U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
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Commission File No. 333-47699
FAN ENERGY INC.
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(Name of small business issuer in its charter)
Nevada 77-0140428
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1801 Broadway Suite 720, Denver, Colorado 80202
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (602) 483-8848
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act: None
Common Stock (Par Value $.01 Per Share)
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Title of Class
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 such filing requirements for the past 90 days. [X] Yes [ ]
No.
Check if there is no 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. [X]
State issuer's revenues for its most recent fiscal year. $ - 0 -
As of December 31, 1998 the issuer had 10,051,705 shares of its $0.01 par
value Common Stock issued and outstanding. As there is no public trading market
for Registrant's securities, Registrant is unable to determine the aggregate
market value of the common stock, the Registrant's only class of voting stock,
held by nonaffiliates.
DOCUMENTS INCORPORATED BY REFERENCE
None
Transitional Small Business Issuer Disclosure Format Yes[ ] No [X]
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PART I
This Report on Form 10-KSB and documents incorporated herein by reference
contain certain "forward-looking statements" as defined by the Private
Securities Litigation Reform Act of 1995 which involve substantial risks and
uncertainties. When used in this report and in other reports filed by the
Company, the forward-looking statements are often identified by the use of such
terms and phrases as "anticipates," "believes," "intends," "estimates," "plans,"
"expects," "seeks," "scheduled," "foreseeable future" and similar expressions.
Although the Company believes the understandings and assumptions on which the
forward-looking statements in this report are based are reasonable, the
Company's actual results, performances and achievements could differ materially
from the results in, or implied by, these forward-looking statements. Certain
factors that could cause or contribute to such differences include those
discussed in "Management's Plan of Operations" and elsewhere herein.
ITEM 1. DESCRIPTION OF BUSINESS.
(a) GENERAL DEVELOPMENT OF BUSINESS
Fan Energy Inc. (the "Company") is an independent energy company engaged in
the exploration and acquisition of crude oil and natural gas reserves.
Originally formed as an Idaho corporation in the early 1900s, the Company's
predecessor was not successful in the exploration of mining properties. In 1988
the predecessor was merged into a newly-formed Nevada corporation as Eastern
Star Mining, Inc. and it was inactive thereafter, with no assets or liabilities
through the end of 1996. In early 1997 the corporation was reactivated when the
holder of a majority of the outstanding Common stock transferred control of the
inactive corporation. The transferee elected new directors and officers and
caused the Company to effect a 10-into-1 reverse stock split. Thereafter, the
Company raised capital through the sale of its securities and acquired an
interest in its oil and gas properties for cash and Common stock. For a
description of the transaction in which the Company acquired the properties, see
Item 2. "Description of Properties." The name of the corporation was changed to
Fan Energy Inc. in December 1997. The Company conducted no business activities
until 1998
(b) NARRATIVE DESCRIPTION OF THE BUSINESS
The Company intends to develop oil and natural gas properties in regions
with known producing horizons, significant available undeveloped acreage and
considerable opportunities to increase reserves, production and ultimate
recoveries through exploratory and development drilling and acquisition of
producing properties. The Company's present activities are focused in the Green
River Basin in Wyoming and the Sacramento Basin in central California where its
exploration prospects are located.
The Company holds an approximately undivided 20% interest in a 5,760 acre
prospect located in Sweetwater County, Wyoming. One exploratory well has been
drilled on the prospect which has been completed as an apparent commercial oil
and gas well. As of the date of this report the well was shut-in awaiting
completion of a natural gas pipeline before production will be commenced. The
operator of the well, Fancher Oil, LLC, owned by the Company's Chairman, plan to
drill two or three development exploratory wells on this prospect in 1999.
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Depending upon the success of the initial drilling, the market for natural gas,
the availability of capital and other factors, as many as 8 to 18 wells may be
drilled to fully test and exploit this prospect in the next one to three years.
In addition, the Company has the right to participate with up to a 20% working
interest in three additional prospects which Fancher Resources, LLC intends to
explore in the vicinity of this prospect which could result in the drilling of
up to three additional exploratory wells in 1999.
The Company also holds an undivided 25% working interest in two exploratory
prospects located in Yolo and Solano Counties in the Sacramento Basin near
Sacramento, California which has been held for sale since late 1998. The
prospects total approximately 25,520 gross acres. In 1998, the Company
participated in drilling five exploratory wells on the property, one of which
was completed as a producer. In 1998 the operator of the prospects, a
nonaffiliated independent oil and gas company, and the Company, together
completed a three dimensional seismic ("3-D Seismic") survey and identified
several potential drilling sites. The initial three exploratory wells on one of
the prospects and the first exploratory well on the other prospect, which the
Company had a 6.25% working interest, were plugged and abandoned as dry holes in
1998. The fifth well, on the second prospect, was placed on production early in
1999. The Company is seeking to sell its interest in these two exploratory
prospects in the Sacramento Basin.
The Company intends to use its present cash assets, the proceeds from sale
of the Sacramento Basin prospects and from a securities offering, and the
anticipated proceeds from the exercise of outstanding stock purchase warrants to
meet the capital requirements for exploration and development of its current
properties and to acquire similar types of interests in other oil and natural
gas properties in the United States and Canada.
The Company presently has only limited reserves of oil or natural gas,
limited production and no cash flow and it is anticipated that only limited
revenue will develop when the two wells in which the Company holds an interest
are placed in production during the first half of 1999. Unless the Company's
exploratory drilling program is successful, and the Company participates in the
development of reserves and production from this property, cash flow will not be
significant. The Company does not serve as the Operator in its two present
prospects. Because it is not the Operator, the Company is not generally in a
position to make determinations with respect to where and when exploratory or
other wells will be drilled, the timing of the drilling, the conduct of
day-to-day activities and related management of the exploitation of the
properties. However, in the Sacramento Basin prospects the Company, or any other
owner of an undivided working interest, is authorized to propose certain
exploration activities and to become the operator for that activity if the
Operator declines to act. See "Item 2. Description of Properties."
Business Strategy
Our intended strategy is to develop and increase oil and natural gas
reserves, production and revenue for the Company and includes the following key
elements.
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o Utilize State-of-the-Art Technologies. Certain of the Company's officers,
directors and consultants have experience in utilizing 3-D Seismic data and
related "state-of-the-art" technologies for analyzing oil and natural gas
drilling and development opportunities. The Company intends to continue to
analyze and review oil and natural gas prospects which the Company holds or
acquires based on analysis of 3-D Seismic data and related technologies,
including "amplitude versus offset" or "AVO" seismic analysis. The Company's
efforts will be focused on improving drilling success rates and accelerating the
development of oil and natural gas reserves.
o Develop Drillsite Inventory. Our interests in the California and Wyoming
prospects include an inventory of up to approximately 18 potential exploratory
and development oil and natural gas wells, based on an initial review of the
completed 3-D Seismic and the two successful wells drilled on the prospects. The
Company also may participate in the drilling of three or more exploratory wells
on nearby prospects which it has the right to acquire a 20% working interest.
The Company believes that the present cash resources, proceeds from an
anticipated securities offering and anticipated proceeds from the exercise of
outstanding warrants will enable the Company to pay its anticipated share of
drilling and completion costs for two to three exploratory wells on the these
prospects. The Company also intends to continue to seek and acquire interests in
other drilling prospects in the United States and Canada.
o Acquire Interests in Producing Oil and Natural Gas Properties. The
Company will continue to evaluate potential acquisitions of interests in
producing and nonproducing oil and natural gas properties in the United States
and Canada which may become available on terms which the Company believes will
be attractive and which have the potential to add to our reserves and production
through the application of lower risk exploitation and exploration techniques.
These acquisitions would be subject to the availability of properties deemed
suitable by the Board of Directors, availability of financial resources,
location and other factors.
Acquisitions of Other Properties
The Company does not presently intend to operate oil and gas properties,
but instead will focus upon acquiring and holding properties which management of
the Company believes, utilizing 3-D Seismic and other state-of-the-art
technologies, have a good potential to develop significant oil or natural gas
production and reserves. The Company presently has not identified any such
properties for acquisition and it is not likely that additional properties will
be acquired until the Company has attained additional capitalization, either
with the proceeds of this Offering, the exercise of outstanding warrants or from
other sources.
The Company may evaluate and pursue acquisitions of interests in producing,
exploratory or development oil and gas properties that meet the Company's
selection criteria, including persons or entities with whom members of our
management may have an affiliation or other relationship. The successful
acquisition of such properties would require an assessment of potential reserves
of oil or natural gas, future oil and natural gas prices, operating costs,
potential environmental and other liabilities and other factors beyond the
Company's control. Such an assessment is necessarily inexact and its accuracy
would be inherently uncertain. The Company intends that upon any such
acquisition, management will perform a review of the subject properties
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generally consistent with industry practices. Such a review, however, would not
reveal all existing or potential problems, nor would it permit a buyer to become
sufficiently familiar with the properties to assess fully their deficiencies or
potential value. Inspections of the properties may not be performed and problems
with existing properties may not be observable even in those cases where an
inspection is undertaken. The Company may assume existing liabilities, including
environmental liabilities, upon any such acquisition and would likely acquire
interests in such properties on an "as is" basis.
The Company's Chairman, George H. Fancher Jr., who has substantial
experience as an operator of exploration and development of oil and gas
properties for his own account, is the operator of the Company's Wyoming
prospect and may be the operator of properties in which the Company acquires an
interest. In such event, charges to the Company for such services will not
exceed usual and customary charges to unaffiliated persons and will be at a rate
no higher than operating charges made to any other participant in a given
project.
Marketing of Production
The price to be received by the Company for any oil and natural gas
production which may be established on Company properties will depend upon
numerous factors beyond the Company's control, including seasonality, the
condition of the national and international economies, the availability of
foreign imports, political conditions in other oil and natural gas producing
countries, domestic governmental regulations, legislation and policies,
decreases in the prices of oil or natural gas could have an adverse affect on
the value of any reserves established by the Company and the Company's cash flow
from any production which may be established. In February 1999, the price paid
by natural gas purchasers in the Sacramento Basin of central California was
approximately $1.80 per mcf and in the Green River Basin of southeastern Wyoming
was approximately $1.50 per mcf. Such prices could be higher or lower at the
time that any production from the Company's exploratory activities is available
for sale, depending upon the above factors and other unforseen circumstances.
Competition
The Company operates in the highly competitive areas of oil and natural gas
exploration, exploitation, acquisition and production with other companies, many
of which have substantially larger financial resources, operations, staffs and
facilities. In seeking to acquire desirable producing properties or production,
the Company faces intense competition from both major and independent oil and
natural gas companies. The Company expects that the inventory of unproved
drilling locations in the two prospects in which the Company has an interest
will be the primary source of new reserves, production and cash flow during the
next year. There can be no assurance that the two prospects will yield
substantial economic returns. Failure of the two prospects to yield significant
quantities of economically attractive reserves in production could have a
material adverse impact on the Company's future financial condition and could
result in a writeoff of a significant portion of its investment in the oil and
gas properties.
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The Company's competitors include major integrated oil and natural gas
companies and numerous independent oil and natural gas companies, individuals
and drilling and income programs. Many of its competitors are large, well
established companies with substantially larger operating staffs and greater
capital resources than the Company's and which, in many instances, have been
engaged in the energy business for a much longer time than the Company. Such
companies may be able to pay more for productive oil and natural gas properties
and exploratory prospects and to define, evaluate, bid for and purchase a
greater number of properties and prospects than the Company's financial or human
resources permit. The Company's ability to acquire additional properties and to
discover reserves in the future will be dependent upon its ability to evaluate
and select suitable properties and to consummate transactions in a highly
competitive environment.
Regulation
Regulation of Oil and Natural Gas Production. The Company's oil and natural
gas exploration, production and related operations are subject to extensive
rules and regulations promulgated by federal, state and local authorities and
agencies. Failure to comply with such rules and regulations can result in
substantial penalties. The regulatory burden on the oil and natural gas industry
increases the Company's cost of doing business and affects its profitability.
Although the Company believes it is in substantial compliance with all
applicable laws and regulations, because such rules and regulations are
frequently amended or reinterpreted, the Company is unable to predict the future
cost or impact of complying with such laws.
The states of California and Wyoming and many other states require permits
for drilling operations, drilling bonds and reports concerning operations and
impose other requirements relating to the exploration and production of oil and
natural gas. Such states also have statues or regulations addressing
conservation matters, including provisions for the unitization or pooling of oil
and natural gas properties, the establishment of maximum rates of production
from wells, and the regulation of spacing, plugging and abandonment of such
wells.
Federal Regulation of Natural Gas. The Federal Energy Regulatory Commission
("FERC") regulates interstate natural gas transportation rates and service
conditions, which affect the marketing of natural gas produced by the Company,
as well as the revenues received by the Company for sales of such production.
Since the mid-1980's, FERC has issued a series of orders that have significantly
altered the marketing and transportation of natural gas. These orders mandate a
fundamental restructuring of interstate pipeline sales and transportation
service, including the unbundling by interstate pipelines of the sale,
transportation, storage and other components of the city-gate sales services
such pipelines previously performed. One of FERC's purposes in issuing the
orders was to increase competition within all phases of the natural gas
industry. Certain aspects of these orders may be modified as a result of various
appeals and related proceedings and it is difficult to predict the ultimate
impact of the orders on the Company and others. Generally, the orders eliminate
or substantially reduce the interstate pipelines' traditional role as
wholesalers of natural gas in favor of providing only storage and transportation
service, and has substantially increased competition and volatility in natural
gas markets.
