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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended: December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________to________
Commission file number 000-24881
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PENNACO ENERGY, INC.
(Name of small business issuer in its charter)
NEVADA 88-0384598
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1050 17th Street
Suite 700
Denver, Colorado 80265
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (303) 629-6700
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
- ----------------------------------- --------------------------------------
Securities registered pursuant to section 12(g) of the act:
Common Stock, par value $.001
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 twelve (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
ninety (90) days.
Yes /X/ No / /
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the 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. / /
The registrant had no operating revenues in 1998.
As of March 24, 1999, the aggregate market value of the 10,251,875 shares of
voting stock held by non-affiliates of the registrant was approximately
$39,726,016 based upon the closing price of the Common Stock on the OTC
Bulletin Board on March 24, 1999 of $3.875 per share.
As of March 24, 1999, the registrant had 15,151,679 shares of Common Stock
outstanding.
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TABLE OF CONTENTS
PART I
Page
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Item 1. Description of Business................................................. 4
Item 2. Description of Property................................................. 10
Item 3. Legal Proceedings....................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders..................... 13
PART II
Item 5. Market for Common Equity and Related Stockholder Matters................ 14
Item 6. Plan of Operation....................................................... 15
Item 7. Financial Statements.................................................... 18
Item 8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure.............................................. 28
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons,
Compliance with Section 16(a) of the Exchange Act.................... 29
Item 10. Executive Compensation.................................................. 30
Item 11. Security Ownership of Certain Beneficial Owners and Management.......... 30
Item 12. Certain Relationships and Related Transactions.......................... 30
Item 13. Exhibits and Reports on Form 8-K........................................ 31
Signatures 32
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DOCUMENT INCORPORATED BY REFERENCE
Some of the information called for by Part III of this Form 10-KSB is
incorporated by reference from the Company's Proxy Statement for its 1999
Annual Meeting of Stockholders (the "Proxy Statement") to be filed with the
Securities and Exchange Commission no later than April 30, 1999.
Transitional Small Business Disclosure Format (Check one): Yes ; No X
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CERTAIN DEFINITIONS
The following are definitions of terms commonly used in the oil and natural
gas industry and this document.
Unless otherwise indicated in this document, natural gas volumes are stated
at the legal pressure base of the state or area in which the reserves are
located at 60 (degrees) Fahrenheit. Natural gas equivalents are determined
using the ratio of six Mcf of natural gas to one barrel of crude oil,
condensate or natural gas liquids so that one barrel of oil is referred to as
six Mcf of natural gas equivalent or "Mcfe." As used in this document, the
following terms have the following specific meanings: "Mcf" means thousand
cubic feet, "Mcf" means million cubic feet, "Bcf" means billion cubic
feet, "Bbl" means barrel, "MBbl" means thousand barrels, "Mcfe" means
thousand cubic feet equivalent, "MMcfe" means million cubic feet equivalent,
"Bcfe" means billion cubic feet equivalent, and "MMBtu" means million British
thermal units.
COAL SEAM. A layer of coal of variable thickness which is found below the
surface of the ground but which may also outcrop at the surface. Coal is a
black organic mineral formed from buried deposits of plant material from
ancient coastal swamps.
DEVELOPED ACREAGE. The amount of acreage which is allocated or assignable to
producing wells or wells capable of production.
DEVELOPMENT WELL. A well drilled within the proved area of an oil or natural
gas reservoir to the depth of a stratigraphic horizon known to be productive.
EXPLORATORY WELL. A well drilled to find and produce oil or natural gas in an
unproved area, to find a new reservoir in a field previously found to be
productive of oil or natural gas in another reservoir, or to extend a known
reservoir.
GROSS ACRES OR GROSS WELLS. The total acres or wells, as the case may be,
in which the Company has a working interest.
OPERATOR. The individual or company responsible to the working interest
owners for the drilling, completion and production of an oil or natural
gas well or lease.
NET ACRES OR NET WELLS. Acreage or wells, as the case may be, net of the
Company's working interest.
PRESENT VALUE OF ESTIMATED FUTURE NET REVENUES BEFORE INCOME TAXES. The
present value of estimated future net revenues to be generated from the
production of proved reserves, net of estimated production and ad valorem
taxes, future capital costs and operating expenses, using prices and costs in
effect as of the date indicated, without giving effect to future federal
income taxes. The future net revenues have been discounted at an annual rate
of 10%.
PROPPANT. Sand or synthetic material used in a fracture stimulation procedure
to support fractures in an oil or gas bearing formation.
PROVED DEVELOPED OIL AND GAS RESERVES. Proved developed oil and gas reserves
are reserves that can be expected to be recovered through existing wells with
existing equipment and operating methods.
PROVED RESERVES. Proved oil and gas reserves are the estimated quantities of
crude oil, 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, i.e.,
prices provided only by contractual arrangements, but not on escalations based
upon future conditions.
PROVED UNDEVELOPED RESERVES. Proved undeveloped oil and gas reserves are
reserves that are expected to be recovered from new wells on undrilled acreage,
or from existing wells where a relatively major expenditure is required for
recompletion. Reserves on undrilled acreage are limited to those drilling units
offsetting productive units that are reasonably certain of production when
drilled.
UNDEVELOPED ACREAGE. Lease acres on which wells have not been drilled or
completed to a point that would permit the production of commercial
quantities of oil and natural gas regardless of whether or not such acreage
contains proved reserves.
WORKING INTEREST. An interest in an oil and natural gas lease which grants the
owner of the interest the right to drill and produce oil and natural gas on
the leased acreage and requires the owner to pay a share of the costs of
drilling and production operations. The share of production to which a
working interest owner is entitled will always be smaller than the share of
costs that the working interest owner is required to bear, with the balance
of the production accruing to the owners of royalty interests.
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INFORMATION REQUIRED IN REGISTRATION STATEMENT
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Pennaco Energy, Inc. ("Pennaco," "we," "ours," "us" or the
"Company") is an independent, development stage exploration and production
company. The Company's current operations are completely focused on the
acquisition, development and production of natural gas from coal bed methane
("CBM") properties in the Rocky Mountain region of the United States. Pennaco
is one of the largest holders of oil and gas leases covering CBM properties
in the Powder River Basin in northeastern Wyoming and southeastern Montana.
As of March 1, 1999, the Company owned oil and gas lease rights with respect
to approximately 311,800 net acres in the Powder River Basin.
The CBM wells in the Powder River Basin are generally 350 to 1,200
feet in depth and typically take only two to three days to drill and
complete. Because of the relatively shallow depth and short amount of time to
drill a well, CBM wells have relatively low drilling, completion and well
connection costs (approximately $60,000 total well cost per well).
Approximately 50% of the total well costs are well connection costs,
comprised of costs of gathering lines, power lines and surface equipment. The
Company plans to contract much of the well connection cost to third party
gatherers in return for payment of a per mcf gathering fee. The CBM gas
recovered from the wells in the Powder River Basin does not require
processing but does require dehydration and compression and could eventually
require carbon dioxide treatment over the next several years.
The Company initiated its drilling program on November 15, 1998 and
had drilled approximately 32 gross (28 net) wells as of December 31, 1998. As
of March 22, 1999, the Company has drilled approximately 135 gross (118 net)
CBM wells and plans to drill approximately 330 net CBM wells in 1999, although
there can be no assurances that it will have sufficient funds to drill all of
these wells, that it would be economic to do so or that these wells will
ultimately be productive. The wells the Company has drilled to date have each
taken an average of three days to drill and are in various stages of completion
and testing while awaiting construction of gathering and compression systems
and connection to a pipeline.
The Company has flow tested most of the 32 wells which were drilled
as of December 31, 1998. These tests resulted in the calculation of proved
non-producing reserves as reviewed by the Company's third party engineers. At
December 31, 1998, the Company had estimated net proved reserves of 18.1 Bcfe
with present value of estimated future net revenues before income taxes
(utilizing a 10% discount rate) of $8.5 million and a standardized measure of
discounted future net cash flows of $6.1 million. Natural gas constituted
100% of the Company's estimated net proved reserves, all of which were
located in the Powder River Basin and 30% of which were developed but
non-producing at year-end. The Company operates all of the wells on its
proved developed non-producing properties.
As of December 31, 1998, the Company had not produced any oil or gas
nor does it have the ability to produce any oil or gas until the permitting
for and construction of a gathering and compression system is completed. The
success of the Company's drilling program (including the magnitude of any
potential reserves) cannot be fully evaluated until the wells are completed,
connected to a gathering system and produced for a period of time. The
Company anticipates initial production and gas sales in April 1999 but there
can be no assurance that third party gatherers will be able to obtain
permitting for and complete construction of gathering, compression, and
transportation systems by that time or that the Company's existing wells will
produce economic quantities of CBM gas.
Pennaco has entered into two gas sale contracts to sell a total of
10,000 MMBtu per day of natural gas for 12 months beginning April 1, 1999 to
two gas purchasers deliverable at Recluse, Wyoming into the Williston Basin
Interstate pipeline (the "WBI"). The Company has entered into agreements to
purchase gas for the month of April 1999 in order to meet its gas sales
contract obligations. The Company believes that once gathering and compression
systems are completed, its initial production from its South Gillette Area will
be sufficient to satisfy its obligations under its gas sales contracts. The
Company recently entered into an agreement with Bear Paw Energy, Inc. ("Bear
Paw Energy"), a subsidiary of TransMontaigne, Inc., under which Bear Paw Energy
will construct, own and operate gas gathering systems as well as provide gas
gathering and compression services to Pennaco in the Company's South Gillette
Area. On March 17, 1999, the Company entered into an agreement with Western Gas
Resources, Inc. ("Western Gas") to compress and transport 11 MMcf per day of
gas from the Dopplebock compressor station located southwest of the Company's
South Gillette Area to the interconnect with WBI at Recluse, Wyoming.
The Company currently maintains its principal executive offices at
1050 17th Street, Suite 700, Denver, Colorado 80265. The Company's telephone
number is (303) 629-6700 and the facsimile number is (303) 629-6800. The
Company also maintains an office at 3651 Lindell Road, Suite A, Las Vegas,
Nevada 89103 and a field office at 400 South Miller Avenue, Gillette, Wyoming
82716.
CMS TRANSACTION
On October 23, 1998, the Company and CMS Energy Corporation's
exploration and production unit, CMS Oil and Gas Company ("CMS") signed a
definitive purchase and sale agreement (the "CMS Agreement") relating to the
development of the Company's Powder River Basin acreage (the "CMS
Transaction") within a designated area of mutual interest ("AMI"). Pursuant
to the terms of the CMS Agreement, CMS acquired an undivided 50% working
interest in approximately 492,000 net acres of Pennaco's leasehold position
in the Powder River Basin for $28.0 million. The Company acquired that
portion of the leasehold position which was conveyed to CMS in the CMS
Transaction for approximately $7.0 million. The purchase price provided for
in the CMS Agreement was the result of arm's length negotiations between the
Company and CMS and was also a function of the consideration originally paid
by the Company for such acreage. The Company's Board of Directors received a
fairness opinion from Hanifen Imhoff, Inc. that the CMS Transaction was fair
to the Company's stockholders from a financial point of view.
Since the announcement of the CMS Transaction, the jointly owned
leasehold contained in the AMI has grown from 492,000 net acres to
approximately 560,000 net acres through additional acreage purchases. The CMS
Agreement provides for the development of the Company's leasehold acreage
within the AMI, with Pennaco and CMS each operating approximately 50% of the
wells to be drilled. As is customary in oil and gas leasehold transactions,
the agreement provides for the adjustment of the purchase price for title
defects discovered prior to closing and for the opportunity for one party to
participate in acquisitions made by the other party in the AMI defined in the
agreement. As of March 12, 1999, approximately $1.2 million of the proceeds
of the CMS Transaction were held in escrow pending resolution of possible
title defects. The agreement also provides for a preferential purchase right
to the other party in the event either CMS or the Company attempts to sell a
portion of its interest in the acreage covered by the agreement. There is no
preferential purchase right in the event that either party enters into a
merger, reorganization or consolidation. All of the leases in the AMI are
dedicated to CMS Gas Transmission and Storage, an affiliate
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of CMS, for gathering, compression and transportation, provided that such
services are offered at competitive market rates.
BUSINESS STRATEGY
Pennaco's business strategy is to build an exploration and
production company that is focused on creating value for its stockholders
through profitable growth in reserves, production and cash flow per share.
The key components of the Company's business strategy include the following.
- - Concentrate activities in the Rocky Mountains and Mid-Continent regions of
the U.S.
- - Leverage the expertise of its technical and management team in areas of
prior experience.
- - Acquire additional undeveloped properties in the Powder River Basin that add
to near-term drilling inventory.
- - Acquire producing properties with development and exploitation potential.
- - Seek to acquire operating control and majority ownership interests in
properties to optimize the timing and efficiency of operations.
- - Actively manage gas gathering, processing, transportation, and marketing
activities to maximize product price realizations.
- - Maintain a strong balance sheet in order to be in a position to capitalize
on opportunities as they occur.
GAS GATHERING, COMPRESSION, MARKETING AND TRANSPORTATION
The Company plans to focus its initial capital spending on drilling,
well completion, production and land acquisition activities rather than gas
gathering and compression operations. Accordingly, the Company plans to
utilize third party gathering services to gather, compress and transport its
natural gas from the wellhead to market in return for gathering and
compression fees. The Company recently entered into an agreement with Bear
Paw Energy under which Bear Paw Energy will construct, own and operate gas
gathering systems as well as provide gas gathering and compression services
to Pennaco outside of the CMS AMI in the Company's South Gillette Area.
