BASIC EARTH SCIENCE SYSTEMS INC, 10KSB, 1999-07-30

BASIC EARTH SCIENCE SYSTEMS INC
10KSB, 1999-07-30
CRUDE PETROLEUM & NATURAL GAS

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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

For the Fiscal Year Ended March 31, 1999

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

Commission file number: 0-7914

BASIC EARTH SCIENCE SYSTEMS, INC.
8547 E. Arapahoe Road, J-464
Greenwood Village, Colorado 80112

Telephone (303) 773-8000

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,
$.001 par value

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: $1,449,000

As of June 30, 1999, 16,530,487 shares of the registrant's common stock were
outstanding and the aggregate market value of such common stock held by
non-affiliates was approximately $504,000.

The proxy statement for the 1999 annual meeting is incorporated by reference
into Part III.

<PAGE>

Basic Earth Science Systems, Inc.

Form 10-KSB

March 31, 1999

Table of Contents
-----------------

Part I: Page
----
Item 1. Description of Business.................................... 3

Item 2. Description of Property.................................... 9

Item 3. Legal Proceedings.......................................... 11

Item 4. Submission of Matters to a Vote of Security Holders........ 11

Part II:
Item 5. Market for Common Equity and Related Stockholder Matters... 11

Item 6. Management's Discussion and Analysis and
Plan of Operation.......................................... 12

Item 7. Consolidated Financial Statements.......................... 21

Item 8. Changes In and Disagreements With Accountants
On Accounting and Financial Disclosure..................... 41

Part III:
Item 9. Directors, Executive Officers, Promoters and
Control Persons; Compliance With
Section 16(a) of the Exchange Act.......................... 41

Item 10. Executive Compensation..................................... 41

Item 11. Security Ownership of Certain Beneficial Owners
and Management............................................. 41

Item 12. Certain Relationships and Related Transactions............. 41

Part IV:
Item 13. Exhibits and Reports on Form 8-K........................... 42

2
<PAGE>

Part I
- ------

ITEM 1
DESCRIPTION OF BUSINESS

Overview
- --------

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 Denver-Julesburg basin in Colorado.

Company Developments
- --------------------

In the fiscal year ended March 31, 1998, the price of oil on the New York
Mercantile Exchange (NYMEX) plummeted from $21.18 per barrel at September 30,
1997 to $15.61 per barrel at March 31, 1998. This decline had a profound impact
on the Company's cash flow, reserves as calculated in accordance with SEC
regulations, plan of operation, and outlook. As a result, the Company's
independent auditors included a "going concern" explanatory paragraph in their
report of Independent Certified Public Accountants at March 31, 1998.

In the year ended March 31, 1999, low oil prices continued to adversely affect
the Company's activities. As anticipated in the previous year's 10-KSB, the
Company was unable to pursue it's long term plan of operation, and instead,
focused internally on controlling lease operating and general and administrative
costs. Despite higher oil prices at year end (relative to the previous year) and
lower operational costs, the Company's independent auditors again included a
"going concern" explanatory paragraph in their report of Independent Certified
Public Accountants. An expanded discussion of this issue can be found in Item 6,
"Management's Discussion and Analysis and Plan of Operation" and in Note 2 to
the Consolidated Financial Statements.

Prior to the decline in oil price in its 1998 fiscal year, the Company had made
significant strides in business development. The following is a summary of these
efforts.

In its fiscal year ended March 31, 1995, the Company reported the successful
establishment of 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 corporate headquarters 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.

In the fiscal year ended March 31, 1996 compared to the previous year, 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 equipment repair
costs associated with the large acquisition in the Williston basin the previous
year.

3
<PAGE>

In the fiscal year ended March 31, 1997 compared to the previous year, oil and
gas sales revenue increased 7% from approximately $2.8 million to approximately
$3.0 million, while Cash Flows from Operating Activities decreased 30% from
$782,000 to $544,000. This decrease in cash flow was primarily a result of
reducing the Company's accounts payable and accrued liabilities and increasing
other current assets.

Contemplated Activities
- -----------------------

GENERAL. The Company's long term plan of operation involving Development,
Acquisitions, Drilling and Divestitures/Abandonments is described below.
However, both during, at, and subsequent to March 31, 1999, the Company has
suspended this plan. Furthermore, despite price increases subsequent to year
end, the Company has yet to pursue its long-term development plan, instead
focusing on reducing general and administrative expenses and returning shut-in
wells back to production. In addition, the Company plans to continue divesting
and/or abandoning marginal wells in an effort to generate additional cash from
sales or the salvage of leasehold equipment. The Company may also 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.

DEVELOPMENT. The Company holds a number of properties that management believes
has 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. However, given current oil prices, management does not
expect to pursue these potential opportunities in the upcoming fiscal year
unless oil prices improve.

ACQUISITIONS. The Company continues to evaluate properties which are made
available for sale. However, there can be no assurances that funds will be
available to pursue such opportunities or that offers the Company submits may be
accepted.

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.

DIVESTITURES/ABANDONMENT. The Company holds a number of marginal, operated and
non-operated properties in several states. Basic intends to continue its efforts
to plug or sell these wells in the coming fiscal year. Management believes that
the salvage value of the associated equipment, net of plugging costs, will have
a positive impact on the Company's cash flow.

4
<PAGE>

Segment Information and Major Customers
- ---------------------------------------

INDUSTRY SEGMENT. The Company is engaged only in the upstream segment of the oil
and gas industry, which comprises 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. 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 typically $2.00 to $2.50 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. 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, 1999, Basic sold 60 percent of its oil and gas
production to a total of three purchasers: 11 percent to Cenex Harvest States,
28 percent to Murphy Oil USA, Inc. and 21 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 marginal properties in its acquisition efforts.

5
<PAGE>

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 Energy Regulatory
Commission (FERC) issued FERC Order 636 (the Order) which is 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 does not 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 cleanup 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. 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.

6
<PAGE>

Certain Risks
- -------------

VOLATILITY OF OIL & GAS PRICES. The Company's revenues, operating results,
profitability, future rate of growth and the carrying value of its oil and gas
properties are substantially dependent upon prevailing market prices for oil and
gas. Historically, the markets for oil and gas have been volatile and in certain
periods have been depressed by excess domestic and imported supplies. Such
volatility is expected to reoccur in the future. Various factors beyond the
control of the Company will affect prices of oil and gas, including worldwide
and domestic supplies of oil and gas, the ability of the members of the
Organization of Petroleum Exporting Countries to agree to maintain oil price and
production controls, political instability or armed conflict in oil and gas
producing regions, the price and level of foreign imports, the level of consumer
demand, the price, availability and acceptance of alternative fuels and weather
conditions. In addition to market factors, actions of state and local agencies
and the United States and foreign governments affect oil and gas prices. These
external factors and the volatile nature of the energy markets make it difficult
to estimate future prices of oil and gas. Any substantial or extended decline in
the price of oil would have a material adverse effect on the Company's financial
condition and results of operations. Such decline could reduce the Company's
cash flow and borrowing capacity and both the value and the amount of the
Company's oil and gas reserves.

UNCERTAINTY OF RESERVE INFORMATION AND FUTURE NET REVENUE ESTIMATES. There are
numerous uncertainties inherent in estimating quantities of proved oil and gas
reserves and their values, including many factors beyond the Company's control.
The reserve information set forth in this Form 10-KSB (see Note 13 to the
Consolidated Financial Statements) represents estimates only. Reserve estimates
are imprecise and may materially change as additional information becomes
available. More importantly, reserve estimates may materially change as oil and
gas prices fluctuate in their normal course and may materially change as a
result of the price on a single day; the last day of the Company's fiscal year.

Estimates of oil and natural gas reserves, by necessity, are projections based
on geologic and engineering data, and there are uncertainties in the
interpretation of such data as well as the projection of future rates of
production and the timing of development expenditures. Reserve engineering is a
subjective process of estimating underground accumulations of oil and natural
gas that are difficult to measure. The accuracy of any estimate is a function of
the quality of available data, engineering, and geological interpretation and
judgement. Estimates of economically recoverable oil and gas reserves and future
net cash flows necessarily depend upon a number of variable factors and
assumptions, such as future operating costs, severance and excise taxes,
development costs, workover costs, remedial costs and the assumed effects of
regulations by governmental agencies, all of which may in fact vary considerably
from actual results. Other variables, specifically oil and gas prices, are fixed
at the prices existing on the last day of the fiscal year whether such prices
are reasonable; and which may vary considerably from actual results. For these
reasons, estimates of the economically recoverable quantities of oil and gas
attributable to any property or any group of properties, classifications of such
reserves based upon risk of recovery, and estimates of the future net cash flows
expected therefrom may vary substantially. Any significant variance in the
assumptions could materially affect the estimated quantity and value of the
reserves. Actual production, revenues and expenditures with respect to the
Company's reserves will likely vary from estimates, and such variances may be
material.