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The price which the Company may receive for the sale of oil and natural gas
liquids would be affected by the cost of transporting products to markets. FERC
has implemented regulations establishing an indexing system for transportation
rates for oil pipelines, which, generally, would index such rates to inflation,
subject to certain conditions and limitations. The Company is not able to
predict with certainty the effect, if any, of these regulations on any future
operations. However, the regulations may increase transportation costs or reduce
well head prices for oil and natural gas liquids.
Environmental Matters. The Company's operations and properties are subject
to extensive and changing federal, state and local laws and regulations relating
to environmental protection, including the generation, storage, handling,
emission, transportation and discharge of materials into the environment, and
relating to safety and health. The recent trend in environmental legislation and
regulation generally is toward stricter standards, and this trend will likely
continue. These laws and regulations may(i) require the acquisition of a permit
or other authorization before construction or drilling commences and for certain
other activities; (ii)limit or prohibit construction, drilling and other
activities on certain lands lying within wilderness and other protected areas;
and (iii) impose substantial liabilities for pollution resulting from the
Company's operations. The permits required for various of the Company's
operations are subject to revocation, modification and renewal by issuing
authorities. Governmental authorities have the power to enforce their
regulations, and violations are subject to fines or injunctions, or both. In the
opinion of management, the Company is in substantial compliance with current
applicable environmental laws and regulations, and the Company has no material
commitments for capital expenditures to comply with existing environmental
requirements. Nevertheless, changes in existing environmental laws and
regulations or in interpretations thereof could have a significant impact on the
Company, as well as the oil and natural gas industry in general.
The Company may agree to indemnify sellers of properties purchased by the
Company against certain liabilities for environmental claims associated with
such properties. No assurance can be given that existing environmental laws or
regulations, as currently interpreted or reinterpreted in the future, or future
laws or regulations will not materially adversely affect the Company's results
of operations and financial condition or that material indemnity claims will not
arise against the Company with respect to properties acquired by the Company.
The Comprehensive Environmental, Response, Compensation, and Liability Act
("CERCLA") and comparable state statutes impose strict, joint and several
liability on owners and operators of sites and on persons who disposed of or
arranged for the disposal of "hazardous substances" found at such sites. It is
not uncommon for the neighboring land owners and other third parties to file
claims for personal injury and property damage allegedly caused by the hazardous
substances released into the environment. The Federal Resource Conservation and
Recovery Act ("RCRA") and comparable state statutes govern the disposal of
"solid waste" and "hazardous waste" and authorize the imposition of substantial
fines and penalties for noncompliance. Although CERCLA currently excludes
petroleum from its definition of "hazardous substance," state laws affecting the
Company's operations impose clean-up liability relating to petroleum and
petroleum related products. In addition, although RCRA classifies certain oil
field wastes as "non-hazardous," such exploration and production wastes could be
reclassified as hazardous wastes thereby making such wastes subject to more
stringent handling and disposal requirements.
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The Company has acquired leasehold interests in numerous properties that
for many years have produced oil and natural gas. Although the previous owners
of these interests may have used operating and disposal practices that were
standard in the industry at the time, hydrocarbons or other wastes may have been
disposed of or released on or under the properties. In addition, some of the
Company's properties may be operated in the future by third parties over whom
the Company has no control. Notwithstanding the Company's lack of control over
properties operated by others, the failure of the operator to comply with
applicable environmental regulations may, in certain circumstances, adversely
impact the Company.
NEPA. The National Environmental Policy Act ("NEPA") is applicable to many
of the Company's planned activities and operations. NEPA is a broad procedural
statute intended to ensure that federal agencies consider the environmental
impact of their actions by requiring such agencies to prepare environmental
impact statements ("EIS") in connection with all federal activities that
significantly affect the environment. NEPA is a procedural statute only
applicable to the federal government, and none of the Company's Sacramento Basin
acreage is located on federal land. The Bureau of Land Management's issuance of
drilling permits and the Secretary of the Interior's approval of plans of
operation and lease agreements all constitute federal action within the scope of
NEPA. Consequently, unless the responsible agency determines that the Company's
drilling activities will not materially impact the environment, the responsible
agency will be required to prepare an EIS in conjunction with the issuance of
any permit or approval.
ESA. The Endangered Species Act ("ESA") seeks to ensure that activities do
not jeopardize endangered or threatened animal, fish and plant species, nor
destroy or modify the critical habitat of such species. Under ESA, exploration
and production operations, as well as actions by federal agencies, may not
significantly impair or jeopardize the species or its habitat. ESA provide for
criminal penalties for willful violations of the Act. Other statutes that
provide protection to animal and plant species and that may apply to the
Company's operations include, but are not necessarily limited to, the Fish and
Wildlife Coordination Act, the Fishery Conservation and Management Act, the
Migratory Bird Treaty Act and the National Historic Preservation Act. Although
the Company believes that its operations are in substantial compliance with such
statutes, any change in these statutes or any reclassification of a species as
endangered could subject the Company to significant expense to modify its
operations or could force the Company to discontinue certain operations
altogether.
Employees
As of the date hereof, the Company had no employees. The Company's five
directors and four part time consultants provide management and other services.
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ITEM 2. DESCRIPTION OF PROPERTY.
Principal Properties
The Company holds interests in two wells and exploratory prospects in two
geographical areas.
Green River Basin. The Horsethief Canyon Prospect is a Frontier sandstone
natural gas exploration prospect on the eastern flank of the Rock Springs Uplift
of the Green River Basin in southwestern Wyoming. There are a number of gas
fields that produce from the Frontier formation in the vicinity of this
prospect. The Marianne Field, located 4 miles to the south, provided the analogy
for the Horsethief Canyon Prospect. The average well in the Marianne Field had
an initial production rate of 1640 MCFD with an ultimate recovery of 2.47
billion cubic feet of gas.
The primary formations of interest in the Horsethief Canyon Prospect are
the Second and Third Frontier sands at a depth of approximately 5500 feet. The
Second Frontier in the prospect area has two zones which are present over a
significant portion of the leasehold which are referred to as the "2D" and "2E"
zones. These sands are present in four nonproducing wells drilled on the
leasehold acreage in the 1970s and early 1980s. Based on log calculations of
these wells and production tests on one of these wells, the Company believes
this formation will yield commercial quantities of gas, using modern completion
and production techniques. The Third Frontier formation is also considered to be
potentially productive in the prospect area based on log and formation tests of
these wells.
In October 1998, the Company entered into an agreement with Fancher
Resources, LLC, in which the Company acquired a twenty percent (20%) working
interest in approximately 3,525 acres including seismic options, farmins and
trades, hereinafter referred to as the Horsethief Canyon Prospect. Subsequently,
a 5,760 acre Federal Exploratory Unit was formed and a 3D Seismic exploration
program was completed. The Company then participated in the drilling of the H.C.
Federal #30-12, centrally located in the prospect acreage. The well was
completed as an apparent oil and natural gas producer in the 2D and 2E zones of
the Second Frontier formation and is awaiting the installation of surface
facilities and pipeline connection. The drilling confirmed the results of the
3-D Seismic and analysis of the older wells in the area. Production is expected
to begin in the summer of 1999. A reserve study prepared by an independent
petroleum engineer, projected this well to produce 1.2 BCF of natural gas and
60,000 bbls of oil over its lifetime.
Presently, there are two proposed development locations to the west of the
discovery well which are expected to find similar sands in a structurally higher
position as encountered in the initial well, based on subsurface geology and the
3-D Seismic survey. These locations were classified as "probable" in the above
reserve study. Drilling is scheduled to commence in May or June 1999. Fancher
Oil LLC ("Fancher") is the designated Operator of this project and has between
27.5% and 55% working interest in the Federal Exploratory Unit. The Company's
working interest in these development wells will range from 10% to 20%,
depending on the location of the well. The Company has the right, but not the
obligation, to participate for up to 20% of Fancher's working interest in any
additional acreage or farmins that may be acquired by Fancher in the area of
mutual interest (AMI) established for this prospect.
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Sacramento Basin. The Sacramento Basin is an asymmetrical trough roughly
160 miles long, 50 miles wide and up to 30,000 feet deep. Sacramento, California
is located in the southern portion of the basin. The majority of the reserves in
the basin are natural gas which occurs in sandstone reservoirs of Late
Cretaceous, Paleocene and Eocene geologic ages. The productive sands are very
porous and permeable, ranging in depth from 2000 to 8000 feet. It is generally
assumed that the gas was generated from deeply buried Cretaceous shales during
the early to mid Tertiary period when such shales reached depths of 12,000' or
greater. Over time the gas migrated upward along geologic structures through
faults and continuous sands where porosity and permeability allowed such
migration. Most reservoirs appear to be water driven and are capable of
producing at relatively high rates until the water production becomes excessive,
resulting in termination of production of natural gas.
The primary formations of interest in the Fiji and Bali Prospects include
the Winters formation, the deepest and least explored, which ranges in depth
from 6,000 to 8,000 feet. The Starkey formation is immediately above the Winters
formation at depths ranging from 4,000 to 6,000 feet. The Mokelumme formation at
a depth of 3,000 to 4,000 feet and the Domengine formation from 2,000 to 3,000
feet are the other areas of interest.
In August 1997, the Company entered into an agreement with George H.
Fancher Jr. pursuant to which the Company agreed to acquire Mr. Fancher's
undivided 25% working interest in two exploratory gas prospects in the
Sacramento Basin of central California. The Company completed this transaction
in early November 1997 at which time Mr. Fancher assigned to the Company his
interest in two Participation Agreements with Slawson Exploration Company, Inc.
(the "Operator"), an unaffiliated independent oil and gas producing company. See
"Certain Relationships and Related Party Transactions." Mr. Fancher reserved a
0.625% net overriding royalty interest in the properties conveyed to the
Company. The Operator has a 11.5% working interest in both prospects and also
holds a 3.5% overriding royalty interest in any properties acquired in the AMI
(as described below). Four nonaffiliated independent oil and natural gas
producing entities hold the balance of the working interest in the two
prospects.
Under the Participation Agreements, the Company is entitled to receive a
25% net working interest (approximately a 18.75% net revenue interest) in oil
and natural gas leases and other property interests obtained by the Operator in
two prospects, designated the "Fiji" prospect and the "Bali" prospect, included
in an area of mutual interest defined in each Participation Agreement ("AMI").
The two AMIs total approximately 70 square miles and the Operator has obtained
oil and gas leases or lease options totaling approximately 30,000 net acres on
the two prospects. The Operator may continue to acquire additional lease acreage
in the AMI. The Company is obligated to pay 33.75% of leasehold acquisition
costs, oil and gas lease rentals and renewals, and costs incurred in connection
with acquisition of 3-D Seismic data within the two AMI's surrounding the two
prospects, for the Company's 25% working interest in the prospects. Each of the
other four working interest owners (other than the Operator) also is required to
pay a portion of expenses larger than its working interest. Through December 31,
1998 the Operator had incurred approximately $3.7 million for land acquisition
and 3-D Seismic data expenses, of which the Company and its predecessor had paid
approximately $1.25 million.
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The Operator holds title to all leasehold agreements, including oil and gas
leases, farmin agreements or other leasehold acquisitions, beneficially for the
Company and other participants in the prospects until such time as production is
established. Therefore the Company does not anticipate that it will be a record
holder of most of the acreage in which it holds an undivided beneficial
interest. The Operator is also entitled to an additional fee from the Company of
$2,500 per well commenced in either prospect. The Company is entitled, at its
sole election, to decline to participate in any particular well proposed to be
drilled by the Operator. If the Company should elect not to participate in a
proposed well, it shall forfeit all of its interest in the leasehold and any
agreements relating to the lands within in the revenue sharing unit for the
proposed well. Once the land acquisition and 3-D Seismic acquisition is
completed, the Operator will operate the exploration, development and
exploitation activities under the terms of a standard Operating Agreement. The
Company will generally be obligated to pay its portion of the expenditures
incurred by the Operator in operating activities, including drilling expenses
and similar expenditures and will be entitled to receive approximately 18.75%
(the net revenue interest) of any production which might be obtained from the
prospects (after provisions for land owner and overriding royalties).
Title to Properties
The Company has the right to acquire from the Operator satisfactory title
to all interest in the two prospects where it holds an interest in accordance
with standards generally accepted in the oil and natural gas industry. The
Company's properties will be subject to customary royalty interests, liens
incident to operating agreements, liens for current taxes and other burdens
which the Company believes do not materially interfere with the use of or affect
the value of such properties. The remaining acreage is held by lease rentals and
similar provisions and requires production in paying quantities prior to
expiration of various time periods to avoid lease termination.
Current Operations
The Company plans to continue to participate in the development of the
Horsethief Canyon Prospect located in Sweetwater County, Wyoming. Two
development wells will be drilled in May or June of 1999 to confirm the results
from the discovery well that was drilled and completed in December 1998. The
well is currently shut-in pending connection to a natural gas pipeline that is
located approximately four (4) miles to the west of the well location.
Connection to the pipeline probably will not occur until after the drilling and
completion of the two development wells.
In addition, the Company has the right to participate in three additional
prospects that Fancher Resources, LLC has developed in the vicinity of the
Horsethief Canyon Prospect that could result in the drilling of three additional
exploratory wells this year. These prospects are referred to as the Northeast
Marianne, Southwest Marianne and Masterson Prospects. The Company has the right,
but not the obligation, to participate for up to 20% of Fancher Resources, LLC's
interest in these prospects, including acreage, farmins or trades. The primary
objective of these prospects are the Second and Third Frontier sands with the
Muddy, Dakota and Lakota formations as secondary objectives. Participation by
the Company will depend upon the Company's available capital resources and
drilling success in the initial wells.