On March 17, 1999 the Company entered into an agreement with Western
Gas to compress and transport 11 MMcf per day of gas from the Doppelbock
compressor station located southwest of the Company's South Gillette Area to
the interconnect with WBI at Recluse, Wyoming. Western Gas will take delivery
of the gas gathered by Bear Paw Energy in the South Gillette area and
transport the gas to Doppelbock.
Production growth in the Powder River Basin is currently impeded by
a natural gas pipeline bottleneck which restricts the movement of natural gas
out of the basin. Currently only two pipelines are available to transport CBM
gas out of the Powder River Basin. The MIGC pipeline, which is operated by
Western Gas, has recently undergone a 40 MMcf per day expansion to 130 MMcf
per day. The MIGC line runs south through the eastern side of the Powder
River Basin to interconnect with two interstate pipelines near Glenrock,
Wyoming, but has little available capacity due to increasing CBM gas
production from the Powder River Basin. A subsidiary of MDU Resources
operates the 42 MMcf per day WBI pipeline which runs northeast from Recluse,
Wyoming to local markets throughout eastern Montana and North Dakota and
interconnects with the Northern Border Pipeline, an interstate pipeline which
travels southeast to the Chicago markets. WBI has limited additional capacity.
Three pipeline construction and expansion projects which would serve
the Powder River Basin have recently been announced, all of which are
reportedly in the process of obtaining permits and acquiring rights of way.
On December 23, 1998, CMS Gas Transmission and Storage, Enron Capital and
Trade Resources Corporation, Western Gas and Colorado Interstate Gas Company
("CIG"), a subsidiary of The Coastal Corporation, jointly announced the
formation of Fort Union Gas Gathering, LLC ("Fort Union"). Fort Union has
announced plans to build a 106 mile, 24 inch gathering pipeline to gather CBM
gas in the Powder River Basin. The new gathering line is expected to have an
initial capacity of approximately 450 MMcf per day of natural gas and can be
expanded with additional compression to 700 MMcf per day. The Fort Union line
is expected to deliver CBM gas to a carbon dioxide treating facility to be
constructed near Glenrock, Wyoming and to interstate pipeline interconnects
near Glenrock. Construction is scheduled to begin in April 1999 with
operations to commence on or about September 1, 1999, although there can be
no assurance that such system will ultimately be constructed or that it will
be completed in the time-frame currently anticipated.
In September 1998, KN Energy, Inc. and Devon Energy Corporation
announced the formation of Thunder Creek Gas Services LLC ("Thunder Creek").
Thunder Creek has announced its intention to build a 126 mile, 24 inch
gathering line capable of delivering up to 450 MMcf per day of natural gas to
multiple interstate pipelines near Douglas, Wyoming. The operations are
scheduled to commence in October 1999, although there can be no assurance
that such system will ultimately be constructed.
Additionally, Wyoming Interstate Gas Company, a subsidiary of the
Coastal Corporation, has filed an application with the Federal Energy
Regulatory Commission ("FERC") to construct a new 143 mile, 24 inch natural
gas pipeline known as the Medicine Bow Lateral from Glenrock to Cheyenne,
Wyoming where the line will interconnect with several interstate pipelines
which serve the mid-continent and west coast regions of the U.S. as well as
the central Colorado markets. The Medicine Bow Lateral is scheduled to
commence operations in December 1999, subject to FERC approval, will have
initial capacity of 260 MMcf per day of natural gas and can be expanded with
additional compression to 390 MMcf per day. There can be no assurance that
such system will ultimately be constructed or that it will be completed in
the time-frame currently anticipated.
On November 11, 1998, the Company entered into a gas brokerage and
administration agreement with Mercator Energy, Inc. ("Mercator") whereby
Mercator agreed to provide gas marketing and administration services to
Pennaco. This agreement was renewed on March 1, 1999 and extends until
September 1, 1999 and converts to a month-to-month basis thereafter. Mercator
has extensive experience in gas marketing services in the Rocky Mountain
region and specifically in the Powder River and surrounding gas producing
basins.
COMPETITION
The Company competes with a number of other potential purchasers of
oil and gas leases and producing properties, many of which have greater
financial resources than the Company. The bidding for oil and gas leases has
become particularly intense in the Powder River Basin with bidders evaluating
potential acquisitions with varying product pricing parameters and other
criteria that result in widely divergent bid prices. The presence of bidders
willing to pay prices higher than are supported by the Company's evaluation
criteria could further limit the ability of the Company to acquire oil and
gas leases. In addition, low or uncertain prices for properties can cause
potential sellers to withhold or withdraw properties from the market. In this
environment, there can be no assurance that there will be a sufficient number
of suitable oil and gas leases available for acquisition by the Company or
that the Company can sell oil and gas leases or obtain financing for or
participants to join in the development of prospects.
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REGULATION
GENERAL
The Company's operations are affected by numerous governmental laws
and regulations including energy, environmental, conservation, tax and other
laws and regulations relating to the energy industry. Many departments and
agencies, both federal and state, are authorized by statute to issue and have
issued rules and regulations binding on the oil and natural gas industry and
its individual participants. Changes in any of these laws and regulations
could have a material adverse effect on the Company's business. In view of
the many uncertainties with respect to current and future laws and
regulations, including their applicability to the Company, the Company cannot
predict the overall effect of such laws and regulations on its future
operations.
The Company believes that its operations comply in all material
respects with all applicable laws and regulations and that the existence and
enforcement of such laws and regulations have no more restrictive effect on
the Company's method of operations than on other similar companies in the
energy industry.
The following discussion contains summaries of certain laws and
regulations and is qualified in its entirety by the foregoing.
OPERATIONS ON FEDERAL OR STATE LEASES
The Company's operations on federal or state oil and gas leases will
be subject to numerous restrictions, including nondiscrimination statutes.
Such operations must be conducted pursuant to certain on-site security
regulations and other permits and authorizations issued by the Bureau of Land
Management ("BLM"), Minerals Management Service and other agencies. In order
to drill wells in Wyoming on federal, state or privately-owned land, the
Company is required to file an Application for Permit to Drill with the
Wyoming Oil and Gas Commission. Drilling on acreage controlled by the federal
government requires the filing of a similar application with the BLM. While
the Company has been able to obtain required drilling permits to date, there
can be no assurance that permitting requirements will not adversely effect
the Company's ability to complete its drilling program at the cost and in the
time period currently anticipated.
Drilling on federal lands in a large portion of the Powder River
Basin is currently limited until the completion of an environmental impact
statement ("EIS") by the BLM. The number of drilling permits allowed on
federal lands subject to the EIS are limited until the EIS is complete. This
limitation could adversely affect the Company's ability to drill on federal
lands. Approximately 53% of the Company's leasehold is comprised of federal
acreage although only a portion of the Company's acreage is currently
included in the EIS. Operators are currently drilling wells on an interim
basis on federal lands with the limited number of drilling permits allowed by
the BLM until the EIS is complete. Pennaco has approximately 38 interim
drilling permits on federal lands within the EIS. The EIS was originally
scheduled for completion in May 1999, but has been delayed until August 1999.
There can be no assurance as to its ultimate completion date.
TRANSPORTATION AND SALE OF NATURAL GAS
The FERC regulates interstate natural gas pipeline transportation
rates as well as the terms and conditions of service. FERC's regulations will
affect the marketing of any natural gas produced by the Company, as well as
any revenues received by the Company for sales of such natural gas. In 1985,
the FERC adopted policies that make natural gas transportation accessible to
natural gas buyers and sellers on an open-access, nondiscriminatory basis.
The FERC issued Order No. 636 on April 8, 1992, which, among other things,
prohibits interstate pipelines from making sales of gas tied to the provision
of other services and requires pipelines to "unbundle" the services they
provide. This has enabled buyers to obtain natural gas supplies from any
source and secure independent delivery service from the pipelines. All of the
interstate pipelines subject to FERC's jurisdiction are now operating under
Order No. 636, open access tariffs. On July 29, 1998, the FERC issued a
Notice of Proposed Rulemaking regarding the regulation of short term natural
gas transportation services. FERC proposes to revise its regulations to
require all available short term capacity (including capacity released by
shippers holding firm entitlements) to be allocated through an auction
process. FERC also proposes to require pipelines to offer additional services
under open access principles, such as "park and loan" services. In a related
initiative, FERC issued a Notice of Inquiry on July 29, 1998 seeking input
from natural gas industry players and affected entities regarding virtually
every aspect of the regulation of interstate natural gas transportation
services. Among other things, FERC is seeking input on whether to retain
cost-based rate regulation for long term transportation services, potential
changes in the manner in which rates are designed, and the use of index
driven or incentive rates for pipelines. The July 29, 1998 Notice of Inquiry
may lead to a subsequent Notice of Proposed Rulemaking to further revise
FERC's regulations.
Additional proposals and proceedings that might affect the natural
gas industry are considered from time to time by Congress, the FERC, state
regulatory bodies and the courts. The Company cannot predict when or if any
such proposals might become effective or their effect, if any, on the
Company's operations. The natural gas industry historically has been closely
regulated. Accordingly, there can be no assurance that the less stringent
regulatory approach recently pursued by the FERC and Congress will continue
indefinitely into the future.
PRODUCTION
The production of oil and natural gas is subject to regulation under
a wide range of state and federal statutes, rules, orders and regulations.
State and federal statutes and regulations require permits for drilling
operations, drilling bonds and reports concerning operations. Wyoming and
Montana have regulations governing conservation matters, including provisions
for the unitization or pooling of oil and natural gas properties, the
establishment of maximum rates of production from oil and natural gas wells
and the regulation of the spacing, plugging and abandonment of wells. The
effect of these regulations is to limit the amount of oil and natural gas the
Company can produce from its wells and to limit the number of wells or the
locations at which the Company can drill. Moreover, each state generally
imposes a production or severance tax with respect to production and sale of
crude oil, natural gas and gas liquids within its jurisdiction.
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ENVIRONMENTAL REGULATIONS
Various federal, state and local laws and regulations governing the
discharge of materials into the environment, or otherwise relating to the
protection of the environment, will affect the Company's operations and
costs. In particular, the Company's exploration, development and production
operations, its activities in connection with storage and transportation of
liquid hydrocarbons and its use of facilities for treating, processing or
otherwise handling hydrocarbons and wastes therefrom will be subject to
stringent environmental regulation. Because CBM wells typically produce
significant amounts of water, the Company is required to file applications
with state and federal authorities, as applicable, to enable it to dispose of
water produced from its wells. While the Company has been able to obtain
required water disposal permits to date, there can be no assurance that such
permitting requirements will not adversely effect the Company's ability to
complete its drilling and development program at the cost and in the time
period currently anticipated.
As with the energy industry generally, compliance with existing
regulations will increase the Company's overall cost of doing business. These
costs include production expenses primarily related to the control and
limitation of air emissions and the disposal of produced water, capital costs
to drill exploration and development wells resulting from expenses primarily
related to the management and disposal of drilling fluids and other oil and
gas exploration wastes and capital costs to construct, maintain and upgrade
production equipment and facilities.
The Comprehensive Environmental Response, Compensation and Liability
Act ("CERCLA"), also known as "Superfund," imposes liability, without regard
to fault or the legality of the original act, on certain classes of persons
that contributed to the release of a "hazardous substance" into the
environment. These persons include the "owner" or "operator" of the site and
companies that disposed or arranged for the disposal of the hazardous
substances found at the site. CERCLA also authorizes the Environmental
Protection Agency and, in some instances, third parties to act in response to
threats to the public health or the environment and to seek to recover from
the responsible classes of persons the costs they incur. In the course of its
ordinary operations, the Company may generate waste that may fall within
CERCLA's definition of a "hazardous substance." The Company may be jointly
and severally liable under CERCLA for all or part of the costs required to
clean up sites at which such wastes have been disposed.
The Company may own or lease properties that have been used for the
exploration and production of hydrocarbons in the past. Many of these
properties will have been owned by third parties whose actions with respect
to the treatment and disposal or release of hydrocarbons or other wastes were
not under the Company's control. These properties and wastes disposed thereon
may be subject to CERCLA and analogous state laws. Under such laws, the
Company could be required to remove or remediate previously disposed wastes
(including wastes disposed of or released by prior owners or operators), to
clean up contaminated property (including contaminated groundwater) or to
perform remedial plugging operations to prevent future contamination.
EMPLOYEES
The Company currently has 14 full-time employees and utilizes the
services of approximately 10 consulting geologists, engineers, and land
acquisition professionals. The Company plans to hire additional employees as
needed. The Company has an outsourcing arrangement with Trinity Petroleum
Management, LLC ("Trinity") which provides for administrative services,
specifically land administration and accounting. The Trinity agreement is
effective until August 31, 1999 when it converts to a month-to-month
arrangement. The Company believes that by outsourcing various administrative
functions to Trinity the Company is able to hire fewer full-time employees
and more efficiently control administrative expenses.
CUSTOMERS
During 1998, the Company made no sales of natural gas. The Company
has entered into two natural gas sales contracts with a term of one year each
beginning April 1, 1999. One contract for 5,000 MMBtu per day is with
Interenergy Resources Corporation, an affiliate of KN and the other also for
5,000 MMBtu per day is with Montana-Dakota Utilities Co., a division of MDU
Resources Group, Inc. The Company is dependent on these two customers to
purchase its initial production, particularly until the completion of the
Fort Union pipeline project.
