake
-------------------------
David J. Flake, Secretary