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The Company intends to concentrate its activities to the drilling and
acquisition of gas reserves primarily in the Green River Basin of southwestern
Wyoming. The Company will actively seek opportunities that can provide long
term, good quality reserves using technology to lower the risk and improve the
recovery. There are no plans to participate in drilling any additional wells in
the California prospects.
Acreage
The following table sets forth, as of December 31, 1998, the gross and net
acres of oil and natural gas leases which the Company beneficially holds or has
the right to acquire.
<TABLE>
<CAPTION>
Prospect Area Developed Undeveloped
- ------------- ------------------------ ------------------------
Gross Net Gross Net
----- --- ----- ---
<S> <C> <C> <C> <C>
Green River Basin:
Horsethief Prospect .......................... -- -- 3,525 705
Sacramento Basin:
Bali Prospect ................................ 160 40 11,389 2,847
Fiji Prospect ................................ - 0 - - 0 - 6,748 1,687
-------- -------- ------- -----
Total .................................. 160 40 18,137 4,534
</TABLE>
Reserves
As of December 31, 1998, the Company had interests in two productive wells
(.45 net wells) in two areas. The wells are operated by others under
arrangements standard in the industry. The following is information about the
reserves attributable to the Company's properties at December 31, 1998, as
estimated by an independent petroleum engineer.
<TABLE>
<CAPTION>
Discounted
Net Gas Net Oil Present Value
------- ------- -------------
Prospect (MMCF) (MBO) ($M)(1)
- --------
<S> <C> <C> <C>
Sacramento Basin ..................................... 380 (2) - 467.9
Green River Basin .................................... 187.3(3) 9.5 211.5
----- --- -----
Total ....................................... 567.3 9.5 $679.4
- ----------------
</TABLE>
(1) Present value of future net revenue, discounted at 10% before any related
income taxes. Assumed product prices used were prices in effect in the
areas at December 31, 1998 without escalation, net of heat content
adjustments, gathering costs and compression charges, or $2.07 per mcf in
the Sacramento Basin, $1.65 per mcf in the Green River Basin and $12 per
barrel for oil in Wyoming. All prices were assumed to remain flat over the
productive lives of the wells. Operating costs utilized were the actual
costs for the wells without escalation.
(2) Includes one well which commenced production in January 1999 and one proved
undeveloped (undrilled) well.
12
<PAGE>
(3) Includes one proved nonproducing well. Does not include two potential wells
assumed to be "probable" of future successful development.
Drilling Activity
The following table summarizes the Company's oil and gas drilling
activities for 1998.
<TABLE>
<CAPTION>
Productive Nonproductive
------------------------- --------------------------
Exploratory Wells Drilled Gross Wells Net Well Gross Wells Net Well
- ------------------------- ----------- -------- ---------- --------
<S> <C> <C> <C> <C>
Sacramento Basin, California.................. 1 .25 4 .8125
Green River Basin, Wyoming.................... 1 .20 - --
</TABLE>
ITEM 3. LEGAL PROCEEDINGS.
No legal proceedings to which the Company is a party were pending during
the reporting period, and the Company knows of no legal proceedings pending or
threatened or judgments entered against any director or officer of the Company
in his capacity as such.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company did not submit any matter to a vote of security holders through
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year covered by this report.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) PRINCIPAL MARKET OR MARKETS
The Company's common stock is not listed on any exchange and there is no
public trading market.
(b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK
As of December 31, 1998, the Company had 10,051,705 shares of common stock
outstanding, held by approximately 522 stockholders.
(c) DIVIDENDS
The Company has never declared or paid cash dividends on its common stock
and anticipates that future earnings, if any, will be retained for development
of its business.
13
<PAGE>
(d) RECENT SALES OF UNREGISTERED SECURITIES
The following is information with respect to all unregistered securities
sold by the Registrant within the past three years:
(i) On December 15, 1996 the Registrant issued 636,700 shares of Common
Stock, valued at $6,367 to an officer and director of the Registrant in
satisfaction of an obligation owed by the Registrant to the officer for expenses
of $6,367 advanced on behalf of the Registrant by such person. The issuance of
the shares was exempt from registration under Section 4(2) of the Securities
Act, as the person to whom the shares were issued, the President and a director
of the Registrant, had full knowledge of the business and affairs of the
Registrant, certificates representing the shares were marked with a restrictive
legend and the shares were taken for investment.
(ii) On June 2, 1997 the Registrant issued 2,500,000 shares of its Common
Stock and 2,500,000 stock purchase warrants to eight non-U.S. citizens for
$500,000 in a private transaction. Each of the warrants entitles the holder to
purchase one additional share of Common Stock of the Registrant at an exercise
price of $0.20 per share on or before June 2, 1998. No underwriter was involved
in the transaction and there were no underwriting discounts or commissions. The
issuance of the securities was exempt from registration under Rule 504 adopted
under Regulation D of the Securities Act. Form D was filed by the Registrant.
(iii) On August 29, 1997 the Registrant issued 2,250,000 shares of its
Common Stock to George H. Fancher Jr. in connection with the acquisition by the
Registrant of oil and gas properties. Upon issuance of the shares, certificates
representing the shares were delivered to an escrow agent pending completion of
the acquisition transaction. The acquisition transaction was completed on or
about November 11, 1997 at which time the shares were delivered to Mr. Fancher.
In the transaction, the Registrant received an assignment of Mr. Fancher's
undivided interest in two natural gas exploration and development prospects
located in the southern part of the Sacramento Basin in California. The
Registrant paid $907,951 in cash and issued the 2,250,000 shares of Common
Stock, valued at $300,000, for the properties. The total of the cash and the
stock is intended to be equal to Mr. Fancher's cost in acquiring and developing
the property prior to transfer to the Registrant. No underwriter was involved in
the transaction. The issuance of the securities to Mr. Fancher was exempt under
Section 4(2) of the Securities Act. Mr. Fancher acquired the securities for
investment, certificates representing the securities were marked with a
restrictive legend and stop transfer instructions were placed with the
Registrant's stock transfer agent.
(iv) On September 15, 1997 the Registrant issued 250,000 shares of its
Common Stock to six persons for services valued by the Registrant at $50,000. Of
the six persons, one is a Canadian attorney who received 25,000 shares for
service as a director of the Registrant and for preparation of documentation for
the Registrant in connection with the acquisition of oil and gas properties and
advise to the officers concerning certain aspects of the acquisition. A second
person, also a director at the time of issuance of the shares, was also the
Secretary and Treasurer of the Registrant and received 50,000 shares. He
provided financial and accounting services to the Registrant and maintained its
14
<PAGE>
books and records. Two of the persons, each of whom received 50,000 shares, have
substantial experience in the oil and natural gas business and served as
consultants to the Registrant in connection with the acquisition of the natural
gas exploration properties. They reviewed in detail the geologic and related
data available concerning the properties and advised the officers concerning the
advisability of the acquisition. A third consultant also received 50,000 shares,
and agreed in August 1997 to become a director of the Registrant at the time
that the acquisition of the oil and gas properties was completed, he assisted
the Registrant to prepare and document its financing and exploration plan and to
evaluate and budget the plan of development of the natural gas exploration
properties. Of the three consultants, two became directors in November 1997 and
the third agreed to provide ongoing consulting services to the Registrant. The
sixth person, who received 25,000 shares, is an employee of a business owned by
the President of the Registrant and an administrative assistant to the
President. This person provided office, administrative and stenographic services
to the Registrant. Each of the persons to whom the shares were issued had full
knowledge of the business and affairs of the Registrant, each signed a written
investment letter which acknowledged the receipt of information concerning the
Registrant and each agreed to hold the shares issued for investment purposes,
the certificates representing the shares each bear a restrictive legend and stop
transfer instructions were entered with the Registrant's stock transfer agent.
No underwriter was involved in the transactions. Based on the foregoing facts,
the issuance of the securities was exempt from registration pursuant to Section
4(2) of the Securities Act and/or Rule 506 adopted thereunder.
(v) On October 31, 1997 the Registrant issued 2,000,000 shares of its
Common Stock and warrants to purchase 1,000,000 shares of Common Stock to 10
non-U.S. citizens for $1,000,000. Each of the warrants entitles the holder to
purchase one additional share of Common Stock at an exercise price of $0.60 per
share on or before October 31, 1998. The Registrant issued cash finder's fees
totaling $45,000 and issued warrants entitling the holders to purchase up to
180,000 shares of Common Stock at $0.50 per share to three nonaffiliated,
non-U.S. citizen finders in connection with the transaction. The Registrant's
President, William E. Grafham, participated in the private placement and
purchased 200,000 shares and 100,000 warrants for $100,000. The issuance of the
securities was exempt from registration pursuant to Regulation S adopted under
the Securities Act. Each of the purchasers agreed that no sale of any of the
securities would be made to any U.S. Person, as defined in Regulation S, except
in compliance with the Securities Act.
(vi) In September 1998, the Registrant issued 2,065,000 shares of its
Common Stock to eight persons upon exercise of outstanding warrants originally
issued June 2, 1997 (see Item 26(b) above). The warrants were exercised at $0.20
per share for total proceeds of $413,000. 435,000 unexercised warrants expired
at the end of August 1998. No underwriter was involved in the transaction and
there were not underwriting discounts or commissions. The issuance of the
securities was exempt from registration under Section 4(2) of the Securities
Act. Each of the persons exercising warrants acquired the securities for
investment, certificates representing the securities were marked with a
restrictive legend and stop transfer instructions were placed with the
Registrant's stock transfer agent.
15
<PAGE>
(vii) Effective July 1, 1998, the Registrant issued 215,000 shares of its
Common Stock to four officers and directors of the Registrant in consideration
for services, valued at $43,000, provided to the Registrant through June 30,
1998. No underwriter was involved in the transaction. The issuance of securities
to the individuals were exempt under Section 4(2) of the Securities Act. Mr.
Fancher acquired the securities for investment, certificates representing the
securities were marked with a restrictive legend and stop transfer instructions
were placed with the Registrant's stock transfer agent.
(e) PROCEEDS FROM SALE OF REGISTERED SECURITIES
In 1998 the Company registered 3,000,000 shares of common stock for a
contemplated public offering. None of the registered shares were sold and the
Company received no proceeds from such offering.
(f) THE SECURITIES ENFORCEMENT AND PENNY STOCK REFORM ACT OF 1990
The Securities Enforcement and Penny Stock Reform Act of 1990 requires
additional disclosure and documentation related to the market for penny stock
and for trades in any stock defined as a penny stock. Unless the Company can
acquire substantial assets and trade at over $5.00 per share on the bid, it is
more likely than not that the Company's securities, for some period of time,
would be defined under that Act as a "penny stock." As a result, those who trade
in the Company's securities may be required to provide additional information
related to their fitness to trade the Company's shares. Also, there is the
requirement of a broker-dealer, prior to a transaction in a penny stock, to
deliver a standardized risk disclosure document that provides information about
penny stocks and the risks in the penny stock market. Further, a broker-dealer
must provide the customer with current bid and offer quotations for the penny
stock, the compensation of the broker-dealer and its salesperson in the
transaction, and monthly account statements showing the market value of each
penny stock held in the customer's account. These requirements present a
substantial burden on any person or brokerage firm who plans to trade the
Company's securities and would thereby make it unlikely that any liquid trading
market would ever result in the Company's securities while the provisions of
this Act might be applicable to those securities.
(g) BLUE SKY COMPLIANCE
The trading of penny stock companies may be restricted by the securities
laws ("Blue Sky" laws) of the several states. Management is aware that a number
of states currently prohibit the unrestricted trading of penny stock companies
absent the availability of exemptions, which are in the discretion of the
states' securities administrators. The effect of these states' laws would be to
limit the trading market, if any, for the shares of the Company and to make
resale of shares acquired by investors more difficult.
16
<PAGE>
ITEM 6. MANAGEMENT'S PLAN OF OPERATION
In the following discussion we are providing an analysis of our financial
condition and the Plan of Operation during the next year. This discussion should
be read in conjunction with our financial statements and the notes thereto.
Certain matters discussed below are based on potential future circumstances and
developments which we anticipate or expect, but which cannot be assured. Such
forward-looking statements include, but are not limited to, our plans to conduct
drilling operations, trends in the results of our operations, anticipated rates
of production, natural gas and oil prices, operating expenses and our
anticipated capital requirements and capital resources. The actual results which
we achieve in our operations could differ materially from the matters discussed
in the forward-look statements.
We have not generated revenue in either of the last two fiscal years. We
plan to generate revenue, commencing in the first quarter of 1999, when we begin
to sell natural gas produced from the first of two successful exploratory wells
which we drilled in 1998. The producing natural gas well in the Bali prospect in
the Sacramental Basin of central California and our interest in the surrounding
unexplored acreage is being held for sale. Pending any sale of those properties,
we will continue to receive revenue from production from this well. The
successful well in the Horsethief Canyon prospect is not expected to begin
producing natural gas and oil until the summer of 1999, assuming that the two
additional wells to be drilled on the prospect have been completed by that time.
In 1998 we did additional geological and geophysical testing and
participated in drilling three unsuccessful exploratory wells on our Fiji
prospect for a net cost of approximately $244,000. Based on the results of these
three unsuccessful wells, at the end of 1998 we elected to discontinue further
drilling.
Also in 1998 we participated in drilling an unsuccessful exploratory well
on the Bali prospect, in which we had a 6.25% working interest, resulting in dry
hole costs of approximately $12,000. A second exploratory well in which we hold
a 25% working interest was drilled and completed as a successful natural gas
well. As stated above, production from this well began in the first quarter of
1999. We expended approximately $89,000 in drilling and completion costs for the
well. Because of the limited drilling success on the Bali prospect, we decided
not to participate in drilling any additional wells and to attempt to sell our
interests in this prospect and in the nearby Fiji prospect.