RECENT DEVELOPMENTS
1999 CAPITAL SPENDING PLAN
The Company has announced a capital spending budget of $18.4 million
for 1999, all of which will be directed towards the Company's Powder River
Basin CBM project. The Company plans to spend approximately $9.4 million to
drill approximately 330 net wells in the Powder River Basin during 1999,
although there can be no assurances that it will have sufficient funds to
drill all of these wells, that it would be economic to do so or that these
wells will ultimately be productive. The wells are expected to include both
joint Pennaco/CMS wells drilled in the AMI and Pennaco wells drilled
primarily on a 100% working interest basis located outside of the AMI. The
balance of the 1999 capital budget, approximately $9.0 million, is allocated
to lease acquisition. The Company does not anticipate the need for additional
funding in order to execute its capital spending plan for 1999 based upon the
Company's current cash position.
CMS GATHERING AGREEMENT AND PIPELINE
The Company and CMS announced on March 30, 1999, that the Company has
entered into a gas gathering agreement with CMS Continental Natural Gas, Inc.
("CMS Continental"), a wholly owned subsidiary of CMS Energy Corporation. Under
this agreement, CMS Continental will provide gas gathering services to Pennaco
and CMS Oil and Gas Company within the Pennaco/CMS AMI, which excludes the
Company's South Gillette Area. CMS also announced plans to construct a $190
million, 110 mile high pressure gathering pipeline through the Pennaco/CMS AMI
acreage in the northern Powder Region Basin CBM play. This new gathering
pipeline will connect at its southern terminus with the Fort Union Pipeline
Project, which will transport gas further south to natural gas markets. See
"Item 1--Description of Business--Gas Gathering, Compression, Marketing and
Transcription". There can be no assurance that such system will ultimately be
constructed or that it will be completed in the time-frame currently
anticipated.
PREDECESSOR ENTITIES
The Company was formed under the laws of the State of Nevada on
January 26, 1998, to engage in the business of oil and gas exploration,
production and marketing. The original predecessor of Pennaco was
incorporated on March 12, 1985 as VCI Video Communications, Inc. in the
Province of British Columbia and subsequently changed its name to AKA Video
Communications Inc. ("AVCI"). On March 25, 1996 the shareholders of AVCI
agreed to exchange all AVCI shares for shares of International Metal
Protection, Inc. ("International Metal"), Pennaco's immediate predecessor.
After said exchange AVCI became inactive and the Directors and shareholders
approved the windup of AVCI. International Metal was incorporated on March 5,
1996, in the State of Wyoming. Following an exchange of all the International
Metal outstanding shares in a share for share exchange with Pennaco,
International Metal was dissolved in February of 1998. The Company is the
sole surviving entity of the reorganization.
RISK FACTORS
WE ARE A NEW COMPANY AND HAVE NO OPERATING HISTORY UPON WHICH TO BASE AN
ASSUMPTION THAT WE WILL ACHIEVE OUR BUSINESS GOALS.
We are a development stage company and have no revenues or income
and we are subject to the risks inherent in the creation of a new business.
Since our principal activities to date have been limited to
7
<PAGE>
organizational activities, prospect development, acquisition of leasehold
interests and commencement of a drilling program, we have no record of any
revenue-producing operations. Consequently, there is no operating history
upon which to base an assumption that we will be able to successfully
implement our business plan.
WE DEPEND ON GATHERING, COMPRESSION AND TRANSPORTATION FACILITIES TO MARKET
OUR PRODUCTION AND WE CANNOT GUARANTEE THAT THESE FACILITIES WILL BE
AVAILABLE WHEN NEEDED.
If we begin producing natural gas, the marketability of this
production will depend in part upon the availability, proximity and capacity
of gas gathering and compression systems, pipelines and eventually,
processing facilities. Pipeline demand in the area is increasing as CBM
development activity continues to expand. Our core land position is located
in an area near the development activity. The terms of the CMS Agreement
provide that Pennaco and CMS Oil and Gas establish an area of mutual interest
around our jointly owned acreage and that both Pennaco and CMS Oil and Gas
dedicate all of the acreage in the to CMS Gas Transmission and Storage
Company for gathering, compression and transportation, which shall be
provided at competitive rates and tariffs. CMS Gas Transmission and Storage
Company is currently negotiating to either join other projects or build its
own infrastructure within the AMI. Meanwhile, outside of the AMI, the Company
entered into an agreement with Bear Paw Energy (see "Description of Business
- - Gas Gathering, Compression, Marketing and Transportation") to lay pipeline
to our planned drill sites, and to gather, compress and transport gas. Unless
and until we are able to obtain satisfactory arrangements for the gathering,
compression and transportation of our gas, we may experience delays, possibly
significant, in connection with our efforts to generate revenues from the
sale of gas. Further, there is limited pipeline capacity to transport gas out
of the Powder River Basin which will require expansion and new construction
to accommodate the increasing production. The expansion of the pipeline
capacity is likely to require significant capital outlays by the pipeline
companies and the related plans and specifications are subject to government
regulatory review, permits and approvals. This approval process may result in
delays in the commencement and completion of any pipeline construction
project. We cannot guarantee that certain of our wells will not be shut in
for significant periods of time due to the lack of capacity in existing
pipelines. Further, we cannot guarantee that any such additional pipeline
capacity will be completed on a timely basis or that we will be permitted to
transport any volumes thereon.
WE FACE RISKS RELATED TO THE LEASES WE ENTER INTO THAT MAY RESULT IN
ADDITIONAL COSTS.
It is customary in the oil and gas industry to acquire a lease
interest in a property based upon a preliminary title investigation. If the
title to the leases we acquire are defective, we could lose the money already
spent on acquisition and development, or incur substantial costs to repair
the title defect. Our oil and gas leases give us the right to develop and
produce oil and gas from the leased properties. It is possible that the terms
of our oil and gas leases may be interpreted differently depending on the
state in which the property is located. For instance, royalty calculations
can be substantially different from state to state, depending on each state's
interpretation of lease language concerning the costs of production. We
believe we have followed industry standards in interpreting our oil and gas
leases in the states where we operate. However, we cannot guarantee that
there will be no litigation concerning the proper interpretation of the terms
of our leases. Adverse decisions in such litigation could result in material
costs or the loss of one or more leases.
THE VOLATILITY OF OIL AND GAS MARKETS MAY AFFECT OUR BUSINESS.
If we begin production, our revenues, profitability and future rate
of growth will be substantially dependent upon prevailing market prices for
natural gas and oil, which can be extremely volatile and in recent years have
been depressed at times by excess domestic and imported supplies. In addition
to market factors, actions of state and local agencies, the United States and
foreign governments, and international cartels affect oil and gas prices. All
of these factors will be beyond our control. These external factors and the
volatile nature of the energy markets make it difficult to estimate future
prices of natural gas and oil. We cannot guarantee that we will be able to
produce oil or gas on an economic basis in light of prevailing market prices.
If we are able to produce natural gas, any substantial or extended decline in
the price of natural gas would have a material adverse effect on our
financial condition and results of operations, including reduced cash flow
and borrowing capacity and could reduce both the value and the amount of our
oil and gas reserves.
WE FACE COMPETITION FROM OTHER COMPANIES IN THE NATURAL GAS BUSINESS AND FOR
THE ACQUISITION OF SUITABLE PROPERTIES.
Competition to acquire properties is intense. We compete with a
number of potential purchasers that possess greater financial resources than
are available to us. Different companies evaluate potential acquisitions
differently. This results in widely differing bids. If other bidders are
willing to pay higher prices than we believe are supported by our evaluation
criteria, then our ability to acquire prospects could be limited. Low or
uncertain prices for properties could cause potential sellers to withhold or
withdraw properties from the market. In such an environment, we cannot
guarantee that there will be a sufficient number of suitable prospects
available for acquisition. Also, we may be limited in our options for
developing prospects.
In addition to competition for leasehold acreage in the Powder River
Basin, the oil and gas exploration and production industry is intensely
competitive as a whole. We will compete against established companies that
have significantly greater financial, marketing, personnel, and other
resources than Pennaco. Such competition could have a material adverse effect
on our ability to execute our business plan and our profitability.
SHUT-IN WELLS, CURTAILED PRODUCTION, AND OTHER PRODUCTION INTERRUPTIONS MAY
AFFECT OUR ABILITY TO DO BUSINESS.
In the event that we initiate production and generate income from our CBM
properties, such production may be curtailed or shut-in for considerable
periods of time due to any one, or a combination of the following factors:
- a lack of market demand
- government regulation
- pipeline and processing interruptions
- production allocations
- diminished pipeline capacity and force majeure
These curtailments in production may continue for a considerable period of
time. There may be an excess supply of gas in areas where our operations will
be conducted. In such an event, it is possible that there will be no market
or a very limited market if we do generate production in the future. There is
also the possibility that drilling rigs may not be available when needed and
there may be shortages of crews, equipment and other manpower requirements.
8
<PAGE>
WE ARE SUBJECT TO OPERATING RISKS WHICH MAY NOT BE COVERED BY OUR INSURANCE.
The oil and natural gas business involves certain operating hazards,
such as:
- well blowouts
- craterings
- explosions
- uncontrollable flows of oil, natural gas or well fluids
- fires
- formations with abnormal pressures
- pipeline ruptures or spills
- pollution
- releases of toxic gas
- other environmental hazards and risks
Any of these hazards could cause us to suffer substantial losses if
they occur after we begin commercial production. In addition, we may be
liable for environmental damage caused by previous owners of the property we
have purchased or leased. As a result, substantial liabilities to third
parties or governmental entities may be incurred, the payment of which could
reduce or eliminate the funds available for exploration, development or
acquisitions or cause us to suffer losses. In accordance with customary
industry practices, we maintain insurance against some, but not all, of such
risks and losses. We currently carry well control insurance as well as
property and general liability insurance. We may elect to self-insure if our
management believes that the cost of insurance, although available, is
excessive relative to the risks presented. The occurrence of an event that is
not covered, or not fully covered, by insurance could have a material adverse
effect on our financial condition and results of operations. In addition,
pollution and environmental risks generally are not fully insurable.
OUR DRILLING ACTIVITIES MAY PRODUCE UNDRINKABLE WATER THAT MUST BE TREATED OR
RE-INJECTED WHICH WILL INCREASE OUR COSTS.
If during the course of drilling activity undrinkable water is
discovered, it may be necessary to install and operate evaporators or to
drill disposal wells to re-inject the produced water back into the
underground rock formations adjacent to the coal seams or to lower sandstone
horizons. In the event we are unable to obtain the appropriate permits,
undrinkable water is discovered or if applicable laws or regulations require
water to be disposed of in an alternative manner, the costs to dispose of
produced water will increase and these costs could have a material adverse
effect on our operations in this area and the profitability of such
operations including rendering future production and development uneconomic.
OUR INDUSTRY IS SUBJECT TO EXTENSIVE REGULATION WHICH MAY INCREASE OUR COSTS.
The oil and gas industry is extensively regulated by federal, state
and local authorities. Legislation and regulations affecting the industry are
under constant review for amendment or expansion, raising the possibility of
changes that may affect, among other things, the pricing or marketing of oil
and gas production. Substantial penalties may be assessed for noncompliance
with various applicable statutes and regulations, and the overall regulatory
burden on the industry increases the cost of doing business and, in turn,
decreases its profitability.
WE RELY UPON OUR DIRECTORS AND OFFICERS TO EFFECTIVELY RUN BUSINESS.
We are dependent upon the personal efforts and abilities of our officers,
who exercise control over Pennaco's day to day affairs. Loss of the services
of one or more of these individuals could have a material adverse effect on
our operations. We do have employment agreements with several of our
executive officers. We do not maintain key person life insurance on any of
our executive officers. We are also dependent upon our directors, some of
whom are engaged in other activities and will devote limited time to our
business.
THERE IS CURRENTLY A LIMITED MARKET FOR OUR SECURITIES WHICH MAY IMPEDE YOUR
ABILITY TO RESELL OUR SECURITIES.
At present, a limited market exists for our common stock on the OTC
Bulletin Board system. We cannot guarantee that the OTC Bulletin Board system
will provide adequate liquidity for our common stock or that a trading market
will be sustained for the common stock. If you purchase shares of our common
stock you may be unable to resell them should you desire to do so. While a
number of institutions make a market in our common stock in the OTC market,
there can be no assurance that such institutions will continue to do so.
Furthermore, it is unlikely that a lending institution will accept our common
stock as pledged collateral for loans until a trading market develops
providing necessary and adequate liquidity for the trading of our common
stock.
"PENNY STOCK" REGULATIONS MAY IMPOSE CERTAIN RESTRICTIONS ON MARKETABILITY OF
SECURITIES.
The SEC has adopted regulations which generally define "penny stock"
to be an equity security that has a market price of less than $5.00 per
share. Our common stock may be subject to rules that impose additional sales
practice requirements on broker-dealers who sell such securities to persons
other than established customers and accredited investors (generally those
with assets in excess of $1,000,000, or annual incomes exceeding $200,000 or
$300,000 together with their spouse).
For transactions covered by these rules, the broker-dealer must make
a special suitability determination for the purchase of such securities and
have received the purchaser's prior written consent to the transaction.
Additionally, for any transaction, other than exempt transactions, involving
a penny stock, the rules require the delivery, prior to the transaction, of a
risk disclosure document mandated by the SEC relating to the penny stock
market. The broker-dealer also must disclose the commissions payable to both
the broker-dealer and the registered representative, current quotations for
the securities and, if the broker-dealer is the sole market-maker, the
broker-dealer must disclose this fact and the broker-dealer's presumed
control over the market. Finally, monthly statements must be sent disclosing
recent price information for the penny stock held in the account and
information on the limited market in penny stocks. Consequently, the "penny
stock" rules may restrict the ability of broker-dealers to sell our common
stock and may affect the ability of investors to sell our common stock in the
secondary market.