7
<PAGE>

Reserves, as calculated by SEC regulations, as referred to in this Form 10-KSB,
should not be construed as the current market value of the estimated oil and gas
attributable to the Company's properties. The timing of actual future net cash
flows from proved reserves, and thus their actual present value, will be
affected by the timing of both the production and incidence of expenses in
connection with both extraction costs and development costs. In addition, the
10% discount factor, which is required to be used for reporting purposes, is not
necessarily the most appropriate discount factor based on interest rates in
effect at the time of calculation.

OPERATING HAZARDS. The oil and gas business involves certain operating hazards
such as well blowouts, craterings, explosions, uncontrollable flows of oil,
natural gas or well fluids, fires, formations with abnormal pressures, pipeline
ruptures or spills, pollution, releases of toxic gas and other environmental
hazards and risks, any of which could result in substantial losses to the
Company. In addition, the Company may be liable for environmental damage caused
by previous owners of properties purchased or leased by the Company. As a
result, substantial liabilities to third parties or governmental agencies may be
incurred, the payment of which could reduce or eliminate the funds available for
acquisitions, development, and exploration, or result in losses to the Company.
Although Basic is not fully insured against all environmental and other risks,
it maintains insurance coverage which it believes is customary in the industry.

Forward-Looking Statements
- --------------------------

This Form 10-KSB includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements other than
statements of historical fact included in this Form 10-KSB including, without
limitation, the statements under Item 1. "Description of Business", Item 6.
"Management's Discussion and Analysis and Plan of Operation", and Note 2 to the
Consolidated Financial Statements located elsewhere herein regarding the
Company's financial position and liquidity, the amount of and its ability to
make debt service payments, its strategies, financial instruments, and other
matters, are forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it can
give no assurance that such expectations will prove to have been correct.
Important factors that could cause actual results to differ materially from the
Company's expectations are disclosed in this Form 10-KSB in conjunction with the
forward-looking statements included in this Form 10-KSB.

The Company's intentions and expectations described in this Form 10-KSB with
respect to possible development activities concerning properties in which it
holds interests may be deemed to be forward-looking statements. These statements
are made based on management's current assessment of the development merits of
the particular property in light of the geological information available at the
time and based on the Company's relative interest in the property and its
estimate of its share of the development cost. Subsequently obtained information
concerning the merits of any property, as well as changes in estimated
development costs and ownership interest, may result in revisions to
management's expectations and intentions and, thus, the Company may alter its
plans regarding these development activities. Furthermore, circumstances beyond
the Company's control may cause such prospects to be eliminated from further
consideration as development prospects.

8
<PAGE>

Other
- -----

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 on oil and gas commodity
prices may cause fluctuations in quarterly or even annual revenues and earnings.

At March 31, 1999, Basic's offices were located in downtown Denver, Colorado.
Subsequent to year end, the Company moved its office to a Denver suburb. At
fiscal year end, the Company had eight employees: three at its main office in
Denver and five at its subsidiary's field office in Bruni, Texas, located
forty-five miles east, southeast of Laredo, Texas.

ITEM 2
DESCRIPTION OF PROPERTY

PRODUCING PROPERTIES: LOCATIONS AND IMPACT. As of March 31, 1999, Basic owned an
interest in 76 oil wells and 10 gas wells. Basic currently operates 61 wells in
five states: North Dakota, Montana, Colorado, Texas and Wyoming. These operated
wells contributed approximately 79 percent of Basic's total liquid hydrocarbon
sales and approximately 54 percent of total gas sales in the year ended March
31, 1999. 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.

Producing Property
------------------

Gross Wells Net Wells
----------- ---------
Oil Gas Oil Gas
--- --- --- ---

Colorado -- 4 -- 2.40
Kansas 2 -- 0.44 --
Louisiana 1 2 0.46 0.06
Montana 14 -- 10.86 --
New Mexico -- 2 -- 0.78
North Dakota 25 -- 12.00 --
Oklahoma -- 1 -- 0.35
Texas 32 1 26.19 0.23
Wyoming 2 -- 0.35 --
---- ---- ----- ----

Total 76 10 50.30 3.82
==== ==== ===== ====

PRODUCTION. Specfic production data relative to the Company's oil and gas
producing properties can be found in the Selected Financial Information table in
Item 6. "Management's Discussion and Analysis and Plan of Operation."

9
<PAGE>

RESERVES. At March 31, 1999, the discounted present value of Basic's estimated
proved reserves was approximately $1,650,000 reflecting a 24% increase from the
previous year's reserves of $1,324,000. This increase was primarily the result
of two factors. First, higher oil prices extending the economic life of the
Company's oil properties. Second, the production realized in the year ended
March 31 1999 provided additional data that allowed for a revised estimate of
remaining reserves. The increase in estimated reserves from these two factors
was partially offset by a decrease in the gas price used to estimate the
Company's gas reserves. The analysis of Basic's estimated oil and gas reserves
can be found in Note 13 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.

Developed Acreage Undeveloped Acreage
----------------- -------------------

Gross Net Gross Net
----- --- ----- ---

Colorado 640 384 -- --
Kansas 600 113 -- --
Louisiana 640 26 -- --
Montana 2,720 2,029 2,600 826
New Mexico 640 248 -- --
North Dakota 5,612 2,445 2,111 511
Oklahoma 160 49 -- --
Texas 3,166 2,311 80 65
Wyoming 634 242 1,016 486
------ ------ ------ ------

Total 14,812 7,847 5,807 1,888
====== ====== ====== ======

FIELD SERVICE EQUIPMENT. At March 31, 1999, the Company's subsidiary, Basic
Petroleum Services, Inc., owned a 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.

OFFICE LEASE. At March 31, 1999, the Company leased approximately 3,000 square
feet of office space in downtown Denver for its corporate headquarters. The
lease term expired April 30, 1999. For a discussion of Basic's new lease
arrangement, see Note 10 to the Consolidated Financial Statements

10
<PAGE>

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, 1999.

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, LLC.

High Low
---- ---
Year Ended March 31, 1998
- -------------------------

First Quarter................................ $ .070 $ .070
Second Quarter............................... .080 .070
Third Quarter................................ .100 .080
Fourth Quarter............................... .110 .070

Year Ended March 31, 1999
- -------------------------

First Quarter................................ $ .070 $ .030
Second Quarter............................... .030 .025
Third Quarter................................ .025 .018
Fourth Quarter............................... .021 .020

The bid price on June 30, 1999 was $0.035. 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, 1999, Basic had approximately 2,470 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.

11
<PAGE>

ITEM 6
MANAGEMENT'S DISCUSSION AND ANALYSIS
AND PLAN OF OPERATION

Going Concern and Liquidity Outlook
- -----------------------------------

The Company's financial statements are presented on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. During the year ended March 31, 1998 (1998), the
Company incurred a sizable net loss, sustained a ceiling limitation write-down
of $870,000 on its oil and gas property assets, and had a working capital
deficit. During the year ended March 31, 1999 (1999), the Company again incurred
a net loss and had a working capital deficit. While oil prices had improved
somewhat by the Company's fiscal 1999 year end, and the situation is somewhat
more favorable, this development is not under management's control and prices
might again decline, placing the Company in a fragile situation. In addition,
the Company's bank debt balance is due April 1, 2000. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
During the past year, the Company restructured its debt and sold certain assets
to meet working capital demands and may be required to do so again in the
future.

With respect to the balloon payment due at April 1, 2000, at current oil prices,
it is management's belief that the Company will not be able to generate
sufficient cash flow from operations to have available on April 1 the necessary
funds to pay the anticipated remaining balance. As of June 30, 1999, there has
been no agreement to further restructure the current debt facility. If no
agreement can be reached, management believes that alternative financing from
another lending institution can be secured or that it will be able to realize
sufficient proceeds from the sale of one or more key oil and/or gas properties
to meet its debt obligation.

The financial statements do not include any adjustments to reflect the possible
future effects on the classification of assets or the amounts and classification
of liabilities that may result from the possible inability of the Company to
continue as a going concern.