On October 1, 1998, we entered into a participation agreement with Fancher
Resources, LLC under which we acquired a 20% working interest in the Horsethief
Canyon prospect. We paid approximately $131,000 representing our agreed share of
acquisition and 3-D Seismic evaluation expenses incurred in assembling the
prospect. We participated in drilling the initial well on this prospect and
incurred approximately $86,000 in drilling and completion costs. As stated
above, we anticipate at least two and as many as 17 additional wells may be
drilled on the prospect, of which at least two will be drilled in 1999. Our
anticipated drilling and completion expenses on the next two wells is
17
<PAGE>
anticipated to be approximately $160,000. We also have the option to acquire a
20% working interest in three additional exploratory natural gas drilling
prospects generated by Fancher Resources, LLC near the Horsethief Canyon
prospect. Our participation in drilling those prospects will be determined by
availability of capital resources.
Because we decided to discontinue further exploration of our Bali and Fiji
prospects due to the nondiscovery of proven reserves, we took a non-cash
impairment charge totaling approximately $1.25 million at the end of 1998. As a
result of this charge, the book value of our oil and natural gas properties was
reduced to the approximate amount of the present value of the oil and natural
gas reserves on these properties.
We estimate that general and administrative expense will be about $150,000
in 1999. Other capital costs associated with participation in acquiring,
exploring and drilling of the Horsethief Canyon and nearby prospects will be at
least $250,000 and could be as much as $700,000, depending on such factors as
the success of initial drilling efforts, decisions by the Operator to conduct
additional exploratory drilling and related factors. In 1998 we incurred general
and administrative expenses of approximately $199,000 which included non-cash
equity compensation to officers and directors of $43,000 and approximately
$57,000 for deferred offering costs related to the offering described below
which we charged to expense at the end of 1998. We also expended a total of
approximately $673,000 in acquisition, exploration and drilling expenses on the
Fiji, Bali and Horsethief Canyon prospects as described above.
At December 31, 1998 we had approximately $15,000 in cash, compared to
$425,000 at December 31, 1997. In September 1998 we received $413,000 in
proceeds from the exercise of 2,065,000 warrants to purchase common stock at
$0.20 per share held by eight warrant holders. Warrants to purchase an
additional 435,000 shares of common stock were not exercised and expired. We
anticipate that our revenue from the production of the one producing natural gas
well on the Bali prospect will be approximately $7,500 to $9,000 monthly during
1999, depending upon the production rates and applicable natural gas prices. We
have not raised any additional cash from any source. We will require additional
capital resources in order for us to complete the 1999 drilling and exploration
activities described above and to pay our ongoing operating expenses.
In May 1998 we commenced a public offering in which we offered up to a
maximum of 3,000,000 common shares at $1.00 per share. No shares were sold and
expenses incurred in connection with the offering during 1998 were expensed at
year end. In January 1999, we decided to revise the offering and reduce the
offering price to $0.30 per share, which offering is expected to recommence
during the second quarter of 1999. We also extended to July 31, 1999 the
expiration date for outstanding warrants entitling the holders to purchase up to
1,180,000 shares of common stock. We plan to reduce the exercise price for these
warrants to $0.30 per share. We are anticipating that at least a portion of
these outstanding warrants will be exercised by the warrant holders. If all the
warrants are exercised, of which there is no assurance, we would receive
approximately $354,000 by July 31, 1999, the date when the warrants will expire
unless they are again extended. If all the warrants should be exercised, the
proceeds to the Company would enable the Company to pay its anticipated
operating expenses and to participate in the drilling of at least two
exploratory wells in 1999. If the Company amends the terms of its public
offering and completes the sale of at least 400,000 shares, the anticipated
18
<PAGE>
minimum amount of the offering, the Company would receive gross proceeds of
approximately $120,000. We can make no assurances as to whether any of the
warrants will be exercised or whether we will be able to successfully complete
any portion of our anticipated offering.
Unless a substantial portion of the outstanding warrants are exercised or
at least the minimum offering in the anticipated offering is completed or we
sell our interests in the Bali and Fiji prospects, we do not believe that our
available cash will be sufficient to pay all of our anticipated general and
administrative expenses, capital lease costs and anticipated drilling expenses
over the next 12 months. As a result we may be unable to participate in drilling
any additional exploratory or development wells on the Horsethief Canyon
prospect or other nearby prospects. If we are able to raise additional capital
we will use the proceeds to pay our ongoing operating expenses and to
participate in additional drilling. To fund the anticipated near term capital
shortfall, we may accept loans from management or other affiliates. Assuming
sufficient capital resources become available, we will continue to seek to
acquire interests in other oil or natural gas properties.
We do not have any employees and instead we use consultants for matters
pertaining to drilling, property evaluations and administration. We do not
presently contemplate hiring employees during the next 12 months.
Year 2000 Considerations. We have considered the impact of Year 2000 issues
on our computer system and applications and developed a remediation plan.
Because we are a small company and use computer systems and applications owned
by our consultants, we do not anticipate that we will incur any material costs
in remediating potential Year 2000 problems. We did not incur any expenses for
such purposes in 1998. The Company's consultants have confirmed to the Company
that Year 2000 issues will be detected and remediated by the middle of 1999. We
are unable to assess whether Year 2000 issues may affect others in the oil and
gas industry with whom we may have operating agreements or other arrangements,
such as oil or gas purchasers, pipeline operators, drilling contractors,
governmental agencies or others. Problems experienced by such other entities
could adversely affect our business.
ITEM 7. FINANCIAL STATEMENTS.
The complete financial statements are included at Item 13 herein.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Company had no disagreements on accounting and financial disclosures
with its independent auditors during the reporting period.
19
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The following table sets forth the names and ages of the current directors
and executive officers of the Company, the principal offices and positions with
the Company held by each person and the date such person became a director or
executive officer of the Company. Each director has served since 1997 except Mr.
Cloudy, who became a director April 9, 1998. Each serves until the next annual
meeting of stockholders.
<TABLE>
<CAPTION>
Names of Executive
Officers and Directors Age Position
- ---------------------- --- --------
<S> <C> <C>
George H. Fancher Jr. .................. 59 Chairman of the Board, Chief Operating
Officer and Director
William E. Grafham...................... 61 President, Chief Executive Officer and Director
Jeffrey J. Scott........................ 36 Vice President and Director
Rex L. Utsler .......................... 53 Vice President and Director
George A. Cloudy ....................... 64 Director
Albert A. Golusin....................... 44 Secretary and Treasurer
</TABLE>
George H. Fancher Jr. Mr. Fancher has been a self employed independent oil
producer, operator and consultant in the Rocky Mountain Area since 1969, doing
business as Fancher Oil Company since 1980. He was employed by Chevron as a
Petroleum Engineer, in Casper, Wyoming, and Denver, Colorado from 1962 until
1966. In 1966, he joined Ball Brothers Research Corporation in Boulder,
Colorado, followed by two years with an independent oil company before forming
Smith-Fancher, independent producers in the Rocky Mountain and Mid-Continent
regions. In 1980, he formed Fancher Oil Company and has operated as a sole
proprietor since that time.
George Fancher has been a director of the Independent Petroleum Association
of America (IPAA), the Independent Petroleum Association of Mountain States
(IPAMS) and the Rocky Mountain Oil and Gas Association (RMOGA). He is a
registered Petroleum Engineer and a member of the Society of Petroleum
Engineers. He has served on the Crude Oil Policy Committee, Improved Oil
Recovery Task Force Committee, and Public Lands Committee of the IPAA. He is
also a member of the Liaison Committee of Cooperating Oil and Gas Associations,
and currently is the past Chairman of the Rocky Mountain Producers Advisory
Group and was on the Board of Directors of the Petroleum Technology Transfer
Council (PTTC).
20
<PAGE>
William E. Grafham. Mr. Grafham has an investment banking background having
worked for two major national Canadian Brokerage houses from 1963 until 1977. In
1977 he established operating companies representing West German partnerships
investing in natural resources. Offices were set up in Calgary, Alberta; Denver,
Colorado; and Vancouver, BC. The Calgary and Vancouver operating companies were
eventually merged into larger entities; while the main assets of the Denver
operation were sold in 1988.
Since 1988 Mr. Grafham, a private investor, has participated in the
formation of a number of businesses investing in technology, oil and gas,
precious metals and mining, and real estate. Most of these investments have
resulted in the companies going public, with involvements in a number of
countries. Mr. Grafham has been active as a director in various companies during
the last five years. He is currently a director or officer of the following
publicly-traded companies which trade on Canadian exchanges:
Company Public Exchange Type of Business
- ------- --------------- ----------------
Jerez Energy International, Inc. Alberta Stock Exchange Oil and gas
Walking Bear Resources Inc. Alberta Stock Exchange Oil and gas
Tellis Gold Mining Company Inc. Vancouver Stock Exchange Technology
Jeffrey J. Scott. Mr. Scott is currently President and Chief Operating
Officer of Calgary-based Jerez Energy International Inc. Jerez is a Canadian
international oil and gas exploration and development company focused in West
Africa. He has held this position since May 1995. Mr. Scott is also Vice
President of Operations of Postell Energy Co. Ltd., a privately held Canadian
oil and gas company. He has held this position since 1986. Mr. Scott is a
graduate of the University of Calgary and has been active in the oil and gas
industry since 1979 and has experience in the areas of production, operations
and management. He is also a director of Petro Well Energy Services, Inc., a
public company which owns oil service rigs.
Rex L. Utsler. Mr. Utsler has over twenty years of executive management
experience in the energy and retail services industries. From 1971 to 1980, Mr.
Utsler was employed by Western Crude Oil Inc., a large independent crude oil
transportation and marketing company in various senior management and executive
positions. In 1980, he founded Bountiful Corporation, a company that specialized
in the purchasing, transportation and marketing of crude oil and served as
president and chief executive officer from 1980 to 1988. Mr. Utsler has been
President of Grease Monkey Holding Corporation, a public company specializing in
automotive services, since September 1998. Mr. Utsler also served as President
and Chief Executive Officer of Grease Monkey Holding Corporation from 1991 to
1997.
George A. Cloudy. Mr. Cloudy has been engaged in the oil exploration
business since 1956. After graduating from Montana School of Mines with an
engineering geology degree, petroleum option, he worked for G.S.I., a division
of Texas Instruments as a geophysicist from 1956 until 1965.
21
<PAGE>
In 1965 he was a co-founder of Digicon Inc., now Veritas DGC. From 1965 to
1994 he served in various capacities as Vice President, North and South America;
Executive Vice President, Europe, Africa and the Far East; President, Digicon
Geophysical Corp., and Vice President of Research. He was a director from
1965-1991. He served as chief geophysicist and exploration coordinator of Oil
Quest Inc. from 1995 to 1997. He is now an individual investor.
Mr. Cloudy is a member of the Society of Exploration Geophysicists, a
registered geologist (California) and a registered professional geophysicist,
Alberta, Canada (APEGGA).
Albert A. Golusin. Mr. Golusin has been a Certified Public Accountant since
1981. From 1985 to 1992, Mr. Golusin was the Controller of a public company
called N-W Group, Inc. which later became Glenayre Electronics. He was
responsible for assisting in the public reporting to regulatory agencies in the
United States and Canada for the company. From 1993 to the present, Mr. Golusin
has consulted to companies in the process of becoming publicly traded. He shares
an office with Arizona Corporate Management, Inc. in Scottsdale, Arizona.
Consultant
Adrian H. Goodisman. Mr. Goodisman has 13 years of exploration and
production experience primarily in the U.S. and Western Canada, as well as
international experience in the UK, Egypt, Australia and Japan. He is a
petroleum engineer and has gained technical excellence in field exploitation,
acquisition/divestment's, reserve determinations and economic evaluations. He
has a Bachelor of Science (honors) degree in mathematics from the University of
Salford, UK and a Master of Science degree in petroleum engineering from the
University of Texas at Austin. Mr. Goodisman is also actively involved with the
Society of Petroleum Engineers (SPE) and is presently on the SPE National
Membership Committee, and a director of the Gulf Coast (Houston) Section. For
the 1995/96 year, he served as Chairman of the Board of Directors for the SPE
Canadian Section.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934.
Not applicable.
ITEM 10. EXECUTIVE COMPENSATION.
The following table sets forth certain information concerning the
compensation paid by the Company for services rendered in all capacities to the
Company for the two fiscal years ended December 31, 1997 and 1998 (there was no
compensation in prior years) of the chief executive officer at December 31, 1998
and all officers and directors, as a group.
22
<PAGE>
<TABLE>
<CAPTION>
Summary Compensation Table
Long Term
Compensation
Annual Compensation -------------
------------------------------------- Securities
Name and Principal Other Annual Underlying All Other
Positions at 12/31/98 Salary Bonus Compensation Options Compensation
- --------------------- ------ ----- ------------ ------- ------------
<S> <C> <C> <C> <C> <C>
William E. Grafham, President
1997 ...................... - 0 - - 0 - - 0 - 200,000 None
1998 ...................... - 0 - - 0 - 10,000(1) -- None
All officers and directors,
as a group (five persons)
1997 ...................... $ 10,027(2) - 0 - $ 30,000(3) 800,000 - 0 -
1998 ...................... $ 30,000(2) - 0 - $ 43,000(4) 100,000 - 0 -
</TABLE>
- ------------------
(1) Includes 50,000 shares of common stock, valued at $10,000, issued for
services as an officer and director.
(2) Paid to Albert A. Golusin, Secretary, for services as a consultant.
(3) Includes 150,000 shares of common stock, valued at $30,000, issued to
three persons for services as officers, directors and representatives of the
Company.