9
<PAGE>
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-KSB includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended
(the "Securities Act") and Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"). All statements other than statements
of historical fact included in the Form 10-KSB, including without limitations
statements under "Description of Business" and "Plan of Operation." Although
the Company believes that the expectations reflected in such forward-looking
statements are reasonable, it can give no assurance as that such expectations
will prove to have been correct. All subsequent written and oral forward-looking
statements are attributable to the Company or persons acting on its behalf or
expressly qualified in the entirety by such factors.
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
OPERATIONS
The Company initiated its drilling program on November 15, 1998 and
had drilled approximately 32 gross (28 net) wells as of December 31,1998. As
of March 22, 1999, the Company has drilled approximately 135 gross (118
net) CBM wells and plans to drill approximately 330 net CBM wells in 1999,
although there can be no assurances that it will have sufficient funds to
drill all of these wells, that it would be commercially reasonable to drill
all of these wells or that these wells will ultimately be productive. All of
the wells drilled to date have been operated by Pennaco. The wells the
Company has drilled to date have each taken an average of three days to drill
and are in various stages of completion and testing while awaiting
construction of gathering and compression systems and connection to a
pipeline. The success of the Company's drilling program (including the
magnitude of any potential reserves) cannot be determined until the wells are
completed, connected to a gathering system and produced for a period of time.
The Company's ability to complete its drilling program is entirely
dependent upon the availability of sufficient capital, equipment and
personnel. The estimated total cost per well is approximately $60,000 to
drill, complete and install well connection facilities. The estimated
drilling portion of the total per well cost is approximately $10,000 per well.
The Company has entered into a drilling agreement with CBM Drilling,
LLC ("CBMD"), pursuant to which Pennaco had prepaid drilling costs of
$333,473 as of December 31, 1998. Based on the agreement that every third
well shall be drilled at no cost to Pennaco, the prepaid drilling costs will
be recovered after approximately 100 additional net wells are drilled for
Pennaco by CBMD. The prepayments to CBMD were made to ensure that drilling
rigs appropriate for CBM drilling operations will be available and dedicated
to the Company's planned drilling program. CBMD currently has four CBM
drilling rigs, three of which are primarily dedicated to the Company's
drilling program.
Approximately 50% of the average $60,000 total well cost is well
connection cost comprised of gathering lines, power lines and surface
equipment. In the South Gillette Area where the Company has drilled most of
the 135 wells drilled as of March 22, 1999, Pennaco has entered into a gas
gathering and compression agreement with Bear Paw Energy that also provides
for well connection services in return for a per mcf gathering fee.
Accordingly, the Company has reduced its average well costs in the South
Gillette Area to approximately $30,000 per well in return for a comprehensive
well connection, gathering and compression fee. In the South Gillette Area,
Bear Paw Energy will construct, own and operate all gathering and compression
facilities from the wellhead to the interconnect with MIGC, Fort Union or
Thunder Creek pipelines. The Company intends to continue to allocate its
capital expenditures to drilling, completion and lease acquisition activities
rather than well connection, gathering and compression activities.
DRILLING ACTIVITY
The following table summarizes the Company's drilling activities,
all of which were located in the Powder River Basin, during the past year:
<TABLE>
<CAPTION>
Wells Drilled
-------------
Period from inception (January 26, 1998)
----------------------------------------
to December 31, 1998
--------------------
Gross Net
<S> <C> <C>
Development
Natural gas 30 28
Non-productive - -
------------------- --------------------
Total 30 28
------------------- --------------------
------------------- --------------------
Exploratory
Natural gas 2 2
Non-productive - -
------------------- --------------------
Total 2 2
------------------- --------------------
------------------- --------------------
</TABLE>
10
<PAGE>
NATURAL GAS RESERVES
The table below sets forth the Company's quantities of proved
reserves as of December 31, 1998, all of which were located in the United
States, and the present value of future net revenue attributed to those
reserves. The estimates were prepared by the independent petroleum
engineering firm of Ryder Scott Company ("Ryder Scott").
<TABLE>
<CAPTION>
December 31, 1998
-----------------
<S> <C>
Proved Reserves
Natural gas (Bcf) 18.1
Oil and condensate (MMBbls) -
--------------------
Total (Bcfe) 18.1
--------------------
--------------------
Proved developed reserves (Bcfe) 5.5
Present value of estimated future net revenues before
Income taxes discounted at 10% (1) $8,528,000
Standardized measure of discounted future net cash flows (2) $6,142,000
</TABLE>
- ----------
(1) The present value of estimated future net revenues on a non-escalated
basis is based on the weighted average price of $1.16 per Mcf of natural
gas at December 31, 1998, the price that the Company believes it would
have realized at the field meter.
(2) The standardized measure of discounted net cash flows represents the
present value of estimated future net revenues after income taxes,
discounted at 10%.
In accordance with SEC requirements, estimates of the Company's
proved reserves and future net revenues are made using sales prices estimated
to be in effect as of the date of such reserve estimates and are held
constant throughout the life of the properties (except to the extent a
contract specifically provides for escalation). Estimated quantities of
proved reserves and future net revenues therefrom are affected by natural gas
and oil prices, which have fluctuated widely in recent years. There are
numerous uncertainties inherent in estimating natural gas and oil reserves
and their estimated values, including many factors beyond the control of the
producer. The reserve data set forth in this document represents only
estimates. Reservoir engineering is a subjective process of estimating
underground accumulation of natural gas and oil that cannot be measured in an
exact manner. The accuracy of any reserve estimate is a function of the
quality of available data and of engineering and geological interpretation
and judgement. As a result, estimates of different engineers, including those
used by the Company, may vary. In addition, estimates of reserves are subject
to revision based upon actual production, results of future development and
exploration activities, prevailing natural gas and oil prices, operating
costs and other factors, which revisions may be material. Accordingly,
reserve estimates are often different from the quantities of natural gas and
oil that are ultimately recovered and are highly dependent upon the accuracy
of the assumptions upon which they are based.
In general, the volume of production from natural gas and oil
properties owned by the Company declines as reserves are depleted. Except to
the extent the Company acquires additional properties containing proved
reserves or conducts successful exploration and development activities, or
both, the proved reserves of the Company will decline as reserves are
produced. Volumes generated from future activities of the Company are
therefore highly dependent upon the level of success in acquiring or finding
additional reserves and the costs incurred in doing so.
Reference should be made to Note 9--"Information Regarding Proved
Oil and Gas Reserves" to the Financial Statements included in this document for
additional information pertaining to the Company's proved natural gas reserves
as of December 31, 1998.
PRODUCTION
The Company had no oil and gas production in 1998. The Company plans
to commence natural gas production in April 1999 (See "Item 1 - Description
of Business - General").
PRODUCTIVE WELLS
The following table sets forth, as of December 31, 1998, the number
of gross and net productive oil and gas wells in which the Company owned an
interest. Productive wells are producing wells and wells capable of
production, including shut-in wells.
<TABLE>
<CAPTION>
Productive Wells
----------------
Natural Gas Oil
------------------ ----------------
Gross Net Gross Net
------------------------------------------------
<S> <C> <C> <C>
32 28 - -
</TABLE>
DEVELOPED AND UNDEVELOPED ACREAGE
The gross and net acres of developed and undeveloped oil and gas
leases held by the Company as of December 31, 1998 are summarized in the
following table. "Undeveloped Acreage" includes leasehold interests that
contain proved undeveloped reserves.
<TABLE>
<CAPTION>
Pro Forma (2)
-------------
Developed Undeveloped Developed Undeveloped
Acreage Acreage (1) Acreage Acreage (1)
-------- ----------- -------- -----------
Gross Net Gross Net Gross Net Gross Net
----- --- ----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wyoming 1,760 1,604 461,025 312,725 1,760 1,604 461,025 212,890
Montana - - 208,227 167,388 - - 208,227 92,044
----- ----- ------- ------- ----- ----- ------- -------
Total 1,760 1,604 669,252 480,113 1,760 1,604 669,252 304,934
----- ----- ------- ------- ----- ----- ------- -------
----- ----- ------- ------- ----- ----- ------- -------
</TABLE>
11
<PAGE>
- --------------
(1) Undeveloped acreage is leased acreage on which wells have not been
drilled or completed to a point that would permit the production of
commercial quantities of natural gas and oil regardless of whether such
acreage contains proved reserves. Of the aggregate 669,252 gross and
480,113 net undeveloped acres, 23,470 gross and 20,166 net acres are held
by production from other leasehold acreage generally owned and operated
by third parties.
(2) Pro forma to give effect to the closing of the CMS Transaction which
occurred on January 15, 1999. See "Item 1 - Description of Business -
CMS Transaction." Approximately 20,000 net undeveloped acres are
subject to an election to purchase on behalf of CMS pursuant to the
terms of the CMS Transaction.
Substantially all the leases summarized in the preceding table will
expire at the end of their respective primary terms unless the existing
leases are renewed or production has been obtained from the acreage subject
to the lease prior to that date, in which event the lease will remain in
effect until the cessation of production. The following table sets forth the
gross and net acres to leases summarized in the preceding table that will
expire during the periods indicated:
<TABLE>
<CAPTION>
ACRES EXPIRING
--------------
Pro Forma (2)
-------------------------
Undeveloped Undeveloped
Acreage Acreage
------- -------
TWELVE MONTHS ENDING: GROSS NET GROSS NET
--------------------- ----- --- ----- ---
<S> <C> <C> <C> <C>
December 31, 1999 4,616 4,077 4,616 3,917
December 31, 2000 3,241 2,892 3,241 2,331
December 31, 2001 6,765 4,929 6,765 4,403
December 31, 2002 56,269 20,789 56,269 14,444
December 31, 2003 and thereafter 574,891 427,260 574,891 264,365
----------- ------------- ----------- ------------
Primary Term Acreage 645,782 459,947 645,782 289,460
Held by Production Acreage(1) 23,470 20,166 23,470 15,474
----------- ------------- ----------- ------------
Total Undeveloped Acreage 669,252 480,113 669,252 304,934
----------- ------------- ----------- ------------
----------- ------------- ----------- ------------
</TABLE>
- -------------
(1) Held by production acreage is leasehold interest in oil and gas properties,
which is beyond its primary term and is being kept in force by virtue of
production of oil and gas in commercial quantities.
(2) Pro forma to give effect to the closing of the CMS Transaction which
occurred on January 15, 1999. See "Item 1 - Description of Business -
CMS Transaction." Approximately 20,000 net undeveloped acres are
subject to an election to purchase on behalf of CMS pursuant to the
terms of the CMS Transaction.
PROPERTIES
Following the second closing of the CMS Transaction on January 15,
1999, the Company owned oil and gas leases covering approximately 304,934 net
acres in the Powder River Basin of Wyoming and Montana. Since the second
closing, Pennaco has acquired an additional 6,800 net acres outside of the
CMS AMI, increasing the Company's leasehold total to approximately 311,800
net acres as of March 1, 1999. Approximately 56% of the acreage is located on
federal and state land and approximately 44% of the acreage is located on
private land. The Company's leases generally have five to ten year primary
terms. The federal leases are generally ten year term leases and newly
acquired fee and state leases are generally five-year term leases.
The Company's Powder River Basin leasehold can generally be divided
into four separate project areas as follows:
South Gillette Area - Pennaco holds approximately 9,000 net acres in
this project area located south of the town of Gillette, Wyoming and outside
the CMS AMI. The Company began its initial drilling program in this area and
the majority of its wells drilled to date are located here. The Company's
South Gillette Area wells have an average 94% working interest and all are
operated by the Company. The wells are in the process of being tested,
dewatered and connected to gathering and compression systems. The Company's
first gas production is expected to begin flowing from this area in April
1999 although there can be no assurance in this regard. The Company has
acquired approximately 6,800 net acres in the South Gillette Area since the
closing of the CMS Transaction.
Northern Fairway Area - Pennaco holds approximately 142,000 net
acres in this project area located north of the town of Gillette, Wyoming, up
to the Wyoming border on the east side of the basin. Virtually all of the
Company's leasehold acreage in this area is included in the AMI with CMS. The
Company drilled and is the operator of 11 exploratory CBM wells in the
Spotted Horse Prospect in this area in January 1999. The Company also drilled
and is the operator of four exploratory CBM wells in the Collums Prospect the
first quarter of 1999. The wells in these two prospects are in the process of
completion and testing.
Border Area - Pennaco holds approximately 92,000 net acres in this
project area located in Montana adjoining the Wyoming border adjacent to the
Northern Fairway Area and the Sheridan Area. All of the Company's leasehold
in this area is included in the AMI with CMS. Some CBM drilling activity has
occurred in the Border Area.
Sheridan Area - Pennaco holds approximately 62,000 net acres in this
project area located in Wyoming primarily east of the town of Sheridan on the
west side of the basin. Virtually all of the Company's leasehold in this area
is included in the AMI with CMS. The Company has not drilled any wells in
this area.
Historically, oil and gas has been produced from a number of other
reservoirs in the Powder River Basin that are typically greater in depth than
CBM locations. Over 75% of the Company's leasehold acreage allow for
development of all depths. These leases cover both the shallow CBM and
exploration potential for oil and gas from the deeper horizons. Past
exploration of the sedimentary section below the Paleocene coal section has
resulted in production from sandstone reservoirs in 25 formations from upper
Cretaceous to Pennsylvanian age. No such production has been generated from
the Company's leases.
TITLE TO PROPERTIES
As is customary in the oil and gas industry, only a preliminary
title examination is conducted at the time oil and gas leases covering
properties believed to be suitable for drilling operations are acquired by
the
12
<PAGE>
Company. Prior to the commencement of drilling operations, a thorough title
examination of the drill site tract is conducted by independent attorneys.