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.

The Company has severely curtailed both its field activities and its
administrative expenses during the past year in an effort to meet its cash
requirements. Given recent oil price increases, management expects to return
selected wells back to production, thereby increasing sales. However, these
wells are marginal in nature and are not expected to have a dramatic impact on
the Company's revenues. With the exception of returning wells back to
production, the Company expects to maintain curtailments in both its field
activities and its administrative expenses, at least during the first half of
the current fiscal year.

Even if the Company is successful in all of these efforts, there can be no
assurance that the Company will be able to continue to meet its existing
obligations as they become due in fiscal year 2000. Additionally, if oil prices
drop again, the Company may again incur ceiling limitations and be required to
write down additional assets.

<PAGE>

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. At March 31, 1998, the Company had two loan agreements with Norwest
Bank of Colorado, N.A. ("the Bank") which included a Declining Balance,
Revolving Line of Credit (DBRLOC) and a Revolving Line of Credit (RLOC). The
RLOC expired on December 31, 1998.

With respect to the DBRLOC, under the terms of the agreement in effect at March
31, 1998, Basic was obligated to make monthly principal payments of $30,000
beginning August 1, 1998. The Company was able to make only one $30,000 payment
on September 30, 1998 followed by a $10,000 principal payment on October 31,
1998. Effective November 3, 1998, Basic and the bank modified the existing loan
agreement and the borrowing base was set at $620,000 with scheduled monthly
principal payments of $10,000 beginning November 30, 1998 and running through
March 31, 1999. At April 30, 1999, the monthly principal payments increased to
$20,000 and will continue at that amount through March 31, 2000. On the maturity
date of April 1, 2000 any remaining balance due is required to be paid in full.

At March 31, 1999, the DBRLOC had a borrowing base of $570,000. Additional
information concerning the Company's debt appears in Note 5 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 principal payments due in fiscal 1998 and 1999, management
recognized that fluctuations in crude oil prices could have a negative impact on
the Company's financial affairs. Accordingly, the Company entered futures and/or
options contracts in order to hedge this exposure. During the fiscal period just
ended, the Company favored options, rather than futures contracts, in order to
participate more fully if prices were to again escalate. However, as of March
31, 1999, these contracts had expired and the Company had not replaced them. The
Company did not hedge any gas production during the past year. Information
concerning the Company's hedging activities appears in Note 1 to the
Consolidated Financial Statements.

LIQUIDITY. The Company's current ratio remained unchanged at 0.7:1 at March 31,
1999 from March 31, 1998. A specific Bank covenant requires the maintenance of a
current ratio of at least 1:1, after adjustment for the removal of the current
portion of long-term debt. At March 31, 1999, the Company was in compliance with
all Bank covenants and the Company's current ratio was 1.1:1 as calculated per
the provisions of the covenants.

Current assets decreased $103,000 (21%) from $481,000 at March 31, 1998 to
$378,000 at March 31, 1999 (see Note 3 to the Consolidated Financial Statements
for further discussion). Oil and gas sales receivable decreased $31,000 (19%)
from $160,000 at March 31, 1998 to $129,000 at March 31, 1999. This decrease was
primarily due to the drop in the number of wells on production at fiscal year

13
<PAGE>

end 1999 compared to fiscal year end 1998. As noted above, Basic was forced to
shut in a number of marginal wells during 1999 as a result of the drop in oil
prices. The majority of these wells remained shut-in at March 31, 1999. Joint
interest and other receivables increased $29,000 (30%) from $97,000 at fiscal
year end 1998 to $126,000 at fiscal year end 1999. This increase can be
attributed to $27,000 receivable recorded in March 1999 for a refund received
after year end of severance taxes paid to Montana in prior years due to a
retroactive change in well classifications and severance tax rates.

Current liabilities decreased $129,000 (18%) from $702,000 at 1998 to $573,000
at 1999. Accounts payable decreased $132,000 (41%) from $324,000 at March 31,
1998 to $192,000 at March 31, 1999. This decrease was a result of the
curtailment of field activities through the postponement of workovers/repairs
and the fact that a number of wells on production at fiscal year end 1998 were
shut-in at fiscal year end 1999.

Cash flows from operating activities decreased 66% from $406,000 in 1998 to
$140,000 in 1999. This decrease in cash flows from operating activities is a
direct result of the downward trend in oil prices beginning in the fourth
quarter of fiscal 1998 and continuing throughout the majority of fiscal 1999.
Net cash used in investing activities decreased 75% from $402,000 in 1998 to
$100,000 in 1999. In 1998, with respect to its planned development activities,
the Company attempted five recompletions, one of which was successful. In 1999,
with tighter cash flow constraints, only one recompletion was attempted. That
one was unsuccessful. Also, the decrease in cash used in investing activities in
1999 from 1998 can be attributed to a slowdown in the Company's
divestiture/abandonment activities. In 1999, Basic plugged and abandoned three
wells compared to six in 1998. With respect to its financing activities, the
Company had a net reduction of its outstanding bank debt of $54,000 in 1999
compared to a net reduction of $49,000 in 1998.

OTHER. The Company recorded a valuation allowance of $3,024,000 at March 31,
1999 equal to the excess of deferred tax assets over deferred tax liabilities.
This valuation allowance reflects management's belief that the benefits from the
deferred tax assets will more than likely not be realized.

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
- -----------------

OVERVIEW. In addition to the Company's routine production-related costs, general
and administrative expenses and debt repayment requirements, the Company
requires capital to fund the development and enhancement of recently acquired
properties and capital to fund the acquisition of additional properties. Given
the current price of the Company's stock, management believes it would be
difficult to raise additional equity capital. Furthermore, given that the
existing bank debt is at its borrowing base ceiling, the Company has no
available debt capacity. Therefore, Company has postponed the acquisition and
development of additional properties. Management intends to fund the Company's
immediate needs with its internally-generated cash flow from operations.

14
<PAGE>

OTHER COMMITMENTS. As of July 10, 1999, the Company has no obligations to
purchase or sell any of its oil and gas properties nor any other commitments
beyond its office lease.

Results of Operations
- ---------------------

1999 Compared with 1998

OVERVIEW. Operations in the year ended March 31, 1999 (1999) resulted in a net
loss of $54,000 compared to net loss of $1,111,000 in the year ended March 31,
1998 (1998). The primary source of the loss in 1998 was a ceiling limitation
charge of $870,000.

REVENUES. Oil and gas sales revenue decreased $997,000 (41%) in 1999 from 1998.
Oil sales revenue declined $909,000 (43%). Lower oil sales volume accounted for
$411,000 (45%) of this decline while the steep drop in oil prices resulted in a
negative variance of $498,000 (55%). In addition, gas sales revenue decreased
$88,000 (28%) in 1999 from 1998. A decrease in gas sales volume accounted for
$54,000 (61%) of this variance while the remaining $34,000 (39%) was
attributable to a drop in gas prices.

VOLUMES AND PRICES. Total liquid sales decreased 19%, from 125,000 barrels in
1998 to 101,000 barrels in 1999, while the average price per barrel decreased
29% from $16.91 in 1998 to $11.96 in 1999. Total gas sales decreased 17%, from
166,000 Mcf in 1998 to 137,000 Mcf in 1999, while the average price per MCF
decreased 13%, from $1.86 in 1998 to $1.61 in 1999. Along with normal production
decline, liquid sales were adversely impacted by the sharp decline in oil
prices. With lower oil prices the Company was forced to shut-in marginally
producing wells in order to reduce expenses in an attempt to maintain a positive
operating cash flow.

EXPENSES. Oil and gas production expense and production taxes decreased $708,000
(43%) in 1999 over 1998 primarily as a result of the curtailment of field
activities. As noted in the preceding paragraph, wells with very high lifting
costs were shut-in when oil prices declined below the cost to produce those
wells. In addition, the Company deferred workovers/repairs, thereby shutting-in
production on many properties which were otherwise profitable, when the payout
of those repairs was unacceptably long or adversely impacted the Company's cash
position or liquidity ratios. Just prior to March 31, 1999, with a modest
recovery in oil prices, the Company placed three wells back on production that
had been shut-in during fiscal 1999.

Production taxes decreased $142,000 (59%) primarily as a result of two factors.
First, because production taxes are a function of sales, the drop in oil and gas
sales revenue directly resulted in a decline in production taxes. Second, Basic
received the benefit of $50,000 in severance tax refunds from two states in
1999. As a result of the decreases in both oil and gas production expense and
production taxes, the overall lifting cost per equivalent barrel decreased 32%,
from $12.40 in 1998 to $8.43 in 1999.