(4) Includes 215,000 shares of common stock, valued at $43,000, issued to
five persons for services as officers, directors and representatives of the
Company.
The Company has an agreement to pay Albert A. Golusin a monthly retainer of
$2,500, as a consultant, for part time accounting, financial reporting and
corporate secretarial services. In addition, Mr. Golusin received 15,000 shares
of Common stock on July 1, 1998 for services he provided to the Company through
June 30, 1998.
Value of Options at December 31, 1998
<TABLE>
<CAPTION>
Aggregate Fiscal Year End Option Values
-------------------------------------------------------------
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Fiscal Year End at Fiscal Year End
Exercisable/Unexercisable Exercisable/Unexercisable(1)
--------------------------- ---------------------------
<S> <C> <C>
William E. Grafham............. 200,000/ -- $ -- / --
All officers and directors
as a group.................... 850,000/50,000 $ -- / --
- ----------------------
</TABLE>
(1) Because there is no trading market, the estimated value is based on the
last price paid for common stock of the Company of $0.20 of the Company's common
stock, less the exercise price of the options.
23
<PAGE>
Option Grants in the Last Two Fiscal Years
The Company granted options during 1997 and 1998 to the following officers
and directors:
<TABLE>
<CAPTION>
Percent of Total
Number of Shares Options Granted Exercise Price Expiration
Name Underlying Options During Year ($/sh) Date
- ---- ------------------ ------------- -------- -----
<S> <C> <C> <C> <C> <C>
1997:
William E. Grafham.............. 100,000(1) 12.3% $0.22 07/02/02
President 100,000(2) 12.3% $0.35 10/30/07
George H. Fancher Jr. .......... 250,000(2) 30.1% $0.35 10/30/07
Rex L. Utsler .................. 100,000 12.3% $0.35 10/30/07
Jeffrey J. Scott ............... 150,000 18.5% $0.35 10/30/07
Albert A. Golusin .............. 30,000(1) 3.7% $0.20 07/02/07
70,000 8.6% $0.35 10/30/07
1998:
George A. Cloudy ............... 100,000(1) 100% $0.50 04/30/08
- ----------------------
</TABLE>
(1) These options become exercisable as to one-half of the shares six
months from the date of grant (July 1, 1997 for Messrs. Grafham and Golusin, and
April 9, 1998 for Mr. Cloudy) and as to the balance, six months thereafter. All
other options are presently exercisable.
(2) The options are nonstatutory ("nonqualified") options. All other
options are intended to be incentive stock options under Section 422A of the
Internal Revenue Code of 1986.
Stock Option Plan
The Company has adopted its 1997 Statutory and Non-Statutory Incentive
Stock Option Plan ("Plan") which authorizes the Company to grant incentive stock
options within the meaning of Section 422A of the Internal Revenue Code of 1986,
as amended, and to grant nonstatutory stock options. The Plan relates to a total
of 1,000,000 shares of Common stock. Options relating to 910,000 shares have
been issued and are outstanding and all are presently exercisable. The options
are exercisable at $0.20 per share for 30,000 shares, $0.22 per share for
100,000 shares, $0.35 per share for 680,000 shares and $0.50 per share for
options to purchase 100,000 shares granted to George A. Cloudy in April 1998 at
the time he joined the Board of Directors. The outstanding options must be
exercised within 10 years from the date of grant and no later than three months
after termination of employment or service as a director, except that any
optionee who is unable to continue employment or service as a director due to
total and permanent disability may exercise such options within one year of
termination and the options of an optionee who is employed or disabled and who
dies must be exercised within one year after the date of death.
The Plan requires that the exercise prices of options granted must be at
least equal to the fair market value of a share of Common stock on the date of
grant, provided that for incentive options if an employee owns more than 10% of
the Company's outstanding Common stock then the exercise price of an incentive
option must be at least 110% of the fair market value of a share of the
Company's Common stock on the date of grant, and the maximum term of such option
24
<PAGE>
may be no longer than five years. The aggregate fair market value of Common
stock, determined at the time the option is granted, for which incentive stock
options become exercisable by an employee during any calendar year is limited to
$100,000.
The Plan is to be administered by the Company's Board of Directors or a
committee thereof which determines the terms of options granted, including the
exercise price, the number of shares of Common stock subject to the option, and
the terms and conditions of exercise. No option granted under the Plan is
transferrable by the optionee other than by will or the laws of descent and
distribution, and each option is exercisable during the lifetime of the optionee
only by such optionee.
Compensation of Directors
The Company does not pay cash compensation to directors. Four of the
directors of the Company were issued 50,000 shares of restricted Common stock of
the Company on July 1, 1998 as compensation for services furnished to the
Company as an officer or director through June 30, 1998. The Company has granted
each of the four directors options to purchase shares of Common stock at $0.35
per share, as shown in the table above. The options were granted under the Plan
and must be exercised within 10 years from the date of grant. George A. Cloudy
received an option to purchase up to 100,000 shares at $0.50 per share in April
1998. The option became exercisable as to half of the shares six months after
the date of grant and the balance will become exercisable one year from the date
of grant.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth, as of March 1, 1999, certain information
with respect to the beneficial ownership of the Company's Common stock by (i)
each director and officer of the Company, (ii) each person known to the Company
to be the beneficial owner of 5% or more of the outstanding shares of Common
stock, with such person's address, and (iii) all of the directors and executive
officers as a group. Unless otherwise indicated, the person or entity listed in
the table is the beneficial owner of the shares and has sole voting and
investment power with respect to the shares indicated.
<TABLE>
<CAPTION>
Shares beneficially
owned prior to offering(1)
Name of Beneficial Owner ---------------------------
or Name of Officer or Director Number Percent
- ------------------------------ ------ -------
<S> <C> <C>
William E. Grafham, Director................................ 943,568(2) 10.5%
Grandview Condominiums #412
Seven Mile Beach
Grand Cayman, BWI
George H. Fancher Jr., Director............................... 3,050,000(3) 35.2%
1801 Broadway, Suite 720
Denver, Colorado 80202
25
<PAGE>
<CAPTION>
Shares beneficially
owned prior to offering(1)
Name of Beneficial Owner ---------------------------
or Name of Officer or Director Number Percent
- ------------------------------ ------ -------
<S> <C> <C>
Rex L. Utsler, Director ...................................... 300,000(4) 4.4%
Jeffrey J. Scott, Director ................................... 250,000(5) 2.5%
George A. Cloudy, Director ................................... 100,000(6) --
Albert A. Golusin, Secretary and Treasurer ................... 215,000(7) 2.4%
David Grafham ................................................ 650,000 8.0%
1307 West 8th Avenue
Vancouver, B.C.
Canada V5H 3W4
Roger Duffield................................................ 400,000 5.0%
c/o Euro Bank Corporation
5th Floor, Anderson Square
Grand Cayman, BWI(8)
Euro Securities Ltd. ......................................... 650,000 8.0%
c/o Euro Bank Corporation
5th Floor, Anderson Square
Grand Cayman, BWI(8)
Linda Kemble ................................................. 650,000 8.0%
#59 Temple Hill Dr. N.E.
Calgary, Alberta
Canada T1Y 404
Don Stewart .................................................. 738,000(9) 9.0%
P. O. Box 245
Grand Cayman, BWI(8)
Susan Scott .................................................. 415,000(11) 5.2%
#2 2109 4th Avenue, N.W.
Calgary, Alberta, Canada T2N 0N6
Alex Whiteside................................................ 405,000(10) 5.1%
1530--1001 13 Avenue, S.W.
Calgary, Alberta, Canada T2R 0L5
All officers and directors as a group (6 persons) ............ 4,663,568(12) 49.1%
- ----------------------
</TABLE>
(1) All securities are owned directly and beneficially unless otherwise
noted. Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of Common stock subject to options and
warrants currently exercisable or exercisable within 60 days of March 1, 1999
26
<PAGE>
are deemed outstanding for computing the percentage of the person or entity
holding such securities but are not outstanding for computing the percentage of
any other person or entity.
(2) Includes 300,000 shares of Common stock underlying presently
exercisable options and warrants.
(3) Includes 250,000 shares underlying presently exercisable stock purchase
warrants and options. In addition, the Company will be required to issue and
deliver to Mr. Fancher an additional 500,000 shares of Common stock if the
Company receives gross revenue from its interest in the Bali and Fiji prospects
at least equal to all direct costs incurred in acquiring the prospects, and
drilling the wells, including cash amounts paid to Mr. Fancher at the time of
acquisition. See "Certain Transactions."
(4) Includes 200,000 shares of Common stock underlying presently
exercisable stock purchase options and warrants
(5) Includes presently exercisable options to purchase up to 150,000
shares.
(6) Includes 100,000 shares underlying presently exercisable stock purchase
warrants.
(7) Includes 100,000 shares of Common stock underlying presently
exercisable options and stock purchase warrants.
(8) Euro Securities Ltd. is controlled by Euro Bank, a bank in Georgetown,
Grand Cayman Island, British West Indies, of which Don Stewart is a director.
Mr. Stewart has no other relationship with, or control over, Euro Securities
Ltd.
(9) Includes 88,000 shares of Common stock underlying presently exercisable
stock purchase warrants.
(10) Includes 135,000 shares of Common stock underlying presently
exercisable stock purchase warrants.
(11) Includes 100,000 shares of Common stock underlying presently
exercisable stock purchase warrants.
(12) Includes 172,000 shares of Common stock underlying presently
exercisable stock purchase warrants.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
On October 31, 1997 the Company sold 2,000,000 shares for $1,000,000 and
paid finder's fees and related offering costs of $47,894 and issued warrants to
purchase an additional 1,180,000 shares on or before October 31, 1997 to 11
non-United States persons or entities pursuant to Regulation S adopted under the
Securities Act. William E. Grafham, the Company's President, a citizen of Canada
and a resident of Grand Cayman, BWI, purchased 200,000 shares and 100,000
warrants for $100,000. The shares are restricted from transfer except in
accordance with applicable United States' laws and the purchasers each agreed to
resell the securities to a "U.S. Person" as defined in Regulation S, only in
accordance with applicable laws. All of the Common stock and the shares
underlying the warrants, other than the shares and warrants held by Mr. Grafham,
have been registered for resale by the holders. The Company reduced the exercise
price for the warrants to $0.30 per share ($354,000 upon exercise of all
warrants) and extended the expiration to July 31, 1999.
On November 11, 1997 the Company completed the acquisition of a 25% working
interest in the Fiji and Bali natural gas exploration and development prospects
in California from George H. Fancher Jr., subject to a net .625% overriding
royalty interest retained by Mr. Fancher. The prospects together totaled over
30,000 acres and are located in the southern part of the Sacramento Basin. See
"Business--Principal Properties." The Company paid $907,951 in cash and issued
2,250,000 shares at a deemed value of $300,000 for the property. Mr. Fancher
acquired the interests in the properties early in 1997 and incurred
approximately $1,208,000 for acquisition of his interest in the properties and
payment of his portion of exploration and leasehold costs and expenses before
transfer to the Company. The Company also paid $6,247 to Mr. Fancher
representing interest on a portion of Mr. Fancher's cost between the time that
the agreement to acquire the properties was made and the date of completion of
27
<PAGE>
the transaction As additional consideration, the Company agreed to issue 500,000
additional restricted shares to Mr. Fancher if the gross revenue received by the
Company from the prospects is at least equal to all direct costs of the Company
associated with acquiring the interest in the prospects and exploration,
drilling and other related expenses by December 31, 1999. At December 31, 1997
the Company had incurred direct costs of approximately $1,275,000, including the
payments to Mr. Fancher. Prior to the acquisition, Mr. Grafham and consultants
retained by the Company reviewed the available geologic data on the properties
and negotiated the purchase price based on the perceived value of the properties
as assembled by the Operator, the acquisition and exploration expenditures on
the properties and the lack of a public market for the Company's shares. Mr.
Fancher agreed to become a director of the Company following completion of the
transaction.
The Company paid $8,000 in 1997 and $24,000 in 1998 to Arizona Corporate
Management, Inc., a corporation owned by William E. Grafham, as reimbursement
for office and related expenses and for rent. The Company has a month-to-month
agreement to pay $2,000 per month to the corporation for office space, use of
certain office equipment and for limited administrative services. The Company
also has an arrangement with George H. Fancher Jr., pursuant to which Fancher
Oil Company was paid $2,000 in 1997 and $24,000 in 1998 and will be paid $2,000
per month in the future for office facilities, use of certain office equipment
and limited administrative and technical support.
On July 1, 1998, the Company issued 215,000 shares to five officers,
directors and consultants for services rendered through June 30, 1998.
On an agreement dated October 1, 1998, the Board of Directors, with Mr.
Fancher abstaining, approved a transaction in which the Company acquired an
undivided 20% working interest (16% net revenue interest) in Fancher Resources,
LLC's approximately 3,525 acre Horsethief exploration prospect located in
Sweetwater County, in the Green River Basin of southwestern Wyoming. The Company
agreed to pay 24% of all costs incurred in acquiring the initial well and in
acquiring, processing and interpreting the 3-D Seismic data and drilling of the
initial well through the casing point for a 20% working interest, which was
equivalent to the rate paid by the nonaffiliated participate in the project.
Under the agreement the Company reimbursed Fancher Resources, LLC $131,000 as
acreage acquisition and seismic survey expenses and approximately $104,000 as
the Company's share of drilling and completion costs in the initial exploratory
well. Fancher Resources, LLC holds a 55% working interest in the prospect and
earns operating fees, standard in the area, from the other working interest
owners. The Company also has the right to participate on an equivalent basis in
four other exploratory oil and natural gas prospects being assembled by the
operator in the area near the Horsethief prospect.