Once production from a given well is established, the Company prepares a
division order title report indicating the proper parties and percentages for
payment of production proceeds, including royalties. The company believes
that title to its leasehold properties is good and defensible in accordance
with standards generally acceptable in the oil and gas industry. The
Company's properties are 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.
OFFICE FACILITIES
The Company's office space is currently subleased pursuant to an
agreement with Evansgroup, Inc. The term of the sublease commenced on April
6, 1998 and expires on September 30, 2000. The sublease covers approximately
11,524 square feet at a yearly rent of approximately $173,000.
The Company also leases office and lodging space in Gillette,
Wyoming. The term of the office lease commenced on October 5, 1998 and
expires on April 4, 1999. The lease covers approximately 9,000 square feet at
a yearly rent of approximately $17,400. In February 1999 a new lease/purchase
agreement was entered into whereby the term of the lease/purchase agreement
commences on April 4, 1999 and expires December 31, 2000. The yearly rent is
approximately $17,400. Under terms of the purchase option, $1,000 per month
of the rent is deemed to apply to a purchase option on the property. The
purchase option expires January 7, 2001.
ITEM 3. LEGAL PROCEEDINGS
The Company may be subject from time to time to routine litigation
in connection with its oil and gas operations. Currently the Company is not
involved in litigation which could have a material impact on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security
holders during 1998.
13
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Since July 1, 1998, Pennaco's common stock, par value $.001 (the
"Common Stock") has been traded over the counter and quoted on the OTC
Bulletin Board System. The following table sets forth the high and low
closing prices for the Common Stock as reported on the OTC Bulletin Board
System for the period from July 1, 1998 through March 24, 1999.
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
Year Ended December 31, 1998
Third Quarter................................ $6.16 $3.03
Fourth Quarter............................... $5.38 $2.50
Year Ended December 31, 1999
First quarter (through March 24, 1999)....... $4.13 $2.97
</TABLE>
As of December 31, 1998, there were approximately 3,225 stockholders
of record of the Common Stock.
DIVIDEND POLICY
The Company intends to retain all of its earnings, if any, to
finance the expansion of its business and for general corporate purposes,
including future acquisitions of properties. The Company does not anticipate
paying cash dividends on its Common Stock in the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES.
Set forth below is certain information concerning all sales of
securities by the Company during the period from inception (January 26, 1998)
through December 31, 1998, that were not registered under the Securities Act:
(a) The Company issued 995,000 shares in January 1998 pursuant to a
share-for-share exchange with the stockholders of International Metal
Protection, Inc. in a transaction conducted solely to reincorporate the
Company in a new jurisdiction. This transaction was exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) of
the Securities Act. There was no change in ownership and the stockholders
made no significant investment decision.
(b) The Company issued 500,000 shares in February 1998 for the purchase
price of $.10 per share pursuant to a private placement exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) of
the Securities Act. At that time, the Company had only a business plan and no
assets. There were eleven offerees in this offering, all of whom made
purchases and all of whom were sophisticated investors. The Company fully
apprised each of the offerees of the Company's start-up nature and gave them
full details regarding the Company's business plan. There was no general
solicitation or advertising used in connection with the offer to sell or sale
of these securities. The purchasers were advised that the securities, once
purchased, could not be resold or otherwise transferred without subsequent
registration under the Securities Act. Each purchaser represented to the
Company that they were purchasing the securities for their own account for
investment purposes only.
(c) The Company issued 4,530,000 shares in February 1998 for a purchase
price of $.22 per share pursuant to a Regulation D, Rule 504 offering.
Offerees were provided with a private placement memorandum containing
detailed information about the Company and its plan. The Company required
each prospective investor to represent in writing that (i) they had adequate
means of providing for their current needs and personal contingencies and had
no need to sell the securities in the foreseeable future and (ii) they,
either alone or with their duly designated purchaser representative, had such
knowledge and experience in business and financial matters that they were
capable of evaluating the risks and merits of an investment in the securities.
(d) The Company issued 5,000,000 shares in April 1998 for a purchase
price of $1.25 per share pursuant to a Regulation D, Rule 506 offering. The
Company accepted subscriptions only from accredited investors. Offerees were
provided with a private placement memorandum containing detailed information
about the Company and its plan. The Company required each prospective
investor to represent in writing that (i) they had received and reviewed the
private placement memorandum and understood the risks of an investment in the
Company; (ii) they had the experience and knowledge with respect to similar
investments which enabled them to evaluate the merits and risks of such
investment, or they had obtained and relied upon an experienced independent
adviser with respect to such evaluation; (iii) they had adequate means to
bear the economic risk of such investment, including the loss of the entire
investment; (iv) they had adequate means to provide for their current needs
and possible personal contingencies; (v) they had no need for liquidity of
their investment in the Company; (vi) they understood that the securities had
not been registered under the Securities Act and may not have not been
registered or qualified under applicable state securities laws and,
therefore, that they could not sell or transfer the securities unless the
securities were subsequently registered or an exemption therefrom was
available to them; (vii) they were acquiring the securities for investment
solely for their own account and without any intention of reselling or
distributing them; and (viii) they understood that the securities would bear
a restrictive legend prohibiting transfers except in compliance with the
provisions of the securities, the subscription agreement executed by the
purchaser and the applicable federal and state securities laws.
(e) The Company issued 128,000 share purchase warrants with an exercise
price of $1.25 per share, exercisable after April 15, 1999, to Yorkton
Securities ("Yorkton"), an accredited investor, in April 1998 pursuant to a
private placement exemption from the registration requirements of the
Securities Act under Section 4(2) of the Securities Act. These warrants were
issued pursuant to a negotiated transaction between the Company and Yorkton,
whereby Yorkton agreed to provide corporate finance services to the Company
for one year in return for these warrants.
(f) The Company issued 2,000,000 shares in June 1998 to RIS Resources
International Corp., a Canadian corporation, pursuant to a Regulation D, Rule
506 offering for a purchase price of $1.75 per share. The Company accepted
subscriptions only from accredited investors. Offerees were provided with a
private placement memorandum containing detailed information about the
Company and its plan. The Company required each prospective investor to
represent in writing that (i) they had received and reviewed the private
placement
14
<PAGE>
memorandum and understood the risks of an investment in the Company; (ii)
they had the experience and knowledge with respect to similar investments
which enabled them to evaluate the merits and risks of such investment, or
they had obtained and relied upon an experienced independent adviser with
respect to such evaluation; (iii) they had adequate means to bear the
economic risk of such investment, including the loss of the entire
investment; (iv) they had adequate means to provide for their current needs
and possible personal contingencies; (v) they had no need for liquidity of
their investment in the Company; (vi) they understood that the securities had
not been registered under the Securities Act and may have not been registered
or qualified under applicable state securities laws and, therefore, that they
could not sell or transfer the securities unless the securities were
subsequently registered or an exemption therefrom was available to them;
(vii) they were acquiring the securities for investment solely for their own
account and without any intention of reselling or distributing them; and
(viii) they understood that the securities would bear a restrictive legend
prohibiting transfers except in compliance with the provisions of the
securities, the subscription agreement executed by the purchaser and the
applicable federal and state securities laws.
(g) The Company issued 796,429 units which were purchased in June, July
and September 1998 pursuant to a Regulation D, Rule 506 offering by three
members of the management team of the Company, for a purchase price of $1.75
per unit, each unit consisting of one share and a one share purchase warrant
for every two shares purchased. Each share purchase warrant has a two year
term with an exercise price of $1.75 per share in the first year and $1.96
per share in the second year. All units were purchased by three members of
the management team of the Company. Offerees were provided with a private
placement memorandum containing detailed information about the Company and
its plan. The Company required each prospective investor to represent in
writing that (i) they had received and reviewed the private placement
memorandum and understood the risks of an investment in the Company; (ii)
they had the experience and knowledge with respect to similar investments
which enabled them to evaluate the merits and risks of such investment, or
they had obtained and relied upon an experienced independent adviser with
respect to such evaluation; (iii) they had adequate means to bear the
economic risk of such investment, including the loss of the entire
investment; (iv) they had adequate means to provide for their current needs
and possible personal contingencies; (v) they had no need for liquidity of
their investment in the Company; (vi) they understood that the securities had
not been registered under the Securities Act and may have not been registered
or qualified under applicable state securities laws and, therefore, that they
could not sell or transfer the securities unless the securities were
subsequently registered or an exemption therefrom was available to them;
(vii) they were acquiring the securities for investment solely for their own
account and without any intention of reselling or distributing them; and
(viii) they understood that the securities would bear a restrictive legend
prohibiting transfers except in compliance with the provisions of the
securities, the subscription agreement executed by the purchaser and the
applicable federal and state securities laws.
(h) The Company issued 980,000 units on September 4, 1998 pursuant to a
Regulation D, Rule 506 offering for a purchase price of $3.25 per unit, each
unit consisting of one share and a one share purchase warrant for every two
shares purchased. Under the terms of the stock subscription agreement, an
additional 235,000 units at a purchase price of $3.25 per unit were held in
escrow pending registration with the SEC by December 31, 1998. Since the
Company was unable to register these shares by December 31, 1998, certain of
the subscribers were given the option to either (i) take the escrowed shares
with the Company receiving the escrowed proceeds or (ii) accept return of the
proceeds with interest while returning the escrowed shares to the Company.
The Company accepted subscriptions only from accredited investors. Offerees
were provided with a private placement memorandum containing detailed
information about the Company and its plan. The Company required each
prospective investor to represent in writing that (i) they had received and
reviewed the private placement memorandum and understood the risks of an
investment in the Company; (ii) they had the experience and knowledge with
respect to similar investments which enabled them to evaluate the merits and
risks of such investment, or they had obtained and relied upon an experienced
independent adviser with respect to such evaluation; (iii) they had adequate
means to bear the economic risk of such investment, including the loss of the
entire investment; (iv) they had adequate means to provide for their current
needs and possible personal contingencies; (v) they had no need for liquidity
of their investment in the Company; (vi) they understood that the securities
had not been registered under the Securities Act and may have not been
registered or qualified under applicable state securities laws and,
therefore, that they could not sell or transfer the securities unless the
securities were subsequently registered or an exemption therefrom was
available to them; (vii) they were acquiring the securities for investment
solely for their own account and without any intention of reselling or
distributing them; and (viii) they understood that the securities would bear
a restrictive legend prohibiting transfers except in compliance with the
provisions of the securities, the subscription agreement executed by the
purchaser and the applicable federal and state securities laws. Yorkton
served as placement agent for this private placement. As compensation,
Yorkton received share purchase warrants to purchase 75,200 shares at an
exercise price of $3.58.
(i) The Company issued warrants to purchase 90,000 shares of common
stock to SMS Operating, LLC as partial consideration for a lease acquisition.
The warrants are exercisable at $4.72 per share anytime after November 24,
1998 and expire November 24, 2002. The estimated fair value of the warrants
issued of $232,201 was capitalized as lease acquisition cost.
ITEM 6. PLAN OF OPERATION
The following information should be read in conjunction with the
Financial Statements and Notes thereto presented elsewhere in this Form
10-KSB. The Company follows the successful efforts method of accounting for
oil and gas properties. See "Organization and Summary of Accounting
Policies," included in Note 1 of the Consolidated Financial Statements.
GENERAL
As a development stage company, the Company had no revenues from
operations in 1998. During the period from the Company's inception (January
26, 1998) through December 31, 1998, the Company reported a net loss of
$3,812,873. The Company realized a gain on sale of property of $1,413,207
based on the $7,600,000 of proceeds received in the first closing of the CMS
Transaction which occurred on November 20, 1998. Expenses incurred from the
Company's inception (January 26, 1998) through December 31, 1998 totaled
$6,547,366, including general and administrative expenses of $3,977,592 and
exploration expenses of $1,825,767, including geologic consulting fees,
geologic data and lease rentals.
In the accompanying financial statements, in accordance with APB No. 25
"Accounting for Stock Issued to Employees," the Company has recognized a
non-cash charge to earnings for compensation expense of approximately
$1,790,000 for the period from inception (January 26, 1998) through December
31, 1998 for stock, warrants, and options issued to certain officers and
employees. Compensation expense was calculated based on the difference
between the closing price per share on the last trading day prior to the date
of employment with the Company and the $1.75 unit price for shares and
warrants purchased by an officer of the Company hired at the beginning of
July and the option price for options awarded to certain officers and key
employees hired in July and August 1998. The restricted securities were
offered as an incentive to attract a senior management team to the Company.
The Company believes that the offers made by the Board of Directors were at
fair market value due to the restricted nature of the securities to be issued
and the lack of a liquid trading market for the Company's
15
<PAGE>
Common Stock at the time of the offer. However, APB No. 25 requires the
measurement of compensation expense at the date of employment rather than at
the offer date. Further, APB No. 25 requires that compensation be measured
based on the quoted market price of the stock once a company's stock is
publicly traded. While the Company was not yet an SEC registrant until
September 8, 1998, the Company's shares have been quoted on the OTC Bulletin
Board System since July 1, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The capital resources of the Company are limited. At present, the
Company is not producing revenues and its main source of funds has been the
sale of the Company's equity securities and the proceeds from CMS
Transaction. The Company had approximately $5.6 million in cash as of
December 31, 1998.
On October 23, 1998, the Company and CMS Oil and Gas Company
announced the CMS Transaction. See "Item 1 - Description of Business - CMS
Transaction." Pursuant to the terms of the CMS Agreement, CMS paid Pennaco
$5.6 million in the form of the CMS Bridge Loan secured by substantially all
of the Company's oil and gas leases. Approximately $3.2 million of such
amount was paid directly to existing creditors of the Company. The Company
used the balance for general corporate purposes. The Company received $7.6
million at the first closing on November 20, 1998 and $14.8 million at the
second closing on January 15, 1999 less approximately $1.8 million which was
deposited into an escrow account subject to customary closing adjustments.