Depreciation, depletion and amortization expense decreased $275,000 (50%) in
1999 from 1998. As a result of the decline in production in 1999 relative to
1998, the depletion rate (the ratio of production for the year divided by the
estimated reserves at the beginning of the year) dropped from 25.5% in 1998 to
18.1% in 1999. This decrease in the depletion rate coupled with the reduction of

<PAGE>

the depletable base (the full cost pool of oil and gas properties) resulted in a
39% drop in the depletion expense per equivalent barrel from $3.50 in 1998 to
$2.13 in 1999.

In the fourth quarter of 1998 Basic's capitalized oil and gas property cost
exceeded the present value (using a 10% discount factor) of estimated future net
revenue from its proved reserves, based on the price of oil at March 31, 1998.
This forced the Company to record a $870,000 write-down of the carrying value of
its oil and gas properties to the value of the underlying reserve valuation.
Basic did not incur a ceiling limitation charge during 1999.

Gross general and administrative (G&A) expense decreased $111,000 (26%) while
net G&A expense decreased $64,000 (36%) in 1999 from 1998. Gross G&A expense
differs from net G&A expense in that the Company is allowed to recover an
overhead fee on wells that it operates. This fee is applied against, and serves
to reduce, gross G&A expense. The decrease in gross G&A expense is a reflection
of management's efforts to reduce expenses in light of the continuing decline in
oil prices throughout much of 1999. Approximately $57,000 of the decrease was a
result of a reduction in personnel, salaries, and related benefits. The entire
$111,000 reduction in gross G&A expense was not reflected in the reduction of
net G&A expense because the Company shut in some of the marginally producing
wells that it operates, thereby reducing the overhead fees that the Company was
allowed to recover. The percentage of gross general and administrative expense
that the Company was able to charge out to operated wells was 57% in 1999
compared to 48% in 1998. Net general and administrative expense per equivalent
barrel decreased from $1.16 in 1998 to $0.91 in 1999.

OTHER INCOME/(EXPENSE). Other income/(expense) increased $10,000 (22%) from a
net expense of $46,000 in 1998 to a $56,000 net expense in 1999. This increase
was primarily the result of higher interest expense due to a higher average
outstanding balance due on the Company's bank debt. This increase was only
partially offset by higher interest and other income.

(Intentionally left blank)

16
<PAGE>

Selected Financial Information
- ------------------------------

The following table shows selected financial information and averages for each
of the three prior years in the period ended March 31.

1999 1998 1997
-------- -------- --------
Production:
Oil (barrels) ......................... 101,000 125,000 133,000
Gas (mcf) ............................. 137,000 166,000 202,000
Revenue: (in thousands)
Oil ................................... $ 1,204 $ 2,113 $ 2,611
Gas ................................... 221 309 402
-------- -------- --------

Total ................................. 1,425 2,422 3,013
Less: total production expense (in thousands)(1) 1,041 1,891 2,131
-------- -------- --------

Gross profit (in thousands) .................... $ 384 $ 531 $ 882
======== ======== ========

Write-down of oil and gas properties
(in thousands) ........................ $ -- $ 870 $ --
Depletion expense (in thousands) ............... $ 263 $ 534 $ 517
General and administrative expense
(in thousands) ........................ $ 113 $ 177 $ 170

Average sales price:
Oil (per barrel) ...................... $ 11.96 $ 16.91 $ 19.56
Gas (per mcf) ......................... 1.61 1.86 1.98
Average production expense(2) .................. 8.43 12.40 12.75
Average gross profit(3) ........................ 3.11 3.47 5.28
Average depletion expense(4) ................... 2.13 3.50 3.09
Average general & administrative expense(5) .... 0.91 1.16 1.02

- --------------------------

1 Operating costs, including production tax

2 Operating costs, including production tax, per equivalent barrel(6)

3 Gross profit per equivalent barrel(6)

4 Depletion expense per equivalent barrel(6)

5 General & administrative expense per equivalent barrel(6)

6 6 mcf of gas is equivalent to 1 barrel oil

17
<PAGE>

Year 2000
- ---------

The "Year 2000" problem is the result of computer programs being written using
two digits rather than four to define the applicable year. Any computer
programs, or embedded computer chips, that have time sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000.
Speculation as to the impact of this issue varies widely.

The Company cannot state that the Year 2000 problem will not pose material
operational problems. Nor is the Company in control of the external forces that
could create these material impacts. The Company has not completed a
comprehensive assessment of the Company's Year 2000 problem, nor established any
written Year 2000 policies. The Company has not secured, and has no plans to
secure, backup power generation equipment for its offices or wellsite locations.
Nor, has the Company made alternate arrangements for the possible failure,
and/or reduced availability, of law enforcement, government services, banking
services, currency or transportation infrastructure.

With a March 31 fiscal year end, from an accounting prospective, the Company is
currently, and effectively, in Year 2000. The Company previously reported that
it was working with the provider of its software accounting system to resolve
Year 2000 issues. The Company received software module updates in March, April
and June 1999. The Company has not experienced any difficulties that were not
immediately resolved. The software provider has assured the Company that its
software is now fully Year 2000 compliant. These modifications were included in
the Company's ongoing software support contract and the Company did not expend
any additional funds to resolve this Year 2000 issue. The vast majority of the
Company's remaining software are Microsoft Windows 95/Office 97 products and are
not expected to create a problem.

The Company is not dependent on any one vendor in a given area, and should not
be impacted by the failure of any one vendor to provide the Company with
necessary supplies and equipment.

The Company sells its primary product, oil, to a number of purchasers, and
sometimes to multiple purchasers in the same geographical area. Furthermore, for
the vast majority of the Company's product, the Company can switch purchasers
within 30 days. For these reasons, the Company has not contacted any of its
purchasers as to whether or not they are Year 2000 compliant, nor does
management believe it necessary at this time.

Recent Accounting Pronouncements
- --------------------------------

In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
market value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. SFAS No. 133 is
effective for fiscal periods beginning after June 15, 1999. Management believes
the adoption of this statement will have no material impact on the Company's
financial statements.

18
<PAGE>

In the fiscal year ended March 31, 1999 the Company adopted SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" which
supersedes SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise. SFAS No. 131 establishes standards for the way that public companies
report information about operating segments in annual financial statements and
requires reporting of selected information about operating segments in interim
financial statements issued to the public. It also establishes standards for
disclosures regarding products and services, geographic areas and major
customers. SFAS No. 131 defines operating segments as components of a company
about which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to allocate
resources and in assessing performance.

SFAS 131 is effective for financial statements for periods beginning after
December 15, 1997 and requires comparative information for earlier years to be
restated. The adoption of this statement did not have a material impact on the
Company's financial statements.

(Intentionally left blank)

<PAGE>

Basic Earth Science Systems, Inc.

Table of Contents

Consolidated Financial Statements
and Accompanying Notes

March 31, 1999 and 1998

Page
----

Report of Independent Certified Public Accountants - BDO Seidman, LLP... 21

Consolidated Balance Sheets............................................. 22 - 23

Consolidated Statements of Operations................................... 24

Consolidated Statements of Shareholders' Equity......................... 25

Consolidated Statements of Cash Flows................................... 26

Notes to Consolidated Financial Statements.............................. 27 - 40

20
<PAGE>

ITEM 7
FINANCIAL STATEMENTS

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors
Basic Earth Science Systems, Inc.
Denver, Colorado

We have audited the accompanying consolidated balance sheets of Basic Earth
Science Systems, Inc. and subsidiaries as of March 31, 1999 and 1998, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the years ended March 31, 1999 and 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 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, the financial position of Basic Earth Science
Systems, Inc. and subsidiaries as of March 31, 1999 and 1998, and the results of
their operations and their cash flows for the years ended March 31, 1999 and
1998, in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has incurred a net loss for the year ended
March 31, 1999, is in a negative working capital position, and has its debt
facility maturing in April 2000. These conditions raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are also described in Note 2. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

BDO SEIDMAN, LLP

Denver, Colorado
June 30, 1999

21
<PAGE>
<TABLE>
<CAPTION>

Basic Earth Science Systems, Inc.