On June 2, 1997 the Company sold 2,500,000 shares and warrants to purchase
an additional 2,500,000 shares at $0.20 per share for $500,000 to eight
purchasers in private transactions with nonUnited States residents. In August
1998, holders of 2,065,000 of the warrants exercised the warrants for $413,000
in proceeds, and 435,000 warrants expired unexercised.
28
<PAGE>
On December 1, 1996 Jean Boyd, then a director and an officer of the
Company, was issued 636,700 shares of Common stock at a deemed value of $0.001
per share in satisfaction of an obligation of $6,367 owed to her for Company
expenses advanced by her in previous years.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following financial information is filed as part of this report:
(1) Financial Statements:
Independent Auditor's Report ...................................... F-2
Balance Sheet December 31, 1998 ................................... F-3
Statements of Operations Years Ended December 31, 1997
and 1998 ..............................F-4
Statement of Stockholders' Equity Years Ended December 31,
1997 and 1998 .................................................. F-5
Statements of Cash Flows Years Ended December 31, 1997
and 1998 ................................................... F-6-F-7
Notes to Financial Statements ............................... F-8--F-19
(2) Schedules
Supplemental Disclosure of Cash Flow Information .................. F-7
Supplemental Schedule of Non-Cash Investing and
Financing Activities .............................................. F-7
(3) Exhibits. The following exhibits required by Item 601 to be filed
herewith are incorporated by reference to previously filed documents:
Exhibit No. Description and Method of Filing
---------- --------------------------------
(3.1) Restated Articles of Incorporation of Eastern Star Mining, Inc.,
as filed with the Nevada Secretary of State February 7, 1997.*
(3.2) Certificate of Amendment of Articles of Incorporation of Eastern
Star Mining, Inc. , as filed with the Nevada Secretary of State
May 19, 1997.*
(3.3) Certificate of Amendment of Articles of Incorporation of Eastern
Star Mining, Inc. , as filed with the Nevada Secretary of State
May 28, 1997.*
(3.4) Certificate of Amendment of Articles of Incorporation of Eastern
Star Holdings, Inc. , as filed with the Nevada Secretary of State
December 10, 1997.*
(3.5) Bylaws of Registrant adopted December 31, 1997.*
(10.1) Letter Agreement dated August 27, 1997 between Registrant and
George H. Fancher Jr. d/b/a Fancher Oil Company.*
29
<PAGE>
Exhibit No. Description and Method of Filing
---------- --------------------------------
(10.2) Agreement With Arizona Corporate Management, Inc. dated
November 1, 1998.*
(10.3) 1997 Incentive and Nonstatutory Stock Option Plan. *
(10.4) Letter regarding conflicts of interest dated March __, 1998
between Registrant and George H. Fancher Jr.*
(10.5) Form of Subscription Agreement for certain officers and
consultants.*
(10.6) Agreement with Albert Golusin.*
(10.7) Participation Agreement dated October 1, 1998 with Fancher
Resources, LLC.
(24) Power of Attorney.
(27) Financial Data Schedule.
- ------------------
* Incorporated by reference to Registration Statement No. 33-64448
on Form SB-2, which became effective May 14, 1998.
(b) Reports on Form 8-K. The Company filed no reports on Form 8-K during
the fiscal quarter ending December 31, 1998.
30
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Independent Auditor's Report ...................................... F-2
Balance Sheet
December 31, 1998 ........................................... F-3
Statements of Operations
Years Ended December 31, 1997 and 1998 .......................F-4
Statement of Stockholders' Equity
Years Ended December 31, 1997 and 1998 ...................... F-5
Statements of Cash Flows
Years Ended December 31, 1997 and 1998 ................ F-6 - F-7
Notes to Financial Statements .............................. F-8 - F-19
F-1
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To The Board of Directors and Stockholders FAN ENERGY INC.
We have audited the accompanying balance sheet of Fan Energy Inc. (a development
stage company) as of December 31, 1998 and the related statements of operations,
stockholders' equity and cash flows for the two years then ended and cumulative
amounts from January 1, 1997 to December 31, 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 audits 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 financial statements referred to above present fairly, in
all material respects, the financial position of Fan Energy Inc. as of December
31, 1998 and the results of its operations and its cash flows for the two years
then ended and cumulative amounts from January 1, 1997 to December 31, 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 losses from its initial
operations and has not earned revenues from its principal operations that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 2. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Wheeler Wasoff, P.C.
WHEELER WASOFF, P.C.
Denver, Colorado
March 10, 1999
F-2
<PAGE>
<TABLE>
<CAPTION>
FAN ENERGY INC.
(A Development Stage Company)
BALANCE SHEET
December 31, 1998
ASSETS
<S> <C>
CURRENT ASSET
Cash ..................................................................... $ 15,875
----------
Total Current Asset .................................................... 15,875
OIL AND GAS PROPERTIES (Note 3) ............................................ 690,584
----------
$ 706,459
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ......................................................... $ 1,736
----------
Total Current Liabilities .............................................. 1,736
----------
COMMITMENTS AND CONTINGENCIES (Note 3)
STOCKHOLDERS' EQUITY (Note 4)
Preferred stock, $.01 par value
Authorized - 5,000,000 shares
Issued - none ...................................................... --
Common stock, $.001 par value
Authorized - 95,000,000 shares
Issued and outstanding - 10,051,704 shares ......................... 10,052
Additional paid-in capital ............................................... 2,249,956
Deficit accumulated during the development stage ......................... (1,655,785)
Additional paid-in capital stock options ................................. 100,500
----------
704,723
----------
$ 706,459
==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
FAN ENERGY INC.
(A Development Stage Company)
STATEMENTS OF OPERATIONS
Years ended December 31, 1997 and 1998
Cumulative
Amounts from
Jan. 1, 1997 to
1997 1998 Dec. 31, 1998
---- ---- ---------------
<S> <C> <C> <C>
REVENUES .......................................... $ -- $ -- $ --
----------- ----------- -----------
OPERATING EXPENSES
General and administrative ...................... 192,985 198,851 391,836
Impairment of oil and gas properties ............ -- 1,257,702 1,257,702
Interest (Note 3) ............................... 6,247 -- 6,247
----------- ----------- -----------
199,232 1,456,553 1,655,785
----------- ----------- -----------
NET (LOSS) ........................................ $ (199,232) $(1,456,553) $(1,655,785)
=========== =========== ===========
NET (LOSS) PER COMMON SHARE - Basic
and Diluted .................................... $ (.07) $ (.17) $ (.29)
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING - Basic and Diluted ......... 3,011,287 8,567,537 5,789,412
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
FAN ENERGY INC.
(A Development Stage Company)
STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1997 and 1998
Deficit Additional
Accumulated Paid-In
Common Stock Additional During the Capital
---------------------- Paid-In Development Stock
Shares Amount Capital Stage Options
------ ------ ---------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1997 ................................... 771,704 $ 772 $ 503,876 $ (504,648) $ --
Reclassification of deficit pursuant to quasi
reorganization ......................................... -- -- (504,648) 504,648 --
Sale of common stock and warrants pursuant to
private placement, at $.20 per unit .................... 2,500,000 2,500 497,500 -- --
Cost of private placement offering ......................... -- -- (430) -- --
Issuance of common stock for services, valued at
$.20 per share ......................................... 250,000 250 49,750 -- --
Sale of common stock and warrants pursuant to
private placement, at $.50 per unit .................... 2,000,000 2,000 998,000 -- --
Costs of private placement offering ........................ -- -- (52,439) -- --
Issuance of common stock for property, valued at
$.133 per share ........................................ 2,250,000 2,250 297,750 -- --
Issuance of common stock warrants for offering costs
Issuance of stock options .................................. -- -- 4,545 -- --
Net (Loss) ................................................. -- -- 2,332 -- 100,500
-- -- -- (199,232) --
----------- ----------- ----------- ----------- ----------
Balance, December 31, 1997 ................................. 7,771,704 7,772 1,796,236 (199,232) 100,500
Issuance of common stock for services, valued at
$.20 per share ......................................... 215,000 215 42,785 -- --
Exercise of common stock warrants for cash, at $.20
per sare ............................................... 2,065,000 2,065 410,935 -- --
Net (Loss) ................................................. -- -- -- (1,456,553) --
----------- ----------- ----------- ----------- ----------
Balance, December 31, 1998 ................................. 10,051,704 $ 10,052 $ 2,249,956 $(1,655,785) $ 100,500
=========== =========== =========== =========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
FAN ENERGY INC.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
Years ended December 31, 1997 and 1998
Cumulative
Amounts from
Jan. 1, 1997 to
1997 1998 Dec. 31, 1998
---- ---- ---------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net (Loss) ........................................................ $ (199,232) $(1,456,553) $(1,655,785)
Adjustments to reconcile net (loss) to net
cash provided by operating activities
Impairment of oil and gas properties ............................ -- 1,257,702 1,257,702
Stock options ................................................... 102,832 -- 102,832
Stock for services .............................................. 50,000 43,000 93,000
Changes in assets and liabilities
Increase (decrease) in accounts payable ....................... 5,315 (3,579) 1,736
Other ......................................................... (10,383) 10,383 --
----------- ----------- -----------
Net cash (used) by operating activities ........................... (51,468) (149,047) (200,515)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash paid for oil and gas properties .............................. (975,491) (672,795) (1,648,286)
----------- ----------- -----------
Net cash (used) in investing activities ........................... (975,491) (672,795) (1,648,286)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of common stock warrants ................... -- 413,000 413,000
Proceeds from sale of common stock ................................ 1,500,000 -- 1,500,000
Cash paid for offering costs ...................................... (48,324) -- (48,324)
----------- ----------- -----------
Net cash provided by financing activities ......................... 1,451,676 413,000 1,864,676
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH ..................................... 424,717 (408,842) 15,875
CASH, BEGINNING OF PERIODS .......................................... -- 424,717 --
----------- ----------- -----------
CASH, END OF PERIODS ................................................ $ 424,717 $ 15,875 $ 15,875
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-6
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended December 31, 1997 and 1998
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
During the years ended December 31, 1997 and 1998, the Company paid cash for
interest of $6,247 and $0, respectively.
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended December 31, 1997, the Company:
o issued 2,250,000 shares of common stock, valued at $300,000 ($.133 per share),
as partial consideration for unproved oil and gas properties.
o issued 680,000 options to purchase common stock to officers, directors and
consultants, valued at $102,832.
o issued 250,000 shares of common stock for services, valued at $50,000 ($.20
per share).
o issued 180,000 warrants to purchase shares of common stock as partial
consideration for finder's fees in conjunction with the private placement sale
of common stock, valued at $4,545.
During the year ended December 31, 1998, the Company issued 215,000 shares of
common stock for services, valued at $43,000 ($.20 per share).
The accompanying notes are an integral part of the financial statements.
F-7
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 1 - ORGANIZATION
Fan Energy Inc. (the "Company") is an independent energy company engaged in
the development, exploration and acquisition of crude oil and natural gas
reserves in the western United States. Originally formed as an Idaho
corporation in the early 1900s, the Company's predecessor was not
successful in the exploration of mining properties. In 1988 the predecessor
was merged into a newly-formed Nevada corporation as Eastern Star Mining,
Inc. and it was inactive thereafter, with no assets or liabilities through
the end of 1996. In early 1997, the corporation was reactivated when the
holder of a majority of the outstanding common stock transferred control of
the inactive corporation. The transferee elected new directors and officers
and caused the Company to effect a 10-into-1 reverse stock split. The name
of the corporation was changed to Fan Energy Inc. in December 1997.
Effective with the change in control and reactivation, the Company
undertook development stage activities as defined by Statement of Financial
Accounting Standards (SFAS) No. 7 and is considered a development stage
company effective January 1, 1997. Its principal activities have been
raising capital through the sale of its securities, acquiring undivided
minority interests in two oil and natural gas exploratory prospects in
California for cash and common stock and one prospect in Wyoming, and
commencing the drilling of exploratory and development wells on these
properties. As of December 31, 1998 the Company has not earned any
production revenue from its oil and gas activities.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OIL AND GAS PROPERTIES
The Company follows the full cost method to account for its oil and gas
exploration and development activities. Under the full cost method, all
costs incurred which are directly related to oil and gas exploration and
development are capitalized and subjected to depreciation and depletion.
Depletable costs also include estimates of future development costs of
proved reserves. Costs related to undeveloped oil and gas properties may be
excluded from depletable costs until such properties are evaluated as
either proved or unproved. The net capitalized costs are subject to a
ceiling limitation. Gains or losses upon disposition of oil and gas
properties are treated as adjustments to capitalized costs, unless the
disposition represents a significant portion of the Company's proved
reserves. A separate cost center is maintained for expenditures applicable
to each country in which the Company conducts exploration and/or production
activities.
Depletion and amortization of the full-cost pool is computed using the
units-of-production method based on proved reserves as determined annually
by the Company and independent engineers. An additional depletion provision
in the form of a valuation allowance is made if the costs incurred on oil
and gas properties, or revisions in reserve estimates, cause the total
capitalized costs of oil and gas properties in the cost center to exceed
the capitalization ceiling. The capitalization ceiling is the sum of (1)
the present value of future net revenues from estimated production of
proved oil and gas reserves applicable to the cost center plus (2) the
F - 8
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
lower of cost or estimated fair value of the cost center's unproved
properties less (3) applicable income tax effects. The valuation allowance
was $1,257,702 at December 31, 1998.
IMPAIRMENT
The Company has adopted SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of" which
requires that long-lived assets to be held and used be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Oil and gas properties
accounted for using the full cost method of accounting, a method utilized
by the Company, are excluded from this requirement, but will continue to be
subject to the ceiling test limitations.