The CMS Bridge Loan was canceled at the second closing. Pro forma for the
CMS Transaction as of December 31, 1998, the Company had no debt and
approximately $19.8 million of cash. As of March 12, 1999, approximately
$1.2 million is held in escrow pending closing adjustments for the CMS
Transaction. While the proceeds of the CMS Transaction allowed the Company to
repay its current liabilities and should allow the Company to fund its planned
$18.4 million capital expenditure program for 1999, the Company will require
further funding to meet its future capital expenditure plans.
Should the Company's cash flow from operations continue to be
insufficient to satisfy its capital expenditure requirements, there can be no
assurance that additional debt or equity financing will be available to meet
these requirements. At present, there are no agreements or understandings
between the Company and its officers and directors or affiliates and any
lending institutions with respect to any debt or equity financings. The
Company plans to pursue a bank credit facility commitment in the second
quarter of 1999. There can be no assurances as to the availability or
borrowing capacity of such a bank facility.
Should the Company be able to obtain debt financing in the future, its
level will have several important effects on the Company's future operations,
including (i) a substantial portion of the Company's cash flow could be
dedicated to the payment of interest on its indebtedness and would not be
available for other purposes and (ii) the Company's ability to obtain
additional financing in the future may be impaired. To address the
operational and administrative requirements of the Company's ongoing
development activities, it is anticipated that during the next 12 months
employee requirements will increase to approximately 18 employees. Currently,
the Company has 14 full-time employees.
CAPITAL EXPENDITURES
The Company had capital expenditures of approximately $19.2 million
in 1998, including approximately $18.1 million for lease acquisitions and
$0.8 million for drilling activities. On February 4, 1999, the Company
announced a capital spending budget of $18.4 million for 1999, all of which
will be directed towards the Company's Powder River Basin CBM project. The
Company plans to spend approximately $9.4 million to drill approximately 330
net wells in the Powder River Basin during 1999, although there can be no
assurances that it will have sufficient funds to drill all of these wells,
that it would be economic to do so or that these wells will ultimately be
productive. The wells will be a combination of joint Pennaco/CMS wells drilled
in the AMI and Pennaco wells drilled primarily on a 100% working interest
basis located outside of the AMI. The balance of the 1999 capital budget,
approximately $9.0 million, is allocated to lease acquisition. The Company
does not anticipate the need for additional funding in order to execute the
announced capital spending plan for 1999 based upon the Company's current cash
position.
16
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
The Board of Directors
Pennaco Energy, Inc.:
We have audited the accompanying balance sheet of Pennaco Energy, Inc. (a
development stage company) as of December 31, 1998, and the related statements
of operations, stockholders' equity and cash flows for the period from January
26, 1998 (inception) 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pennaco Energy, Inc. as of
December 31, 1998, and the results of its operations and its cash flows for the
period from January 26, 1998 (inception) to December 31, 1998, in conformity
with generally accepted accounting principles.
KPMG LLP
Denver, Colorado
March 12, 1999
17
<PAGE>
ITEM 7.
PENNACO ENERGY, INC.
(A Development Stage Company)
Balance Sheet
December 31, 1998
<TABLE>
<CAPTION>
Pro Forma
Historical (Note 2)
---------------- ---------------
(unaudited)
<S> <C> <C>
Current Assets:
Cash $5,622,776 19,804,190
Accounts receivable 374,728 374,728
Unit subscriptions receivable 763,750 763,750
Assets held for sale 6,931,995 -
Drilling deposit 333,473 333,473
Inventory 231,116 231,116
Prepaid expenses and other current assets 151,858 151,858
---------------- ---------------
Total current assets 14,409,696 21,659,115
---------------- ---------------
Property and equipment, at cost:
Oil and gas properties, using the successful
efforts method of accounting (note 8):
Unproved 4,656,965 4,656,965
Proved 1,358,769 1,358,769
Other property and equipment 296,119 296,119
---------------- ---------------
6,311,853 6,311,853
Less accumulated depreciation (61,607) (61,607)
---------------- ---------------
Net property and equipment 6,250,246 6,250,246
---------------- ---------------
Deferred income tax asset 1,266,000 1,806,000
Other assets 99,795 99,795
---------------- ---------------
$22,025,737 29,815,156
---------------- ---------------
---------------- ---------------
Current liabilities:
Bridge loan payable (notes 2 and 3) $5,600,000 -
Lease acquisitions payable 618,586 -
Accounts payable and accrued liabilities 1,964,228 1,964,228
Income taxes payable - 5,389,000
---------------- ---------------
Total current liabilities 8,182,814 7,353,228
---------------- ---------------
Stockholders' equity (note 5):
Common stock, $.001 par value. Authorized
50,000,000 shares; 14,795,179 shares
issued and outstanding 15,152 15,152
Additional paid-in capital 17,640,644 17,640,644
Retained earnings (deficit) accumulated
during the development stage (3,812,873) 4,806,132
----------------- ---------------
Total stockholders' equity 13,842,923 22,461,928
---------------- ---------------
Commitments (note 7)
$22,025,737 29,815,156
---------------- ---------------
---------------- ---------------
</TABLE>
See accompanying notes to financial statements.
18
<PAGE>
PENNACO ENERGY, INC.
(A Development Stage Company)
Statement of Operations
Period from January 26, 1998 (inception) to December 31, 1998
<TABLE>
<S> <C>
Revenue:
Gain on sale of property $1,413,207
Interest income 55,286
-----------
Total revenue 1,468,493
-----------
Expenses:
Exploration 1,825,767
Depreciation and amortization 61,607
General and administrative 3,977,592
Interest expense 682,400
-----------
Total expenses 6,547,366
-----------
Loss before income taxes (5,078,873)
Income tax benefit 1,266,000
-----------
Net loss and deficit accumulated during
the development stage $(3,812,873)
-----------
-----------
Loss per share (0.34)
-----------
-----------
Weighted average common shares outstanding 11,245,298
-----------
-----------
</TABLE>
See accompanying notes to financial statements.
19
<PAGE>
PENNACO ENERGY, INC.
(A Development Stage Company)
Statement of Stockholders' Equity
Period from January 26, 1998 (inception) to December 31, 1998
<TABLE>
<CAPTION>
Common Stock Units Additional
------------ to be Paid-in Accumulated
Shares Amount Issued Capital Deficit Total
------ ------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Balances at January 26,
1998 (inception) - $ - - - - -
Common stock issued in
connection with share
exchange (note 1) 995,000 995 - (995) - -
Common stock issued for cash,
net of offering costs of
$178,014 (note 5) 12,030,000 12,030 - 10,607,551 - 10,619,581
Compensation relating to
common stock and warrants
(note 5) - - - 1,340,000 - 1,340,000
Stock option compensation
(note 5) - - - 450,000 - 450,000
Units issued for cash, net of
offering costs of $324,675
(note 5) 1,770,179 1,770 - 4,231,993 - 4,233,763
Warrants issued for properties
and services (note 5) - - - 248,702 - 248,702
Units to be issued from escrow
(note 5) 356,500 - 357 763,393 - 763,750
Net loss for the period - - - - (3,812,873) (3,812,873)
-------------- ---------- ------------- -------------- ----------------- ------------------
Balances at December 31, 1998 15,151,679 $14,795 357 17,640,644 (3,812,873) 13,842,923
-------------- ---------- ------------- -------------- ----------------- ------------------
-------------- ---------- ------------- -------------- ----------------- ------------------
</TABLE>
See accompanying notes to financial statements.
20
<PAGE>
PENNACO ENERGY, INC.
(A Development Stage Company)
Statement of Cash Flows
Period from January 26, 1998 (inception) to December 31, 1998
<TABLE>
<S> <C>
Cash flows from operating activities:
Net loss $(3,812,873)
Adjustments to reconcile net loss to net cash used in
operating activities:
Gain on the sale of property (1,413,207)
Depreciation and amortization 61,607
Compensation relating to common stock and warrants issued 1,340,000
Stock option compensation 450,000
Warrants issued for services 16,500
Deferred income tax benefit (1,266,000)
Increases in operating assets and liabilities:
Accounts receivable (374,728)
Prepaid expenses and other current assets (151,858)
Inventory (231,116)
Other assets (99,795)
Accounts payable and accrued liabilities 1,964,228
---------------
Net cash used by operating activities (3,517,242)
----------------
Cash flows from investing activities:
Capital expenditures (19,198,439)
Proceeds from sale of properties 7,600,000
Drilling deposit (333,473)
Increase in lease acquisitions payable 618,586
---------------
Net cash used by investing activities (11,313,326)
----------------
Cash flows from financing activities:
Proceeds from issuance of bridge loans 8,800,000
Repayment of bridge loan (3,200,000)
Proceeds from issuance of note payable 500,000
Repayment of note payable (500,000)
Proceeds from issuance of common stock, net of offering costs 14,853,344
---------------
Net cash provided by financing activities 20,453,344
Net increase in cash 5,622,776
Cash at beginning of period -
---------------
Cash at end of period $ 5,622,776
---------------
---------------
Supplemental disclosures of cash flow information:
Cash paid for interest $ 682,400
---------------
---------------
Cash paid for income taxes $ -
---------------
---------------
</TABLE>
See accompanying notes to financial statements.
21
<PAGE>
PENNACO ENERGY, INC.
(A Development Stage Company)
December 31, 1998
Notes to Financial Statements
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ORGANIZATION AND BASIS OF PRESENTATION
Pennaco Energy, Inc. (the "Company") is an independent energy
company primarily engaged in the acquisition and development of
natural gas production from coal bed methane properties in the
Rocky Mountain region of the United States. The Company was
incorporated on January 26, 1998 under the laws of the state of
Nevada and its headquarters are in Denver, Colorado.
The Company's activities to date have been limited to
organizational activities, prospect development activities,
acquisition of leases and option rights, and commencement of its
drilling program. The Company currently has oil and gas lease
rights in the Powder River Basin in northeastern Wyoming and
southeastern Montana. Currently the Company has no revenue
producing operations. Accordingly, the Company is considered to be
in the development stage.
The Company was incorporated as a wholly-owned subsidiary of
International Metal Protection Inc. ("International Metal").
Subsequently, all of the outstanding shares of International Metal
were exchanged for shares of the Company and International Metal
was merged into the Company. The 995,000 shares issued in the
exchange were recorded at their par value of $.001 per share as
International Metal had no assets or liabilities at the date of the
merger. International Metal and its predecessor, AKA Video
Communications Inc., had been inactive for the two years ended
December 31, 1997 and prior thereto.
(b) USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities in the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
(c) SIGNIFICANT RISKS
The Company is subject to a number of risks and uncertainties
inherent in the oil and gas industry. Among these are risks related
to fluctuating oil and gas prices, uncertainties related to the
estimation of oil and gas reserves and the value of such reserves,
effects of competition and extensive environmental regulation,
risks associated with the search for and the development of oil and
gas reserves, and many other factors, many of which are necessarily
beyond the Company's control. The Company's financial condition and
results of operations will depend significantly upon the Company's
ability to find and develop natural gas and oil reserves and upon
the prices received for natural gas and oil produced, if any. These
prices are subject to fluctuations in response to changes in
supply, market uncertainty and a variety of additional factors that
are beyond the control of the Company.
(d) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with
an initial maturity of three months or less to be cash equivalents.
(e) OIL AND GAS ACTIVITIES
The Company follows the successful efforts method of accounting for
its oil and gas activities. Accordingly, costs associated with the
acquisition, drilling and equipping of successful exploratory wells
are capitalized. Geological and geophysical costs, delay and
surface rentals and drilling costs of unsuccessful exploratory
wells are charged to expense as incurred. Costs of drilling
development wells, both successful and unsuccessful, are
capitalized. Upon the sale or retirement of oil and gas properties,
the cost thereof and the accumulated depreciation and depletion are
removed from the accounts and any gain or loss is credited or
charged to operations. Upon the sale of a partial interest in an
unproved property, the proceeds are treated as a recovery of cost.
If the proceeds exceed the carrying amount of the property, a gain
is recognized in operations. Depletion of capitalized acquisition,
exploration and development costs is computed on the
units-of-production method by individual fields as the related
proved reserves are produced.
Capitalized costs of unproved properties are assessed periodically
and a provision for impairment is recorded, if necessary, through a
charge to operations.
Proved oil and gas properties are assessed for impairment on a
field-by-field basis. If the net capitalized costs of proved oil
and gas properties exceeds the estimated undiscounted future net
cash flows from the property a provision for impairment is recorded
to reduce the carrying value of the property to its estimated fair
value.
(f) OTHER PROPERTY AND EQUIPMENT
Other property and equipment is recorded at cost. Depreciation and
amortization is provided using the straight-line method over the
estimated useful lives of the assets, which range from 3 to 15
years.
(g) INCOME TAXES
The Company provides for income taxes using the asset and liability
method of accounting for income taxes. Under the asset and
liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and
net operating loss carryforwards. Deferred tax assets and liabilities
are measured using enacted income tax rates expected to apply to
taxable income in the years in which those differences are expected
to be recovered or settled. Under the asset and liability method, the
effect on deferred tax assets and liabilities of a change in income
tax rates is recognized in the results of operations in the period
that includes the enactment date.