Consolidated Balance Sheets

March 31, 1999 and 1998

Assets
- ------
1999 1998
------------ ------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 38,000 $ 52,000
Accounts receivable:
Oil and gas sales 129,000 160,000
Joint interest and other receivables 126,000 97,000
Allowance for doubtful accounts (54,000) (54,000)
Other current assets 139,000 226,000
------------ ------------

Total current assets 378,000 481,000
------------ ------------

Property and equipment:
Oil and gas properties (full cost method) 32,619,000 32,559,000
Furniture, fixtures and equipment 424,000 450,000
------------ ------------

33,043,000 33,009,000
Accumulated depreciation (369,000) (374,000)
Accumulated depletion - FCP (includes cumulative ceiling
limitation charges of $14,961,000) (31,479,000) (31,217,000)
------------ ------------

Net property and equipment 1,195,000 1,418,000
Other noncurrent assets 168,000 85,000
------------ ------------

Total noncurrent assets 1,363,000 1,503,000
------------ ------------

Total assets $ 1,741,000 $ 1,984,000
============ ============

See accompanying report of independent certified
public accountants and notes to consolidated
financial statements.

22
</TABLE>

<PAGE>

Basic Earth Science Systems, Inc.

Consolidated Balance Sheets

March 31, 1999 and 1998

Liabilities and Shareholders' Equity
- ------------------------------------
1999 1998
------------ ------------
Current liabilities:
Accounts payable $ 192,000 $ 324,000
Accrued liabilities 141,000 144,000
Current portion of long-term debt 240,000 234,000
------------ ------------

Total current liabilities 573,000 702,000
------------ ------------

Long-term debt 330,000 390,000
------------ ------------

Commitments

Shareholders' equity:
Preferred stock, $.001 par value
Authorized - 3,000,000 shares
Issued - 0 shares -- --
Common stock, $.001 par value
Authorized - 32,000,000 shares
Issued - 16,879,752 shares at
March 31, 1999 and 1998 17,000 17,000
Additional paid-in capital 22,692,000 22,692,000
Treasury stock (349,265 shares at March
31, 1999 and 1998); at cost (23,000) (23,000)
Accumulated deficit (21,848,000) (21,794,000)
------------ ------------

Total shareholders' equity 838,000 892,000
------------ ------------

Total liabilities and shareholders' equity $ 1,741,000 $ 1,984,000
============ ============

See accompanying report of independent certified
public accountants and notes to consolidated
financial statements.

Basic Earth Science Systems, Inc.

Consolidated Statements of Operations

Years Ended March 31,

1999 1998
------------ ------------
Revenues:
<S> <C> <C>
Oil and gas sales $ 1,425,000 $ 2,422,000
Well service revenue 24,000 28,000
------------ ------------

Total revenues 1,449,000 2,450,000
------------ ------------

Expenses:
Oil and gas production 942,000 1,650,000
Production tax 99,000 241,000
Well servicing expenses 21,000 30,000
Write down of oil and gas properties -- 870,000
Depreciation, depletion and amortization 272,000 547,000
General and administrative 113,000 177,000
------------ ------------

Total expenses 1,447,000 3,515,000
------------ ------------

Income (loss) from operations 2,000 (1,065,000)
------------ ------------

Other Income (Expense):
Interest and other income 16,000 13,000
Interest expense (72,000) (59,000)
------------ ------------

Total other expense (56,000) (46,000)
------------ ------------

Net loss $ (54,000) $ (1,111,000)
============ ============

Basic and diluted weighted average shares outstanding 16,530,487 16,553,884
============ ============

Basic and diluted loss per share $ (0.003) $ (0.067)
============ ============

See accompanying report of independent certified
public accountants and notes to consolidated
financial statements.

24
</TABLE>

Basic Earth Science Systems, Inc.

Consolidated Statements of Shareholders' Equity

Years Ended March 31, 1999 and 1998

Additional
Common stock paid-in Treasury stock Accumulated
Shares Par value capital Shares Amount deficit
------ --------- ------- ------ ------ -------

<S> <C> <C> <C> <C> <C> <C> <C>
Balance, April 1, 1997 16,879,752 $ 17,000 $ 22,692,000 (299,265) $ (15,000) $(20,683,000)

Purchase of treasury stock -- -- -- (90,000) (10,000) --

Sale of treasury stock -- -- -- 40,000 2,000 --

Net loss -- -- -- -- -- (1,111,000)
------------ ------------ ------------ ------------ ------------ ------------

Balance, March 31, 1998 16,879,752 17,000 22,692,000 (349,265) (23,000) (21,794,000)

Net loss -- -- -- -- -- (54,000)
------------ ------------ ------------ ------------ ------------ ------------

Balance, March 31, 1999 16,879,752 $ 17,000 $ 22,692,000 (349,265) $ (23,000) $(21,848,000)
============ ============ ============ ============ ============ ============

See accompanying report of independent
certified public accountants and notes to
consolidated financial statements.

25
</TABLE>

Basic Earth Science Systems, Inc.

Consolidated Statements of Cash Flows

Years Ended March 31,

1999 1998
----------- -----------
Increase (decrease) in cash and cash equivalents:

Cash flows from operating activities:
<S> <C> <C>
Net loss $ (54,000) $(1,111,000)
Adjustments to reconcile net income to
net cash provided by operating activities:
Write down of oil and gas properties -- 870,000
Depreciation, depletion and amortization 272,000 547,000
Bad debt expense -- 14,000
Change in:
Accounts receivable 2,000 126,000
Other assets 37,000 47,000
Accounts payable and accrued liabilities (133,000) (101,000)
Other 16,000 14,000
----------- -----------

Net cash provided by operating activities 140,000 406,000
----------- -----------

Cash flows from investing activities:
Capital expenditures:
Oil and gas properties (213,000) (597,000)
Support equipment (5,000) (15,000)
Proceeds from sale of lease and well equipment inventory 22,000 1,000
Proceeds from sale of oil and gas properties 96,000 209,000
----------- -----------

Net cash used in investing activities (100,000) (402,000)
----------- -----------

Cash flows from financing activities:
Principal payments on long-term debt (121,000) (265,000)
Proceeds from borrowing 67,000 224,000
Purchase of treasury stock -- (10,000)
Proceeds from sale of treasury stock -- 2,000
----------- -----------

Net cash used in financing activities (54,000) (49,000)
----------- -----------

Cash and cash equivalents:
Decrease in cash and cash equivalents (14,000) (45,000)
Balance, beginning of year 52,000 97,000
----------- -----------

Balance, end of year $ 38,000 $ 52,000
=========== ===========

Supplemental disclosure of cash flow information:
Cash paid for interest $ 66,000 $ 59,000

See accompanying report of independent
certified public accountants and notes to
consolidated financial statements.

26
</TABLE>

<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 subsidiary. 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 properties 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. The Company incurred a
ceiling limitation charge of $870,000 during the year ended March 31, 1998, as
the carrying value of the oil and gas properties exceeded the underlying reserve
valuations. Basic did not incur a ceiling limitation charge during the year
ended March 31, 1999.

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 applied as a
reduction of oil and gas properties. In the years ended March 31, 1999 and 1998,
Basic reduced the carrying value of its oil and gas properties $96,000 and
$209,000, respectively, as a result of the sale of its interest in certain oil
and gas properties.

The majority of Basic's operated liquid reserves are located in the Williston
basin of North Dakota and Montana and in south Texas, and the majority of
Basic's operated gas reserves are located in Colorado's Denver-Julesburg basin.

All capitalized costs are depleted on a composite units-of-production method
based on estimated proved reserves attributable to the oil and gas properties
owned by Basic. Depletion per equivalent barrel of production was $2.13 and
$3.50 for the years ended March 31, 1999 and 1998, 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. Support equipment and other equipment are stated at
cost. Depreciation of support equipment and other property is computed using
various methods over periods ranging from five to seven years.

27
<PAGE>

INVENTORY. Inventory, consisting primarily of tubular goods and oil field
equipment, are stated at the lower of cost or market, cost being determined by
the FIFO method.

FAIR VALUE OF FINANCIAL INSTRUMENTS. Unless otherwise specified, the Company
believes the carrying value of financial instruments approximates their fair
value.

LONG-TERM ASSETS. The Company applies Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets"
in evaluating long-lived assets for possible impairment. Under SFAS No. 121,
long-lived assets and certain intangibles are reported at the lower of cost or
their estimated recoverable amounts.