DEFERRED OFFERING COSTS
Deferred offering costs at December 31, 1997 consisted of costs incurred in
connection with a proposed public offering of the Company's common stock.
As the offering was not successful, costs incurred of $57,029 were charged
to operations in 1998.
INCOME TAXES
The Company has adopted the provisions of SFAS No. 109, "Accounting for
Income Taxes". SFAS 109 requires recognition of deferred tax liabilities
and assets for the expected future tax consequences of events that have
been included in the financial statements or tax returns. Under this
method, deferred tax liabilities and assets are determined based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
At December 31, 1998, the Company had a net operating loss carryforward of
approximately $850,000 that may be offset against future taxable income
through 2018.
The Company has fully reserved the tax benefits of these operating losses
because the likelihood of realization of the tax benefits cannot be
determined.
The tax benefit of the loss carryforward has been offset by a valuation
allowance of the same amount. Of the total tax benefit $113,000 is
attributable to 1998.
Temporary differences between the time of reporting certain items for
financial and tax reporting purposes consist primarily of compensation
expense related to the issuance of stock options and exploration and
development costs on oil and gas properties.
F - 9
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principle requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
The oil and gas industry is subject, by its nature, to environmental
hazards and cleanup costs. At this time, management knows of no substantial
costs from environmental accidents or events for which it may be currently
liable. In addition, the Company's oil and gas business makes it vulnerable
to changes in wellhead prices of crude oil and natural gas. Such prices
have been volatile in the past and can be expected to be volatile in the
future. By definition, proved reserves are based on current oil and gas
prices and estimated reserves. Price declines reduce the estimated quantity
of proved reserves and increase annual amortization expense (which is based
on proved reserves).
(LOSS) PER COMMON SHARE
(Loss) per common share is computed based on the weighted average number of
common shares outstanding during each period. Convertible equity
instruments such as stock warrants and options are not considered in the
calculation of net loss per share, as their inclusion would be
antidilutive.
In February 1997 SFAS No. 128, "Earnings Per Share" was issued effective
for periods ending after December 15, 1997. There is no impact on the
Company's financial statements from adoption of SFAS No. 128.
SHARED BASED COMPENSATION
In October 1995 SFAS No. 123" Accounting for Stock-Based Compensation" was
issued. This standard defines a fair value based method of accounting for
an employee stock option or similar equity instrument. This statement gives
entities a choice of recognizing related compensation expense by adopting
the new fair value method or to continue to measure compensation using the
intrinsic value approach under Accounting Principles Board (APB) Opinion
No. 25. The Company has elected to utilize APB No. 25 for measurement; and
will, pursuant to SFAS No. 123, disclose supplementally the pro forma
effects on net income and earnings per share of using the new measurement
criteria. During the years ended December 31, 1997 and 1998, the Company
issued warrants and/or options to purchase shares of its common stock (Note
4).
F - 10
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH EQUIVALENTS
For purposes of reporting cash flows, the Company considers as cash
equivalents all highly liquid investments with a maturity of three months
or less at the time of purchase. On occasion, the Company has cash in banks
in excess of federally insured amounts.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist of cash. The Company maintains cash
accounts at one financial institution. The Company periodically evaluates
the credit worthiness of financial institutions, and maintains cash
accounts only in large high quality financial institutions, thereby
minimizing exposure for deposits in excess of federally insured amounts.
BASIS OF ACCOUNTING
The accompanying financial statements have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and extinguishment of liabilities in the normal
course of business.
As previously discussed, the Company is in the development stage and has
not realized revenues from its planned operations. As such, the Company, as
of December 31, 1998 has incurred net operating losses since reactivation
as a development stage company of $1,655,785 and does not have sufficient
working capital to fund its planned operations during the next twelve
months. Additional funding will be required to complete the Company's
planned drilling program, put successful wells into production and finance
general and administrative expenses. These circumstances raise substantial
doubt about the Company's ability to continue as a going concern. In order
to meet the Company's continuing financing needs, management of the Company
intends to raise working capital through the sale of common stock or other
securities, or through other financing.
The Company's financial statements do not include any adjustments related
to the realization of the carrying value of assets or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence.
The ability of the Company to continue operations as a going concern is
dependent upon its success in obtaining capital through sale of common
stock or other securities and ultimately achieving profitable operations.
F - 11
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW TECHNICAL PRONOUNCEMENTS
In June 1997 SFAS No. 130, "Reporting Comprehensive Income" was issued
effective for fiscal years beginning after December 31, 1997, with earlier
application permitted. The Company has adopted SFAS No. 130 effective with
the fiscal year ended December 31, 1998. Adoption of SFAS No. 130 has not
had an impact on the Company's financial statements.
In June 1997 SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information" was issued effective for fiscal years beginning after
December 31, 1997, with earlier application permitted. The Company has
adopted SFAS No. 131 effective with the fiscal year ended December 31,
1998.
In February 1998 SFAS No. 132, "Employers' Disclosure about Pensions and
Other Postretirement Benefits", was issued effective for fiscal years
beginning after December 15, 1997, with earlier application encouraged. The
Company has adopted SFAS No. 132 effective with the fiscal year ending
December 31, 1998. Adoption of SFAS No. 132 has not had any impact on the
Company's financial statements.
In June 1998 SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", was issued for fiscal years beginning after June 15,
1999. Adoption of SFAS No. 133 is not expected to have a material impact on
the Company's financial statements.
In October 1998 SFAS No. 134, "Accounting for Mortgage Broker Securities",
was issued. SFAS No. 134 is not expected to have an impact on the Company's
financial statements.
NOTE 3 - OIL AND GAS PROPERTIES
In 1997, the Company acquired a 25% undivided working interest in two
natural gas exploration and development prospects located in the southern
part of the Sacramento Basin in California. The Company paid $907,951 in
cash and issued 2,250,000 shares of common stock, valued at $300,000 ($.133
per share), for the properties. The total value of cash paid and stock
issued approximates the transferor's historical basis in the property of
$1,207,951. As additional consideration, the Company agreed to issue
500,000 additional restricted shares to the transferor if the gross revenue
received by the Company from the prospects is at least equal to all direct
costs of the Company associated with acquiring the interest in the
prospects and drilling and other related expenses by December 31, 1999. The
Company paid to the transferor interest in the amount of $6,247 (8% per
annum) for funds advanced by the transferor on the property from the date
of the acquisition agreement (August 27, 1997) to the closing of the
agreement (November 11, 1997). Concurrently with the closing, the
transferor became a director and officer of the Company.
F - 12
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 3 - OIL AND GAS PROPERTIES (CONTINUED)
In 1998 the Company acquired a 20% working interest in certain Wyoming oil
and gas leases held by an entity controlled by the chief operating
officer/director of the Company, for $131,000 which includes seismic costs
incurred to the date of purchase.
The Company may be subject to various possible contingencies, which are
primarily from interpretations of federal and state laws and regulations
affecting the oil and gas industry. Although management believes it has
complied with the various laws and regulations, new rulings and
interpretations may require the Company to make adjustments.
Capitalized costs associated with oil and gas producing activities as of
December 31, 1998 are as follows:
Proved properties $ 1,012,485
Unproved properties 935,801
-----------
1,948,286
Less valuation allowance (1,257,702)
-----------
Net capitalized costs $ 690,584
===========
Information relating to the Company's costs incurred in its oil and gas
operations during the years ended December 31, 1997 and 1998 is summarized
as follows:
1997 1998
Property acquisition - Unproved properties $1,214,866 $ 172,919
Exploration costs 60,625 368,699
Development costs -- 131,177
---------- ----------
$1,275,491 $ 672,795
========== ==========
Property acquisition costs include costs incurred to purchase, lease, or
otherwise acquire a property. Exploration costs include the costs of
geological and geophysical activity, dry holes, and drilling and equipping
exploratory wells. Development costs include costs incurred to gain access
to prepare development well locations for drilling, to drill and equip
development wells.
As of December 31, 1998, the Company had not earned any revenue from its
oil and gas activities and none of its properties had produced oil or gas.
F - 13
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 3 - OIL AND GAS PROPERTIES (CONTINUED)
OIL AND GAS RESERVES (UNAUDITED)
The following unaudited reserve estimates presented as of December 31, 1998
was prepared by an independent petroleum engineer. There are many
uncertainties inherent in estimating proved reserve quantities and in
projecting future production rates and the timing of development
expenditures. In addition, reserve estimates of new discoveries that have
little production history are more imprecise than those of properties with
more production history. Accordingly, these estimates are expected to
change, as future information becomes available.
Proved oil and gas reserves are the estimated quantities of crude oil,
condensate, natural gas and natural gas liquids which geological and
engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
conditions.
At December 31, 1998 proved reserves were as follows:
GAS OIL
(MMCF) (MBBL)
Beginning of year -- --
Proved developed producing 190.0 --
Proved developed non-producing 187.3 9.5
Proved undeveloped 190.0 --
----- ----
End of year 567.3 9.5
===== ====
STANDARD MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (UNAUDITED)
The standardized measure of discounted future net cash flows is based on
estimated quantities of proved reserves and the future periods in which
they are expected to be produced and on year-end economic conditions.
Estimated future gross revenues are priced on the basis of year-end prices.
Estimated future gross revenues are reduced by estimated future development
and production costs, as well as certain abandonment costs and by estimated
future income tax expense. Future income tax expenses have been computed
considering the tax basis of the oil and gas properties plus available
carryforwards and credits.
The standardized measure of discounted future net cash flows should not be
construed to be an estimate of the fair market value of the Company's
proved reserves. Estimates of fair value would also take into account
anticipated changes in future prices and costs, the reserve recovery
variances from estimated proved reserves and a discount factor more
representative of the time value of money and the inherent risks in
producing oil and gas. Significant changes in estimated reserve volumes or
product prices could have a material effect on the Company's financial
statements.
F - 14
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 3 - OIL AND GAS PROPERTIES (CONTINUED)
The following table presents the standardized measure of the discounted
future net cash flows attributable to the Company's proved oil and gas
reserves as of December 31, 1998:
(in 000's)
Future cash inflows $1,210
Future production costs (224)
Future development costs (101)
Future income tax expense (221)
--------
Future net cash flows 664
10% annual discount for estimated timing of
cash flows (206)
Net operating loss carryforward 221
--------
Standardized measure of discounted future
net cash flows $ 679
========
The following table presents the principal sources of the changes in the
standardized measure of discounted future net cash flows for the year ended
December 31, 1998:
(in 000's)
Standardized measure of discounted future net cash flows,
beginning of year $ --
Discoveries 679
------
Standardized measure of discounted future net cash flows, end
of year $ 679
=====
Proved reserves were discovered in the fourth quarter of 1998, price
variations were nominal, therefore there is no change in standardized
measure due to price change.
NOTE 4 - STOCKHOLDERS' EQUITY
COMMON STOCK
In 1997, the Company completed the sale of common stock and warrants
pursuant to a private placement as follows:
o 2,500,000 units, at a price of $.20 per unit, consisting of 2,500,000
shares of common stock and warrants to purchase 2,500,000 shares of
common stock at an exercise price of $.20 per share before June 2,
1998. Proceeds to the Company were $500,000, before costs of the
offering of $430.
F - 15
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 4 - STOCKHOLDERS' EQUITY (CONTINUED)
o 2,000,000 units, at a price of $.50 per unit, consisting of 2,000,000
shares of common stock and warrants to purchase 1,000,000 shares of
common stock at an exercise price of $.60 per share before October 31,
1998 (extended to July 31, 1999). Proceeds to the Company were
$1,000,000 before costs of the offering of $52,439.
In 1997 the Company issued shares of common stock for non-cash
consideration, as follows:
o 250,000 shares for services, of which 150,000 shares are to officers
and directors, valued at $50,000 ($.20 per share).
o 2,250,000 shares to an officer/director as partial compensation for
the acquisition of oil and gas prospects, valued at $300,000 ($.133
per share).
In 1998 the Company issued shares of common stock, as follows:
o 215,000 shares for services to officers and directors, valued at
$43,000 ($.20 per share which amount was reduced from $.50 per share
by the Board of Directors).
o 2,065,000 shares for $413,000 cash ($.20 per share) for exercise of
common stock warrants.
QUASI REORGANIZATION
Effective January 1, 1997, the stockholders of the Company approved a plan
of informal quasi reorganization. Pursuant to the plan, the Company's
accumulated deficit of $504,648 as of the date of reorganization was
eliminated and charged to additional paid-in capital.
WARRANTS
In 1997, the Company issued warrants to purchase 180,000 shares of common
stock at an exercise price of $.50 per share through October 31, 1998
(extended to July 31, 1999) as partial consideration for a finders fee in
conjunction with the private placement sale of $.50 units described above.
The warrants are valued at $4,545, using the Black-Scholes option pricing
model.
At December 31, 1998 the status of outstanding warrants is as follows:
Issue Shares Exercise Expiration
Date Exercisable Price Date
October 31, 1997 1,000,000 $.60 July 31, 1999
October 31, 1997 180,000 $.50 July 31, 1999
F - 16
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 4 - STOCKHOLDERS' EQUITY (CONTINUED)
At December 31, 1998 the per share weighted-average grant date fair value
and per share weighted average exercise price of outstanding warrants
granted during 1997 are $.01 and $.58, respectively.
STOCK OPTION PLAN
In July 1997 the Company adopted its 1997 Statutory and Nonstatutory
Incentive Stock Option Plan (the Plan) allowing for the issuance of
incentive stock options and nonstatutory stock options to purchase an
aggregate 1,000,000 shares of common stock to directors, officers,
employees and consultants of the Company. The Plan is administered by the
Board of Directors.