5
<PAGE>
(h) STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION (SFAS 123), defines a fair value method of
accounting for stock compensation plans. SFAS 123 allows an entity
to measure compensation costs for these plans using the intrinsic
value based method of accounting as prescribed in Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES (APB 25), which the Company has elected to follow. The
pro forma disclosures of net loss and loss per share required by
SFAS 123 are included in note 5.
(i) LOSS PER SHARE
Loss per share is based on the weighted average number of common
shares outstanding during the period. Outstanding stock options and
warrants were excluded from the computation as their effect was
antidilutive.
(2) CMS TRANSACTION
On October 23, 1998, the Company and CMS Oil and Gas Company signed a
definitive agreement (the "CMS Agreement") relating to the development
of the Company's Powder River Basin acreage (the "CMS Transaction").
Pursuant to the terms of the CMS Agreement, CMS Oil and Gas Company will
acquire an undivided 50% working interest in approximately 492,000 net
acres of Pennaco's leasehold position in the Powder River Basin for
$28,000,000. The Company acquired the leasehold position which is being
conveyed to CMS in the CMS Transaction for approximately $7,000,000. The
purchase price provided for in the CMS Agreement was the result of arm's
length negotiations between the Company and CMS. The joint operating
agreement between the parties will be modeled after the 1989 AAPL Model
Form of Joint Operating Agreement. The CMS Agreement provides that the
parties will in good faith negotiate a development agreement for the
exploration, development and production of coal bed methane from the
leases. The development agreement will provide that each party will
operate approximately 50% of the wells drilled in the area of mutual
interest. Pennaco and CMS have divided the acreage in the area of mutual
interest into project areas which will be operated by one party or the
other. As is customary in oil and gas leasehold transactions, the
agreement provides for the adjustment of the purchase price for title
defects discovered prior to closing and for the opportunity for one
party to participate in acquisitions made by the other party in the area
of mutual interest defined in the agreement. The agreement also provides
for a preferential purchase right to the other party in the event either
CMS or the Company attempts to sell a portion of its interest in the
acreage covered by the agreement. There is no preferential purchase
right in the event that either party enters into a merger,
reorganization or consolidation. All of the leases in the area of mutual
interest are dedicated to CMS Gas Transmission and Storage, an affiliate
of CMS Oil and Gas Company, for gathering, compression and
transportation.
Pursuant to the terms of the CMS Agreement, CMS agreed to pay Pennaco
$5,600,000 of earnest money in the form of a non-interest bearing bridge
loan (the "CMS Bridge Loan") which was secured by substantially all of
the Company's oil and as leases. Approximately $3,200,000 of such amount
was paid directly to existing creditors of the Company. The CMS
Transaction is structured such that the conveyance of the working
interests was to occur at two separate closings. The first closing
occurred on November 20, 1998, and the second occurred on January 15,
1999. The Company received $7,600,000 at the first closing and received
$14,800,000 at the second closing, less approximately $1,800,000 which
is held in escrow subject to customary closing adjustments. As of March
12, 1999, approximately $1,200,000 was held in escrow pending CMS
closing adjustments. The CMS Bridge Loan was canceled at the second
closing.
The unaudited pro forma balance sheet of the Company as of December 31,
1998 gives effect to the sale of the interest in the properties and the
use of a portion of the proceeds to repay the bridge loan and the lease
acquisitions payable, all as if the transactions had occurred on that
date.
(3) BRIDGE LOAN
The Company borrowed $3,200,000 on September 4, 1998 under a bridge loan
with interest payable at 18% per year. The bridge loan was paid in full
on October 23, 1998 with proceeds from the CMS Transaction.
(4) INCOME TAXES
The income tax benefit of $1,266,000 includes a deferred federal income
tax benefit of $1,196,000 and a deferred state income tax benefit of
$70,000. The income tax benefit recorded for the period from inception
to December 31, 1998 differs from the expected income tax benefit (based
on the statutory rate of 34%) primarily as a result of state income
taxes, and stock and stock option compensation which is not deductible
for tax purposes.
At December 31, 1998, the Company has a net operating loss carryforward
for federal income tax purposes of approximately $431,000 which is
available to offset future federal taxable income, if any, through 2018.
The tax effects of temporary differences that give rise to the deferred
tax assets at December 31, 1998, relate to the net operating loss
carryforward.
23
<PAGE>
(5) STOCKHOLDERS' EQUITY
(a) COMMON STOCK
Since its formation in January 1998, the Company completed four
private placement offerings of common stock. In February 1998,
500,000 shares were issued at $.10 per share. Proceeds to the
Company were approximately $50,000. Also in February 1998,
4,530,000 shares were issued at $.22 per share. Proceeds to the
Company were approximately $997,000. In April 1998, 5,000,000
shares were issued at $1.25 per share. The proceeds to the Company
were $6,250,000. In June 1998, 2,000,000 shares were issued at
$1.75 per share. Proceeds to the Company were approximately
$3,500,000. The Company incurred approximately $178,014 in offering
costs relating to these offerings, which have been charged to
additional paid-in capital.
In June 1998, the Company offered certain individuals the right to
acquire common stock at $1.75 per share along with a share purchase
warrant for every two shares purchased, conditioned upon their
acceptance of employment as officers of the Company. No
compensation cost was recorded for the individuals who commenced
employment with the Company prior to July 1, 1998 (the date the
Company's common stock commenced trading) as the estimated fair
value of common stock approximated the common stock issuance price
and the warrant exercise price. Compensation expense of $450,000
was recorded for the shares and warrants issued subsequent to July
1, 1998 based on the difference between the closing price per share
on the last trading day prior to the date of employment with the
Company and the common stock issuance price and the warrant
exercise price.
During the period from inception to December 31, 1998 a total of
796,429 units were issued at $1.75 per unit to officers and key
employees of the Company. The units consist of one share of common
stock and one warrant for each two shares issued. The warrants have
an exercise price of $1.75 per share in the first year and $1.96
per share in the second year and are exercisable at any time.
Proceeds to the Company were approximately $1,394,000.
In September 1998, the Company issued 980,000 units at $3.25 per
unit. Each unit consists of one share of common stock and one
warrant for each two shares issued. The warrants with an exercise
price of $5.00 per share expire on March 4, 1999. Proceeds to the
Company were approximately $3,165,000. Offering costs of $324,675
were charged to additional paid in capital.
Under the terms of the stock subscription agreement, one of the
subscribers to the offering subscribed for an additional 235,000
units. An additional $763,750 was deposited into an escrow account
representing the aggregate purchase price of the additional 235,000
units. Under the terms of the escrow agreement the shares and the
shares of common stock underlying the warrants were to be
registered for resale under the Securities Act of 1993 (the "Act")
with the U.S. Securities and Exchange Commission by December 31,
1998. The Company has also undertaken to have the shares qualified
by way of an exemption order provided by the respective Securities
Commissions in Canada.
The escrow proceeds of $763,750 were deposited into an interest
bearing escrow account together with certificates representing the
units to be purchased. Under the terms of the subscription
agreement, the registration statement was required to be declared
effective and the Canadian exemption order was to be obtained on or
before December 31, 1998. The registration statement has not been
declared effective. Accordingly as of December 31, 1998, the
subscriber may elect to either purchase the escrow units or receive
a refund from the escrow account paid with their subscription, plus
interest thereon, and an additional unit for each 10 units
purchased in the offering. On February 28, 1999 all the subscribers
elected to receive an additional unit for each 10 units purchased
in the offering and, as a result, an additional 121,500 units are
to be issued. The additional units to be issued have been reflected
in the accompanying financial statements as units to be issued from
escrow and the $763,750 to be received from escrow has been
reflected as unit subscriptions receivable. The subscriber is also
entitled to receive an additional unit for each 10 units previously
acquired in the offering in the event that the Company does not
maintain an effective registration statement until such time as the
registered securities may be resold pursuant to Rule 144
promulgated under the Act.
(b) WARRANTS
At December 31, 1998 the Company has outstanding 607,500 warrants
with an exercise price of $5.00 per share. These warrants were
exercisable any time within six months of the date of issuance. The
warrants expired unexercised on March 4, 1999.
At December 31, 1998 the Company also has outstanding 398,215
warrants with an exercise price of $1.75 per share for the first
year and $1.96 per share for the second year. 310,715 of these
warrants were issued July 1, 1998 and 87,500 were issued September
4, 1998. The warrants expire two years from the date of issuance.
The Company issued warrants to purchase 128,000 shares of common
stock to a company for corporate finance services for a period of
one year commencing April 15, 1998. The warrants are exercisable at
$1.25 per share anytime after April 15, 1999 and expire April 15,
2000. The estimated fair value of the warrants issued of $16,500
was charged to expense during the period from January 26, 1998
(inception) to December 31, 1998. In September 1998, the Company
agreed to issue warrants to purchase 75,200 shares of common stock
to the same company in connection with the placement of units in
the September 1998 unit offering. The warrants are exercisable at a
price of $3.58 per share and expire September 4, 2000.
The Company issued warrants to purchase 90,000 shares of common
stock to SMS Operating, LLC as partial consideration for a lease
acquisition. The warrants are exercisable at $4.72 per share
anytime after November 24, 1998 and expire November 24, 2002. The
estimated fair value of the warrants issued of $232,202 was
capitalized as lease acquisition cost.
(c) STOCK OPTION AND INCENTIVE PLAN
On March 24, 1998, the Company adopted the 1998 Stock Option and
Incentive Plan (the Plan). The aggregate number of shares which may
be issued as awards under the Plan is 4,500,000 shares. As of
December 31, 1998, options to purchase common stock have been
granted to key employees and directors at exercise prices ranging
from $1.25 to $5.00 per share.
Stock option activity for the Plan for the period from inception to
December 31, 1998 is as follows:
24
<PAGE>
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
NUMBER OF PRICE
OPTIONS PER SHARE
------- ---------
<S> <C> <C>
BALANCE, JANUARY 26, 1998 (INCEPTION) - $ -
Granted 2,969,365 2.71
Canceled (204,000) 1.27
----------
BALANCE, DECEMBER 31, 1998 2,765,365 2.82
----------
----------
</TABLE>
A summary of the range of exercise prices and the weighted-average
contractual life of outstanding stock options at December 31, 1998,
is as follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AVERAGE AVERAGE EXCERCISABLE AVERAGE
DECEMBER 31, EXERCISE REMAINING LIFE DECEMBER 31, EXERCISE
1998 PRICE (YEARS) 1998 PRICE
------------------ -------------- ---------------- ----------------- -------------
<S> <C> <C> <C> <C> <C>
$1.25 800,000 1.25 9.3 612,500 1.25
2.50 914,000 2.50 8.4 4,000 2.50
3.25 430,000 3.25 4.6 - -
3.63 1,215 3.63 4.0 - -
4.56 12,150 4.56 3.8 - -
5.00 608,000 5.00 4.2 - -
------------------ -----------------
$1.25-5.00 2,765,365 2.81 7.1 616,500 1.24
------------------ -----------------
------------------ -----------------
</TABLE>
The Company applies APB Opinion 25 and related interpretations in
accounting for its stock option plans. No compensation expense has
been recognized for options granted at or above market value at
date of grant. Compensation expense of $1,340,000 has been recorded
for the period from inception to December 31, 1998 for options
granted below the market value, based upon the difference between
the option price and the quoted market price at the date of grant.
Had compensation cost for the Company's stock-based compensation
plans been determined based upon the fair value of options on the
grant dates, consistent with the provisions of SFAS 123, the
Company's pro forma net loss and loss per share for the period from
January 26, 1998 (inception) to December 31, 1998 would have been
$6,447,183 and $.57, respectively.
The weighted average fair value of options granted during 1998 was
$1.34 per share. The weighted average remaining contractual life of
all options outstanding at December 31, 1998 was approximately 7.1
years. The fair value of each option grant was estimated at the
date of grant using the Black-Scholes option-pricing model with the
following assumptions: no expected dividends, expected life of the
options of 1 to 10 years, volatility of 72%, and a risk-free
interest rate of 5.5%.
(6) RELATED PARTY TRANSACTIONS
RIS Resources International Corporation (RIS International) owned
4,000,000 shares of the Company's common stock at December 31, 1998. A
member of the Board of Directors of the Company also serves as a
consultant to RIS International. From April 1, 1998 through June 22,
1998 he served as an officer of the Company. Since that time he has
consulted with the Company and has received approximately $5,700 as
compensation for his services.
During the period from inception to December 31, 1998, a company for
which the Company's Chairman serves as a director provided
administrative services for the Company for which it received
compensation of approximately $16,000. In addition the Chairman was paid
approximately $150,000 for the period from January 26, 1998 (inception)
to December 31, 1998.
One of the Company's Directors provided legal services to the Company
during the period from inception to December 31, 1998. The Director's
firm was paid approximately $192,000 and the Director was paid
approximately $22,500 for the period from inception to December 31, 1998.
(7) COMMITMENTS
(a) EMPLOYMENT AGREEMENTS
The Company has entered into four-year employment agreements with
two officers, its President and its Chief Financial Officer and
Executive Vice President. Under the terms of the agreement with the
President, if employment is terminated without cause prior to June
1, 1999, the President is entitled to termination compensation of
$2,000,000, or $3,000,000 if he is terminated without cause after
June 1, 1999 but before the expiration of his employment agreement
in June 2002. Under terms of the agreement with the Executive Vice
President and Chief Financial Officer, if employment is terminated
without cause prior to July 1, 1999, the Chief Financial Officer
and Executive Vice President is entitled to termination
compensation of $400,000, $750,000 if he is terminated without
cause after July 1, 1999 but before July 1, 2000 and $1,250,000 if
he is terminated without cause thereafter but prior to the
expiration of his employment agreement.