EARNINGS (LOSS) PER SHARE. Effective for the year ended March 31, 1998, the
Company implemented SFAS No. 128, "Earnings Per Share." SFAS No. 128 provides
for the calculation of "Basic" and "Diluted" earnings per share. Basic earnings
(loss) per share is computed by dividing net income (loss) by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution of securities that could share in the
earnings of an entity and is calculated by dividing net income (loss) by the
diluted weighted average number of common shares. The diluted weighted average
number of common shares is computed using the treasury stock method for common
stock issuable, in the case of the Company, to outstanding stock options.

In loss periods, dilutive common equivalent shares are excluded as the effect is
anti-dilutive. Thus the Company excluded options to purchase 440,000 shares of
common stock in the computation of diluted earnings per share for both the years
ended March 31, 1999 and 1998 because their effect is anti-dilutive.

STOCK OPTION PLANS. The Company applies Accounting Principles Board Opinion 25,
"Accounting for Stock Issued to Employees," (APB Opinion 25) and related
Interpretations in accounting for all stock option plans. Under APB Opinion 25,
no compensation cost has been recognized for stock options granted to employees
as the option price equals or exceeds the market price of the underlying common
stock on the date of grant.

SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net income as if compensation cost for
the Company's stock option plans had been determined in accordance with the fair
value based method prescribed in SFAS No. 123.

COMPREHENSIVE INCOME. The Company has adopted SFAS No. 130, "Reporting
Comprehensive Income." Comprehensive income is comprised of net income and all
changes to the statements of shareholders' equity, except those due to
investment by shareholders, changes in additional paid-in capital and
distributions to shareholders. The adoption of SFAS No. 130 did not impact the
Company's financial statements for 1999 or 1998.

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-term maturity of those instruments.

28
<PAGE>

HEDGING. Hedging techniques are traditionally used to limit exposure to price
fluctuations. Under futures contracts, the Company would receive or make
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 receives payments from NYMEX if the closing price is less
than the floor price at which the put option was purchased.

The Company has favored options, rather than futures contracts, in order to
participate more fully if prices were to again escalate. 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.

At March 31, 1999, the Company had no open option contracts. At March 31, 1998,
the Company had thirty-nine open options contracts to hedge future deliveries
with maturities ranging from April 1998 through December 1998 at floor prices
ranging from $14 to $20 per barrel. The fair market value of the open options
contracts at March 31, 1998 was $64,000, with a cost basis of $36,000 which was
included in other current assets.

Cash flows from hedging activities are consolidated into oil and gas revenues on
the Statements of Operations and, as a result, are included in operating
activities in the Statements of Cash Flows. The Company realized gains of
approximately $69,000 and $17,000 on its hedging activities during the years
ended March 31, 1999 and 1998, respectively.

If the Company were to sell futures it would be required to furnish an initial
cash margin. The purchase of put or call options, on the other hand, does not
require a cash margin to be maintained. During the year ended March 31, 1998 the
Company had in place a tri-party agreement to fund the initial margin
requirement and any margin calls up to $150,000. However, during the past two
years the Company has not utilized futures contracts as instruments for its
hedging activities. As a result, the Company allowed the tri-party agreement to
expire under its own terms effective December 31, 1998.

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 seller of a put or
call option 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
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.

INCOME TAXES. The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes" which requires the use of the "liability
method." Accordingly, deferred tax liabilities and assets are determined based
on the temporary differences between the financial statement and tax bases of
assets and liabilities, using enacted tax rates in effect for the year in which
the differences are expected to reverse.

NEW ACCOUNTING PRONOUNCEMENTS. In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which requires
companies to record derivatives on the balance sheet as assets or liabilities,

29
<PAGE>

measured at fair market value. Gains or losses resulting from changes in the
values of those derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. The key criterion for
hedge accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. SFAS No. 133 is
effective for fiscal periods beginning after June 15, 1999. Management believes
the adoption of this statement will have no material impact on the Company's
financial statements.

RECLASSIFICATIONS. Certain prior year amounts may have been reclassified to
conform to current year presentation.

2. Going Concern
- ----------------

30
<PAGE>

3. Other Current Assets
- -----------------------

Other current assets at March 31, 1999 and 1998 consisted of the following:

1999 1998
-------- --------

Lease and well equipment inventory $135,000 $184,000
Option contracts -- 36,000
Other current assets 4,000 6,000
-------- --------

Total other current assets $139,000 $226,000
======== ========

The lease and well equipment inventory represents well site production equipment
owned by the Company that has been transferred from wells that the Company
operates. This occurs when the Company plugs a well or replaces defective,
damaged or suspect equipment on a producing well. In this case, salvaged
equipment is valued at prevailing market prices, removed from the full cost pool
and made available for sale. This equipment is carried on the balance sheet at a
value not to exceed the original carrying value established at the time it was
placed in inventory. The equipment is eventually sold to third parties at
current fair market prices. Sale of this equipment is expected to occur in less
than one year. This policy does not preclude the Company from further
transferring serviceable equipment to other wells that the Company operates on
an as-needed basis. The majority of the decrease in 1999 of lease and well
equipment inventory is to recognize the reclassification of specific equipment
that has been identified for use on Company-operated wells and as such has been
added to other noncurrent assets.

4. Other Noncurrent Assets
- --------------------------

Other noncurrent assets at March 31, 1999 and 1998 consisted of the following:

1999 1998
-------- --------

Lease and well equipment inventory $ 86,000 $ --
Plugging bonds 69,000 69,000
Notes receivable 13,000 13,000
Other -- 3,000
-------- --------

Total other noncurrent assets $168,000 $ 85,000
======== ========

The lease and well equipment inventory represents well site production equipment
owned by the Company that has either been purchased or has been transferred from
wells that the Company operates. When placed in inventory, new equipment is
valued at cost and salvaged equipment is valued at prevailing market prices. The
inventory is carried at the lower of the original carrying value or fair market
value.

31
<PAGE>

Plugging bonds represents Certificates of Deposit furnished by the Company to
third parties who supply plugging bonds to federal and state agencies where the
Company operates wells.

See Note 10 below for discussion of notes receivable.

5. Long-Term Debt
- -----------------

Outstanding debt of the Company as of March 31, 1999 and 1998 is as follows:

1999 1998
-------- --------
Bank note under loan
agreement (see below) $570,000 $624,000

Less current portion 240,000 234,000
-------- --------

Total long-term debt $330,000 $390,000
======== ========

With respect to the DBRLOC, the borrowing base at March 31, 1998 was $750,000.
Under the terms of the agreement in effect at March 31, 1998, Basic was
obligated to make monthly principal payments of $30,000 beginning August 1,
1998. The Company was able to make only one $30,000 payment on September 30,
1998 followed by a $10,000 principal payment on October 31, 1998. Effective
November 3, 1998, Basic and the bank modified the existing loan agreement and
the borrowing base was set at $620,000 with scheduled monthly principal payments
of $10,000 beginning November 30, 1998 and running through March 31, 1999. At
April 30, 1999, the monthly principal payments increased to $20,000 and will
continue at that amount through March 31, 2000. On the maturity date of April 1,
2000 any remaining balance due is required to be paid in full. At March 31,
1999, the DBRLOC had a borrowing base of $570,000.

Under the DBRLOC loan agreement, the Company must maintain certain covenants
with regard to various financial ratios and net worth criteria. Failure to
maintain any covenant, after a curative period, creates a default under the loan
agreement and requires repayment of the entire outstanding balance. Effective
March 31, 1998, the Bank amended the original DBRLOC by lowering the required
net worth the Company must maintain to $750,000 from $1,700,000. Another
specific bank covenant requires the maintenance of a current ratio of at least
1:1 after adjustment for the removal of the current portion of long-term debt.
The Company was in compliance with both these covenants at March 31, 1999 and
1998.

32
<PAGE>

The DBRLOC is collateralized and secured by mortgages on substantially all of
the Company's producing oil and gas properties. At March 31, 1999 and 1998, the
Company's effective annual interest rate was 9.75% and 10.5%, respectively.

Below is a schedule of the Company's required debt payments as of March 31,
1999:

Fiscal year Amount
----------- ------

2000 $ 240,000
2001 330,000
-----------

$ 570,000
===========

6. Commitments
- --------------

The Company leased its office space for approximately $3,200 per month through
April 30, 1998 and $3,450 per month from May 1, 1998 through the end of the
lease term at April 30, 1999. Rental expense was approximately $41,000 for both
the years ended March 31, 1999 and 1998. Due to the magnitude of the projected
rent increase (approximately 37%) and a required three-year lease commitment,
the Company, in April 1999, moved its office to a new location. The new office
space is in a building owned by Ray Singleton, president of Basic (see Note 10
below). Under the terms of the new lease agreement, the Company has a one-year
lease term through March 31, 2000 with monthly payments of $1,200.