The Plan provides that incentive stock options be granted at an exercise
price equal to the fair market value of the common shares of the Company on
the date of the grant and must be at least 110% of fair market value when
granted to a 10% or more shareholder. The term of all stock options granted
under the Plan may not exceed ten years, and no later than three months
after termination of employment, except the term of incentive stock options
granted to a 10% or more shareholder which may not exceed five years.
The status of outstanding options granted pursuant to the 1997 Plan was as
follows:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average
Number Exercise Fair Exercise
of Shares Price Value Price
<S> <C> <C> <C> <C>
Options Outstanding - January 1, 1997 -- -- -- --
Granted 810,000 $.33 $.20 $.20 - .35
-------
Options Outstanding - December 31, 1997
(680,000 exercisable) 810,000 $.33 $.20
Granted 100,000 $.50 $ -- $.50
-------
Options Outstanding - December 31, 1998
(860,000 exercisable) 910,000 $.35 $.18
=======
</TABLE>
The weighted average contractual life of options outstanding at December
31, 1998 was 9.5 years.
F - 17
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 4 - STOCKHOLDERS' EQUITY (CONTINUED)
The Company has adopted the disclosure-only provisions of SFAS No. 123. Had
compensation cost for the Company's stock option plan been determined based
on the fair value at the grant date consistent with the provisions of SFAS
No. 123, the Company's net loss and loss per share for 1997 would have been
increased to the pro forma amounts indicated below:
Net (loss) applicable to common stockholders - as reported $(1,456,553)
===========
Net (loss) applicable to common stockholders - pro forma (1,461,206)
===========
(Loss) per share - as reported (.17)
====
(Loss) per share - pro forma (.17)
====
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants: dividend yield of 0%; expected volatility of
0%; discount rate of 5.25%; and expected life of 10 years.
At December 31, 1998 the number of options exercisable was 860,000 and the
weighted average exercise price of these options was $.34.
In 1997, the Company recognized as compensation expense $100,500 for
670,000 options issued October 30, 1997 to Officers/Directors, pursuant to
APB No. 25, and $2,332 for 10,000 options issued to non-employees, pursuant
to SFAS No. 123. Those options were issued at an exercise price of $.15 per
share less than the then private placement cost of common stock.
STOCK SPLIT
Effective January 1, 1997 the Company effected a 10-into-1 reverse stock
split. The Company did not change the authorized number of common shares or
par value of the common stock. All information in these notes and the
accompanying financial statements gives retroactive effect to the 10-into-1
reverse stock split.
NOTE 5 - RELATED PARTY TRANSACTIONS
In 1997 and 1998 the Company paid an aggregate $10,000 and $48,000,
respectively, to entities controlled by Officers/Directors of the Company
for office space and administrative services in Scottsdale, Arizona ($8,000
- 1997, and $24,000 - 1998) and Denver, Colorado ($2,000 - 1997, and
$24,000 - 1998), at the rate of $2,000 per month.
In November 1997 the Company entered into a one-year agreement with its
Secretary/Treasurer to provide financial and other services to the Company
for $2,500 per month. During 1997 the Company paid the Secretary/Treasurer
$10,027 for services provided and issued 50,000 shares of common stock,
valued at $10,000 ($.20 per share). During 1998 the Secretary/Treasurer was
paid $30,000 under the agreement, which was converted to a month to month
basis.
F - 18
<PAGE>
FAN ENERGY INC.
(A Development Stage Company)
Notes to Financial Statements
Years ended December 31, 1997 and 1998
NOTE 5 - RELATED PARTY TRANSACTIONS (CONTINUED)
In 1998, the Company acquired a 20% working interest in certain undeveloped
oil and gas properties for $131,000 from an entity controlled by the chief
operating officer/director of the Company. (See Note 3)
NOTE 6 - SEGMENT REPORTING
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information" was issued, which amends the requirements for a public
enterprise to report financial and descriptive information about its
reportable operating segments. Operating segments, as defined in the
pronouncement, are components of an enterprise about which separate
financial information is available that is evaluated regularly by the
Company in deciding how to allocate resources and in assessing performance.
The financial information is required to be reported on the basis that is
used internally for evaluating segment performance and deciding how to
allocate resources to segments. The Company has adopted SFAS No. 131 for
the year ended December 31, 1998.
The Company has one reportable segment, oil and gas producing activities.
The Company has concentrated its oil and gas exploration and development
activities in the western United States, primarily in California and
Wyoming. All activities in this segment have been with industry partners.
The Company has not earned any revenue from its oil and gas activities.
However the Company has discovered proved reserves from its 1998 drilling
program. The Company's total assets of $706,459 at December 31, 1998 and
operating expenses of $199,232 and $1,456,553 for the years ended December
31, 1997 and 1998, respectively, are attributable to this segment.
NOTE 7 - PROPOSED STOCK OFFERING
The Company's Board of Directors approved the filing of a Registration
Statement on Form SB-2 with the Securities and Exchange Commission relating
to an initial public offering of a minimum 400,000 shares and a maximum
3,000,000 shares of the Company's common stock at a price of $.30 per
share, on a "best efforts" basis by the officers and directors of the
Company.
F - 19
<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.
FAN ENERGY INC.
Date: March 31, 1999 By /s/ George H. Fancher Jr.
-----------------------------------
George H. Fancher, Jr., Chairman and
Chief Operating Officer
Date: March 31, 1999 By /s/ Rex Utsler
-----------------------------------
Rex Utsler, Chief Financial Officer
and Treasurer
Date: March 31, 1999 By /s/ Albert Golusin
-----------------------------------
Albert A. Golusin, Principal Accounting
Officer
In accordance with the Exchange Act, the report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Date: March 31, 1999 By /s/ George H. Fancher Jr.
----------------------------------
Director
Date: March 31, 1999 By /s/ Rex Utsler
---------------------------------
Director
Date: March 31, 1999 By /s/William E. Grafham
---------------------------------
Director
Date: March 31, 1999 By /s/ Jeffrey J. Scott
---------------------------------
Director
Date: March 31, 1999 By /s/ George A. Cloudy
---------------------------------
Director
31
<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
EXHIBITS TO
FAN ENERGY INC.
INDEX TO EXHIBITS
Exhibit No. Description and Method of Filing
---------- --------------------------------
(3.1) Restated Articles of Incorporation of Eastern Star Mining,
Inc., as filed with the Nevada Secretary of State February 7,
1997.*
(3.2) Certificate of Amendment of Articles of Incorporation of
Eastern Star Mining, Inc., as filed with the Nevada Secretary
of State May 19, 1997.*
(3.3) Certificate of Amendment of Articles of Incorporation of
Eastern Star Mining, Inc., as filed with the Nevada Secretary
of State May 28, 1997.*
(3.4) Certificate of Amendment of Articles of Incorporation of
Eastern Star Holdings, Inc., as filed with the Nevada
Secretary of State December 10, 1997.*
(3.5) Bylaws of Registrant adopted December 31, 1997.*
(10.1) Letter Agreement dated August 27, 1997 between Registrant and
George H. Fancher Jr. d/b/a Fancher Oil Company.*
(10.2) Agreement With Arizona Corporate Management, Inc. dated
November 1, 1998.*
(10.3) 1997 Incentive and Nonstatutory Stock Option Plan. *
(10.4) Letter regarding conflicts of interest dated March __, 1998
between Registrant and George H. Fancher Jr.*
(10.5) Form of Subscription Agreement for certain officers and
consultants.*
(10.6) Agreement with Albert Golusin.*
(10.7) Participation Agreement dated October 1, 1998 with Fancher
Resources, LLC.
(24) Power of Attorney.
(27) Financial Data Schedule.
- ------------------
* Incorporated by reference to Registration Statement No. 33-64448
on Form SB-2, which became effective May 14, 1998.
32
October 1, 1998
Fan Energy Inc.
1801 Broadway, Suite720
Denver, Colorado 80202
Re: Participation Agreement
HORSETHIEF CANYON PROSPECT
T21N, R102-103W, 6th P.M.
Sweetwater County, Wyoming
Gentlemen:
This Agreement will constitute our understanding regarding Fan Energy Inc.,
hereinafter referred to as "FEI", purchase of an interest in Fancher Resources,
LLC, hereinafter referred to as "Fancher", Horsethief Canyon Prospect,
Sweetwater County, Wyoming.
1. Fancher will assign 20% of its right, title and interest in and to all
of its leasehold, being approximately 3525 net acres as depicted on
Exhibit "A" attached hereto. In addition, Fancher will assign 20% of
its right, title and interest in and to all leasehold and/or minerals
which are acquired within the prospect outline as shown on said
Exhibit "A" (map). Further, Fancher agrees to assign 20% interest in
and to all acreage trades, farmins, seismic options, etc. which are
secured for the Horsethief Prospect. All leasehold, minerals and
acreage trades are hereinafter referred to as the "interests".
2. FEI agrees to pay $28,000 to Fancher for acreage and geological cost
associated with Horsethief Canyon Prospect, upon execution of this
letter agreement.
3. In delivering the interests, Fancher will deliver to FEI an 80% NRI on
acreage which is currently owned, on this date, by Fancher as well as
any open UPRC acreage where a lease is earned pursuant to shooting 3D
seismic. Fancher will deliver an 80% NRI on all other interests
assigned to FEI within the prospect. In the event an earned interest
is less than 80% NRI Fancher will deliver said interest as is without
reserving additional overriding royalty interests.
<PAGE>
Fan Energy Inc.
October 1, 1998
Page Two
4. Fancher has acquired 3D seismic data over the Horsethief Canyon
Prospect as shown on Exhibit B. FEI agrees to pay 24% of all costs
involved in acquiring, processing, and interpreting the 3D seismic
data over the Horsethief Canyon Prospect. Notwithstanding said
payment, the ownership of such data will be FEI 20% and Fancher 80%.
The estimated gross cost to acquire, process and interpret the 3D
seismic data in the Horsethief Canyon prospect is estimated to be
$500,000. FEI's cost to date for seismic is shown on Exhibit E and is
due upon execution of this Agreement.
5. An area of mutual interest is hereby established, effective for
acquisitions after this date, consisting of the Horsethief Canyon
Prospect lands as shown on Exhibit "A". The AMI will remain in effect
for the term of any oil and gas leases which become subject to this
agreement, whether by acquisition, extension or renewal and shall
thereafter terminate unless production is established on any portion
of said land through this agreement, and shall then continue so long
as there is production. Any acquisition to the AMI, shall be reported
within ten (10) days in writing describing the acquired interest and
cost of same, FEI will have twenty (20) days from receipt of such
notice in which to elect to participate in the interest by payment of
its proportionate share of the actual cost of the interest plus 10%.
Failure to participate in an acquisition to the AMI shall remove that
interest from the terms of this agreement.
6. FEI agrees to pay 24% of all costs to casing point on the initial well
drilled on the Horsethief Canyon Prospect, as reflected in the AFE
attached hereto and made a part of this Agreement. The initial well
will be spudded on or before November 1, 1998.
7. A Federal Exploratory Unit has been formed as shown on Exhibit F. FEI
agrees to ratify and adopt the Horsethief Canyon Unit Agreement and
Unit Operating Agreement. The Horsethief Canyon Unit Operating
Agreement will control all operations of the parties while it is in
effect. In the event any lands subject to this agreement are
contracted out of the Horsethief Canyon Unit, or if the Horsethief
Canyon Unit is terminated, then such lands will be automatically
subject to the AAPL 610-1989 JOA attached hereto as Exhibit D.
<PAGE>
Fan Energy Inc.
October 1, !998
Page Three
8. FEI will have a continuing right of first refusal to participate, on
similar terms to Horsethief Canyon Prospect, in Fancher's four other
prospects in this area as shown on Exhibit "C" attached hereto and any
other prospects or re-entries that Fancher may develop in the subject
area. These prospects are identified as Northeast Marianne, Southwest
Marianne, Deadman Wash and Shiprock. FEI will have fifteen (15) days
from the presentation and review of each prospect in which to elect to
participate in the aforementioned prospects.
9. Simultaneous with the execution of this agreement Fancher and FEI will
enter into the AAPL Model Form 610-1989 Operating Agreement attached
hereto as Exhibit "D" which designates Fancher Oil LLC as Operator.
Said Operating Agreement will contain a provision which allows
Fancher, as operator, to charge a reasonable fee for G&A related to
the time required to administer this project on a mutually acceptable
basis.
If the terms as outlined above are satisfactory, please so indicate by
signing below in the space provided and return one copy of this agreement to my
attention. Thank you for your time and consideration of this matter. Should you
have any questions, please advise.
Sincerely,
FANCHER RESOURCES, LLC
/s/ George H. Fancher Jr.
George H. Fancher Jr.
GHF:jh
enclosures
AGREED TO AND ACCEPTED THIS
1ST DAY OF OCTOBER, 1998.
FAN ENERGY INC.
By /s/ Jeff Scott
----------------------------------
Jeff Scott, Director
EXHIBIT 24
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints George
H. Fancher Jr. and Albert A. Golusin, and each of them, his true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him in his name, place and stead, in his capacity as an
officer, director, or both of Fan Energy Inc., a Nevada corporation ("Company"),
to sign the Company's Annual Report on Form 10-KSB, and any and all amendments
thereto and to file the same with the United States Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact or agents or any of them, or their or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Signature Title Date
- --------- ----- ----
/s/ Rex Utsler Director March 24, 1999
---------------------------------
Rex Utsler
/s/ William E. Grafham Director March 24, 1999
---------------------------------
William E. Grafham
/s/ Jeffrey J. Scott Director March 23, 1999
---------------------------------
Jeffrey J. Scott
/s/ George A. Cloudy Director March 24, 1999
---------------------------------
George A. Cloudy
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