7. Shareholders' Equity
- -----------------------

STOCK OPTION PLAN. During the years ended March 31, 1999 and 1998, the Company
granted options to purchase an aggregate of 50,000 and 140,000 shares,
respectively, of its common stock to officers and directors for services
rendered. At March 31, 1999 and 1998, all options were still outstanding. Option
holders may exercise their options at prices ranging from $0.0325 to $0.115
(which approximated the fair market value at the date of grant) per share over a
period not to exceed ten years beginning on the grant date, provided they remain
directors or employees of the Company.

A summary of the status of the Company's stock option plan and outstanding
options as of March 31, 1999 and 1998 and changes during the years ending on
those dates is presented below:

<PAGE>

1999 1998
------------------- ------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ ----- ------ -----

Outstanding, beginning of year 440,000 $0.0811 300,000 $0.0694

Granted 50,000 0.0325 140,000 0.1061
Cancelled (50,000) 0.0650 -- --
Exercised -- -- -- --
-------- ------- -------- -------

Outstanding, end of year 440,000 $0.0774 440,000 $0.0811
======== ======= ======== =======

Options exercisable, end of year 440,000 $0.0774 440,000 $0.0811
======== ======= ======== =======

Weighted average fair value of
options granted during the year $0.0325 $0.1061
======= =======

SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net income and net income per share as
if compensation costs for the Company's stock option plans and other stock
awards had been determined in accordance with the fair value based method
prescribed in SFAS No. 123. The Company estimated the fair value of each stock
award at the grant date by using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in the year ended March
31, 1999: dividend yield at 0 percent; expected volatility of approximately 82
percent; risk-free interest rate of 5.11 percent; and expected lives of ten
years for the options. The assumptions used for grants in the year ended March
31, 1998: dividend yield of 0 percent for all years; expected volatility of
approximately 80 percent; risk-free rate of 6 percent; and expected ten year
life for the options.

Under the accounting provisions for SFAS No. 123, the Company's net income and
net income per share would have been adjusted to the following pro forma
amounts:

Years Ended March 31,

1999 1998
--------- ------------
Net loss:
As reported $ (54,000) $ (1,111,000)
Pro forma $ (54,000) $ (1,119,000)
Net loss per share (basic and diluted):
As reported $ (0.003) $ (0.067)
Pro forma $ (0.003) $ (0.068)

34
<PAGE>

The following table provides a summary of the stock options outstanding at March
31, 1999:

Options Outstanding Options Exercisable
- --------------------------------------------------- ----------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices at 3/31/99 Life Price at 3/31/99 Price
------ ---------- ---- ----- ---------- -----

$ 0.0325 50,000 9.33 years $ 0.0325 50,000 $ 0.0325
0.0650 150,000 7.33 0.0650 150,000 0.0650
0.0781 100,000 6.33 0.0781 100,000 0.0781
0.0900 50,000 8.33 0.0900 50,000 0.0900
0.1150 90,000 8.67 0.1150 90,000 0.1150
- ------------- ------- ---------- -------- ------- --------

$ .0325-0.115 440,000 7.72 years $ 0.0774 440,000 $ 0.0774
============= ======= ========== ======== ======= ========

8. Major Customers
- ------------------

Purchasers of 10% or more of Basic's oil and gas production for the years ended
March 31, 1999 and 1998 are as follows:

1999 1998
---- ----

Murphy Oil USA, Inc. 28% 21%
Norco Crude Gathering, Inc. 21% 24%
Cenex Harvest States 11% 19%

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 readily available.

9. Income Tax
- -------------

Due primarily to the availability of net operating loss carryforwards and
favorable book to tax differences, the Company had no taxable income during the
years ended March 31, 1999 and 1998.

A reconciliation between the income tax provision at the statutory rate on
income taxes and the income tax provision at March 31, 1999 and 1998 is as
follows:

<PAGE>

1999 1998
----------- -----------

Federal income tax provision at statutory rates $ (18,000) $ (378,000)
State income tax (2,000) (37,000)
Expired net operating loss carryforward 778,000 1,722,000
Change in valuation allowance (782,000) (1,320,000)
Expired investment tax credit carryforward 24,000 13,000
----------- -----------

Income tax expense (benefit) $ -- $ --
=========== ===========

The Company recorded a valuation allowance of $3,024,000 and $3,906,000 at March
31, 1999 and 1998, respectively, equal to the excess of deferred tax assets over
deferred tax liabilities as it was unable to determine that these benefits are
more likely than not to be realized.

The components of the net deferred tax assets and liabilities are shown below:

For the Years Ended March 31,

1999 1998
----------- -----------

Net operating loss carryforward $ 1,915,000 $ 2,760,000
Statutory depletion carryforward 1,389,000 1,389,000
Other 56,000 80,000
----------- -----------

Total gross deferred tax assets 3,360,000 4,229,000
Valuation allowance (3,024,000) (3,906,000)
----------- -----------

Net deferred tax asset 336,000 323,000
Deferred tax liability - depreciation,
depletion and amortization (336,000) (323,000)
----------- -----------

Net deferred taxes $ -- $ --
=========== ===========

As of March 31, 1999, the Company has a net operating loss carryforward for tax
purposes of approximately $5,046,000 which expires as follows:

3/31/00 $ 2,759,000
3/31/01 1,315,000
3/31/02 447,000
3/31/03 and beyond 525,000
-----------

$ 5,046,000
===========

10. 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

36
<PAGE>

gas prospects generated by independent third parties only on the same terms and
conditions as accepted by each other. During the year ended March 31, 1999 the
Company purchased from a third party an approximate 56% interest in the Edwin M.
Dahl #23-1 well in McKenzie County, North Dakota for approximately $5,000. As a
part of the purchase, Ray Singleton, president of Basic, bought a 20% working
interest in the well for a proportionate cost of approximately $2,000. In the
year ended March 31, 1998 there were no significant related party transactions
with respect to oil and gas properties.

As mentioned in Note 6 above, the Company is currently leasing its office space
from Mr. Singleton. The lease agreement is favorable in comparison to other
arrangements and options available to the Company in terms of available office
space, lease term and lease rates.

Included in other noncurrent assets is a $13,000 note receivable from Mr.
Singleton. Interest is paid quarterly at the same rate as that charged by the
Bank as discussed in Note 5 above. The entire outstanding principal balance is
due and payable on October 6, 2000.

In addition, during the year ended March 31, 1999 an officer and director of the
Company provided consulting services at a per diem rate comparable to prevailing
market rates. The total amount paid during the year was $26,000.

11. 401(k) Plan
- ---------------

Effective October 1997, the Company implemented a savings plan (the Plan) which
allows participants to make contributions by salary reduction pursuant to
Section 401(k) of the Internal Revenue Code.

Employees are required to work for the Company one year before they become
eligible to participate in the Plan. The Company matches 100% of the employee's
contributions up to 3% of the employee's salary. Contributions are vested when
made. During the years ended March 31, 1999 and 1998, the Company contributed
approximately $6,000 and $4,000, respectively to the Plan.

12. Fourth Quarter Adjustment
- -----------------------------

The Company recorded a $45,000 adjustment in the fourth quarter ended March 31,
1999 to reduce the depletion expense that had been recorded in the prior three
quarters in the fiscal year ended March 31, 1999. The adjustment was made due to
a revision in the estimated oil and gas reserves at March 31, 1999. See Note 13
to follow.

13. Unaudited Oil and Gas Reserve Information
- ---------------------------------------------

The oil and gas reserve estimates presented herein, for both the years ended
March 31, 1999 and 1998, were derived from reports prepared by the independent
petroleum engineering firm, Heinle & Associates, Inc. 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, and these changes could be material.

37
<PAGE>

The properties included in the oil and gas estimates presented below comprise
73% of the Company's oil production and 77% of its gas production in the year
ended March 31, 1999. Other properties contributed only a marginal amount to
Basic's total production and management has elected not to incur the additional
expense of evaluating these properties for inclusion in its estimated oil and
gas reserves. During the years ended March 31, 1999 and 1998 there were
acquisitions and sales of certain properties that were not included in the
following reserve analyses.

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:

Proved Developed and Undeveloped Reserves
-----------------------------------------

Oil and
natural gas Natural
liquids gas
(bbl) (mcf)
----- -----
Proved developed and undeveloped
reserves at March 31, 1997 613,000 989,000

Revisions of previous estimates (171,000) (51,000)
Production (125,000) (166,000)
-------- --------
Proved developed and undeveloped
reserves at March 31, 1998 317,000 772,000

Revisions of previous estimates 213,000 137,000
Production (101,000) (137,000)
-------- --------

Proved developed and undeveloped
reserves at March 31, 1999 429,000 772,000
======== ========

38
<PAGE>

Proved Developed Reserves
-------------------------

Oil and
natural gas Natural
liquids gas
(bbl) (mcf)
----- -----

March 31, 1998 312,000 735,000
March 31, 1999 425,000 734,000

Costs incurred in oil and gas property acquisition, exploration and development
activities are summarized as follows:

Costs Incurred
--------------

Years Ended March 31

1999 1998
-------- --------

Development costs $143,000 $240,000
Exploration costs 51,000 255,000
Acquisitions:
Proved 2,000 --
Unproved 17,000 102,000
-------- --------

Total $213,000 $597,000
======== ========

The table below 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, 1999 and 1998. The future production and development
costs represent the estimated future expenditures to be incurred in developing
and producing the proved reserves, assuming continuation of existing economic
conditions. Discounting the annual net cash flows at 10% illustrates the impact
of timing on these future cash flows.

39
<PAGE>

Standardized Measure of Estimated Discounted Future Net Cash Flows
------------------------------------------------------------------

At March 31,

1999 1998
----------- -----------

Future cash inflows $ 7,268,000 $ 5,412,000
Future cash outflows:
Production cost (4,750,000) (3,522,000)
Development cost (45,000) (45,000)
----------- -----------

Future net cash flows 2,473,000 1,845,000
Adjustment to discount future
annual net cash flows at 10% (823,000) (521,000)
----------- -----------
Standardized measure of discounted
future net cash flows $ 1,650,000 $ 1,324,000
=========== ===========

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, 1999 and 1998.

Changes in Standardized Measure of Estimated Discounted Net Cash Flows
----------------------------------------------------------------------

Years Ended March 31,

1999 1998
---------- -----------

Standardized measure, beginning of period $ 1,324,000 $ 3,082,000

Sales of oil and gas, net of production cost (384,000) (530,000)

Net change in sales prices, net of production cost 5,000 (431,000)

Discoveries, extensions and improved recoveries,
net of future development cost -- --

Purchase of reserves -- --

Sales of reserves -- --

Revisions of quantity estimates 764,000 (584,000)

Accretion of discount 132,000 308,000

Changes in rates of production and other (191,000) (521,000)
----------- -----------

Standardized measure, end of period $ 1,650,000 $ 1,324,000
=========== ===========

40
<PAGE>

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 1999 Proxy Statement, which
is incorporated herein by reference.

ITEM 10
EXECUTIVE COMPENSATION

Information concerning this item will be in Basic's 1999 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 1999 Proxy Statement, which
is incorporated herein by reference.

ITEM 12
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning this item will be in Basic's 1999 Proxy Statement, which
is incorporated herein by reference.

41
<PAGE>

Part IV
- -------
ITEM 13
EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit
No. Document
--- --------

3i(1) Restated Certificate of Incorporation included in Basic's Form
10-K for the year ended March 31, 1981

3i(1) By-laws included in Basic's Form S-1 filed October 24, 1980

3i(1) Certificate of Amendment to Basic's Restated Certificate of
Incorporation dated March 31, 1996

10(i)a(1) Loan Agreement between Norwest Denver, N.A. and Basic, dated
August 1, 1994

10(i)a(1) Sales Agreement between Basic and TransTexas, dated March 3,
1995, pertaining to the sale of deep exploration rights

10(i)a(1) Purchase & Sale Agreement between Basic and MCM, dated March 6,
1995, pertaining to Williston basin acquisition

10(i)a(1) Amended Loan Agreement between Norwest Denver, N.A. and Basic,
dated March 30, 1995

10(i)a(1) Amended Loan Agreement between Norwest Denver, N.A. and Basic,
September 13, 1995

10(i)a(1) Amended Loan Agreement between Norwest Denver, N.A. and Basic,
December 13, 1996

10(i)a Amended Loan Agreement between Norwest Denver, N.A. and Basic,
November 3, 1998

10(ii)(1) Oil and Gas Incentive Compensation Plan included in Basic's Form
10-K for the year ended March 31, 1985

22(1) Subsidiaries of Basic included in Basic's Form 10-K for the year
ended March 31, 1987

1 Previously filed and incorporated herein by reference

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, 1999.

42
<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.
Date
----

/s/ Ray Singleton July 29, 1999
- ----------------- -------------
Ray Singleton, President

/s/ Ray Singleton July 29, 1999
- ----------------- -------------
Ray Singleton, Acting Accounting Officer

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
- ----------------- ----

/s/ G. W. Breuer July 29, 1999
- ---------------- -------------
G. W. Breuer, Director

/s/ David J. Flake July 29, 1999
- ------------------ -------------
David J. Flake, Director

/s/ Edgar J. Huffman July 29, 1999
- -------------------- -------------
Edgar J. Huffman, Director

/s/ Ray Singleton July 29, 1999
- ----------------- -------------
Ray Singleton, Director

NORWEST BANKS Norwest Bank Colorado, N.A.
Denver
1740 Broadway
Denver, Colorado 80274
303/861/8811

November 3, 1998

Mr. Ray Singleton
Basic Earth Science Systems, Inc.
Suite 1670 633 17th Street
Denver, CO 80202

Dear Ray:

Reference is made to the agreement between Basic Earth Science Systems, Inc.,
("Borrower") and Norwest Bank Colorado, N.A. ("Norwest") dated March 30, 1995
("Loan Agreement") as amended from time to time. Effectively immediately, the
Borrowing Base shall be set at $620,000. The Borrowing Base shall reduce monthly
by $10,000 beginning November 30, 1998 through March 31, 1999 and by $20,000
beginning April 30, 1999 through March 31, 2000. On the Maturity Date of April
1, 2000 the Borrowing Base shall be zero. The Borrowing Base schedule is
presented below for clarification.

Effective Borrowing
Date Base
---- ----

11/02/1998 620,000
11/30/1998 610,000
12/31/1998 600,000
01/31/1999 590,000
02/28/1999 580,000
03/31/1999 570,000
04/30/1999 550,000
05/31/1999 530,000
06/30/1999 510,000
07/31/1999 490,000
08/31/1999 470,000
09/30/1999 450,000
10/31/1999 430,000
11/30/1999 410,000
12/31/1999 390,000
01/31/2000 370,000
02/29/2000 350,000
03/31/2000 330,000
04/01/2000 0

Also effectively immediately the consolidated net worth requirement shall be
decreased from $1,700,000 to $750,000. Should you have any questions regarding
this matter, please feel free to contact me 863-5231. Please acknowledge your
acceptance of and agreement to the above listed changes to the Loan Agreement by
signing below. All other terms and conditions of the Loan Agreement as amended
shall remain in full force and effect.

Very sincerely,

/s/ Don McDonald
- ----------------
Don McDonald
Vice President

AGREED TO AND ACCEPTED THIS 4TH OF NOVEMBER, 1998.

BASIC EARTH SCIENCE SYSTEMS, INC.

By: /s/ Ray Singleton
- ---------------------
Ray Singleton, President

c. Susan Hillyard,
Heppenstall, Savage, Hillyard & Muller, LLC

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 38,000
<SECURITIES> 0
<RECEIVABLES> 255,000
<ALLOWANCES> (54,000)
<INVENTORY> 139,000<F1>
<CURRENT-ASSETS> 378,000
<PP&E> 33,043,000
<DEPRECIATION> (31,848,000)
<TOTAL-ASSETS> 1,741,000
<CURRENT-LIABILITIES> 573,000
<BONDS> 0
0
0
<COMMON> 17,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 1,741,000
<SALES> 1,425,000
<TOTAL-REVENUES> 1,449,000
<CGS> 1,041,000<F2>
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 113,000<F3>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 72,000
<INCOME-PRETAX> (54,000)<F4>
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (54,000)<F4>
<EPS-BASIC> (.003)<F4>
<EPS-DILUTED> (.003)<F4>
<FN>
<F1> And other current assets
<F2> Operating expenses
<F3> General & Administrative
<F4> (Loss)
</FN>

</TABLE>