25
<PAGE>
(b) LEASE COMMITMENTS
The Company entered into an amendment to its office lease agreement
in Denver, Colorado effective June 1, 1998. The amended lease
covers 11,524 square feet for a term of two years and four months.
During the term of the lease, rent is payable in the amount of
$172,860 base rent per year. During the seven months of the lease
from June 1, 1998 through December 31, 1998, the Company paid
$100,835 in rent.
The company also leases office and lodging space in Gillette,
Wyoming. The term of the lease commenced on October 5, 1998 and
expires on April 4, 1999. The lease concerns approximately 9,000
square feet at a yearly rent of approximately $17,400. In February
1999 a new lease/purchase agreement was entered into. The term of
the lease/purchase agreement commences on April 4, 1999 and expires
December 31, 2000. The yearly rent during that term is
approximately $17,400. Under the terms of the purchase option,
$1,000 per month of the rent is deemed to apply to a purchase
option on the property. The purchase option expires January 7, 2001.
(8) SUPPLEMENTAL FINANCIAL DATA - OIL AND GAS ACTIVITIES
Capitalized costs related to oil and gas activities are as follows:
<TABLE>
<CAPTION>
December 31
1998
-----------------
<S> <C>
Unproved oil and gas properties, at cost $4,656,965
Proved oil and gas properties 1,358,769
-----------------
Capitalized costs $6,015,734
-----------------
-----------------
</TABLE>
Costs incurred in oil and gas activities for the period from January 26,
1998(inception) to December 31, 1998 are as follows:
<TABLE>
<S> <C>
Unproved property acquisition costs $18,132,430
Development costs 734,852
Exploration costs 1,860,804
-----------------
Total costs incurred $20,728,086
-----------------
-----------------
</TABLE>
Unproved 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, delay rentals,
and drilling and equipping exploratory wells. Development costs include
costs incurred to gain access to and prepare development well locations
for drilling, and to drill and equip development wells.
(9) INFORMATION REGARDING PROVED OIL AND GAS RESERVES (UNAUDITED)
PROVED OIL AND GAS RESERVES. Proved oil and gas reserves are the
estimated quantities of crude oil, 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, i.e., prices and costs as of
the date the estimate is made. Prices include consideration of changes
in existing prices provided only by contractual arrangements, but not on
escalations based upon future conditions.
The table below sets forth the Company's quantities of historical proved
reserves as estimated by independent petroleum engineers, all of which
were located in the United States, and the present values attributed to
those reserves. The estimates were prepared by the independent petroleum
engineering firm of Ryder Scott Company. Reserve estimates are
inherently imprecise and are continually subject to revisions based on
production history, results of additional exploration and development,
prices of oil and gas and other factors.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
Gas
(BCF)
-----
<S> <C>
Proved developed and undeveloped reserves:
Balance at January 26, 1998 (inception) -
Extensions and discoveries 18.1
-----------------
Balance at December 31, 1998 18.1
-----------------
-----------------
Proved developed reserves:
Balance at January 26, 1998 (inception) -
-----------------
-----------------
Balance at December 31, 1998 5.5
-----------------
-----------------
</TABLE>
Standardize Measure of Discounted Future Net Cash Flows
Future net cash flows presented below are computed using year-end prices
and costs. Future corporate overhead expenses and interest expense have
not been included.
26
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998
-----------------
(in thousands)
<S> <C>
Future cash inflows, net of production taxes $20,250
Future production costs (6,831)
Future development costs (1,422)
Future income tax expenses (3,468)
---------------
Future net cash flows 8,529
---------------
10% annual discount for estimated timing of cash flows (2,387)
---------------
Standardized measure of discounted future net cash flows $6,142
---------------
---------------
</TABLE>
The principal sources of changes in the standardized measure of
discounted future net cash flows, are as follows:
<TABLE>
<CAPTION>
Period from
January 26, 1998
(inception)
to December 31, 1998
--------------------
(in thousands)
<S> <C>
Net change due to extensions and discoveries $8,528
Net change in income taxes (2,386)
--------------------
Net changes 6,142
Balance at January 26, 1998 (inception) -
--------------------
Balance at December 31, 1998 $6,142
--------------------
--------------------
</TABLE>
The standardized measure of discounted future net cash flows relating to
proved oil and gas reserves and the changes in standardized measure of
discounted future net cash flows relating to proved oil and gas reserves
were prepared in accordance with the provisions of Statement of
Financial Accounting Standards No. 69. Future cash inflows were computed
by applying current prices at year-end to estimated future production.
Future production and development costs are computed by estimating the
expenditures to be incurred in developing and producing the proved oil
and gas reserves at year-end, based on year-end costs and assuming
continuation of existing economic conditions. Future income tax expenses
are calculated by applying appropriate year-end tax rates to future
pretax net cash flows relating to proved oil and gas reserves, less the
tax basis of properties involved and tax credits and loss carryforwards
relating to oil and gas producing activities. Future net cash flows are
discounted at a rate of 10% annually to derive the standardized measure
of discounted future net cash flows. This calculation procedure does not
necessarily result in an estimate of the fair market value or the
present value of the Company's oil and gas properties.
27
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
David E. Coffey C.P.A. was previously the principal accountant for Pennaco
Energy, Inc. On October 30, 1998, his appointment as principal accountant was
terminated and KPMG Peat Marwick LLP was engaged as principal accountants. The
decision to change accountants was approved by the Board of Directors.
In connection with the audit of the period from January 26, 1998 (date of
inception) to April 15, 1998, and the subsequent interim period through October
30, 1998, there were no disagreements with David E. Coffey, C.P.A. on any matter
of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements if not resolved to his
satisfaction would have caused him to make reference in connection with his
opinion to the subject matter of the disagreement.
The audit report of David E. Coffey, C.P.A. on the financial statements of
Pennaco Energy, Inc. as of April 15, 1998 and for the period from January 26,
1998 (inception) to April 15, 1998, did not contain any adverse opinion or
disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit
scope, or accounting principles.
28
<PAGE>
PART II
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and officers of the Company and their respective ages and
positions are set forth in the following table
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Jeffrey L. Taylor 31 Chairman of the Board, Director
Paul M. Rady 45 Chief Executive Officer, President, Director
Glen C. Warren, Jr. 43 Chief Financial Officer, Executive
Vice President, Director
Gregory V. Gibson 49 Vice President, Legal, Secretary, Director
Terrell A. Dobkins 46 Vice President of Production
Brian A. Kuhn 40 Vice President of Land
Mark A. Erickson 39 Director
David W. Lanza 30 Director
</TABLE>
JEFFREY L. TAYLOR, CHAIRMAN OF THE BOARD, DIRECTOR
Currently Mr. Taylor is the President and Director of Foreign Investments
for the London Taylor Group. The London Taylor Group is a southern
California-based financial service provider acting as venture capitalist and
investment banker to private and small cap public companies. During the last
five years, Mr. Taylor has been a Member of the Board of Directors of various
public companies including, TransAmerica Industries, Yuma Gold Mines, and
Cornucopia Resources. He has also served during the last five years as Vice
President of Metallica Resources, Vice President of Goldbelt Resources, Vice
President of Arrowhead Minerals Corporation, and Executive Vice President of
Corporate Finance of Ultra Petroleum. Prior to founding the London Taylor Group,
Mr. Taylor was an analyst and financial service provider for Global Resource
Investments, Inc. of Carlsbad, California and the Chief Financial Officer for
International Art Commission of San Francisco, California. Mr. Taylor holds a
Master of Business Administration, Finance degree from the University of San
Diego.
PAUL M. RADY, CHIEF EXECUTIVE OFFICER, PRESIDENT, DIRECTOR
Mr. Rady joined the Company in June 1998 as its Chief Executive Officer,
President and Director. Mr. Rady has entered into an employment agreement with
an initial term of four years with automatic renewal provisions. Mr. Rady was
with Barrett Resources Corporation ("Barrett"), an oil and gas exploration and
production company listed on the New York Stock Exchange, for approximately
eight years. During his tenure at Barrett, Mr. Rady held various executive
positions including his most recent position as Chief Executive Officer,
President and Director. As Chief Executive Officer he was responsible for all
aspects of the Company including, operations, financings, representing the
corporation to the investment community, and working with the Board of Directors
to set the direction of the Company. Other positions held by Mr. Rady were Chief
Operating Officer, Executive Vice President - Exploration, and Chief Geologist -
Exploration Manager. Prior to his employment at Barrett, Mr. Rady was with Amoco
Production Company ("Amoco") based in Denver, Colorado for approximately 10
years. Mr. Rady received a Bachelor of Arts degree in Geology from Western State
College of Colorado and a Master of Science Degree in Geology from Western
Washington University.
GLEN C. WARREN, JR., CHIEF FINANCIAL OFFICER, EXECUTIVE VICE PRESIDENT, DIRECTOR
Mr. Warren joined the Company in July 1998 as its Chief Financial Officer,
Executive Vice President and Director. Mr. Warren has entered into an employment
contract with an initial term of four years with automatic renewal provisions.
Prior to assuming his duties as the Company's Chief Financial Officer, Mr.
Warren was an investment banker with Lehman Brothers Inc. in New York and
focused on equity and debt financing, as well as mergers and acquisitions for
energy and natural resource companies. Prior to Lehman Brothers, Mr. Warren was
also an investment banker with Dillon, Read & Co., Inc. and Kidder, Peabody &
Co. Incorporated with a total of nine years of investment banking experience.
Mr. Warren also has six years of exploration and production experience with
Amoco Production Company in New Orleans. Mr. Warren received an MBA degree from
the Anderson Graduate School of Management at U.C.L.A. in 1989 and a Juris
Doctorate degree and a Bachelor of Arts degree in Interdisciplinary Science,
both from the University of Mississippi.
GREGORY V. GIBSON, VICE PRESIDENT, LEGAL, SECRETARY, DIRECTOR
Mr. Gibson has been an attorney specializing in securities and securities
broker dealerships for over 15 years. Mr. Gibson is a southern California-based
practicing attorney with the law firm of Gibson, Haglund & Johnson. Prior to his
present affiliations, Mr. Gibson was corporate counsel for three years to Global
Resource Investment Limited, a southern California-based broker-dealer
specializing in resource and foreign publicly traded securities. Prior to
working at Global, Mr. Gibson was practicing securities and international law
with the law firms of Gibson & Haglund and Gibson, Ogden & Johnson. Mr. Gibson
attended Claremont Men's College and Brigham Young University for undergraduate
studies and received his Juris Doctorate degree from Pepperdine University
School of Law.
TERRELL A. DOBKINS, VICE PRESIDENT OF PRODUCTION
Mr. Dobkins has over 20 years experience in the petroleum industry.
Mr. Dobkins started his career at Amoco Production Company where he had
extensive experience in Rocky Mountain Low Permeability Gas Reservoirs and
worked in operations, completions and reservoir engineering. Mr. Dobkins worked
as a Manager for three years at American Hunter Exploration where he was
involved in all U.S. operations and engineering. More recently, Mr. Dobkins
served eight years at Barrett Resources, most recently as Manager of
Acquisitions, and was involved in the development of several projects, including
completions, operations and reservoir engineering. Mr. Dobkins received a
Bachelor of Science degree in Chemical Engineering from the University of New
Mexico.
29
<PAGE>
BRIAN A. KUHN, VICE PRESIDENT OF LAND
Mr. Kuhn has 18 years experience in the oil and gas industry as a
landman. Mr. Kuhn worked as a landman for thirteen years at Amoco Production
Company from June 1980 to April 1993. While at Amoco, Mr. Kuhn spent three years
in the Powder River Basin and other basins of the Rocky Mountain region. Most
recently, Mr. Kuhn was employed as a Division Landman for five years at Barrett
Resources Corporation where he worked in the Rocky Mountain region and numerous
other basins. Mr. Kuhn has extensive experience in the acquisition of producing
properties, testifying as expert witness before state regulatory agencies,
management of lease acquisition and negotiation of both large and small
exploration transactions. Mr. Kuhn earned a BBA in Petroleum Land Management
from the University of Oklahoma in May 1980. Mr. Kuhn is also a member of the
American Association of Petroleum Landmen, Oklahoma City Association of
Petroleum Landmen and the Tulsa Association of Petroleum Landmen.
MARK A. ERICKSON, DIRECTOR
Mr. Erickson is a registered petroleum engineer with fifteen years
experience in project financial modeling and management. He is currently a
consultant with RIS USA. Prior to that, Mr. Erickson worked as an asset manager
for North American Resources Company, a $200 million subsidiary of Montana
Power. He received his Bachelor of Science degree in Petroleum Engineering at
Montana Tech and Masters of Science degree in Mineral Economics from the
Colorado School of Mines.
DAVID LANZA, DIRECTOR
Mr. Lanza has been a real estate developer, oil and gas real property and
lease developer, and business owner in California, Nevada, Colorado, Texas and
Wyoming for the past ten years. He is currently the President of Hust Brothers,
a commercial real estate and development company, Vice President and principal
of Hust Brothers Inc., a national automotive wholesale company, and President
and principal of Colusa Motor Sales. Mr. Lanza has majority interest in
Marysville Auto Parts which owns and operates 13 automotive chain stores. Mr.
Lanza graduated from the University of Southern California receiving his
Bachelor of Science in Business Administration.
Other information required by this item is incorporated by reference
from the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from
the section entitled "Executive Compensation" in the Proxy Statement. Nothing in
this report shall be construed to incorporate by reference the Board
Compensation Committee Report on Executive Compensation or the stock Performance
Graph which are contained in the Proxy Statement, but expressly not incorporated
herein.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from
the section entitled "Security Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from
the section entitled "Certain Relationships and Other Transactions" in the Proxy
Statement.
30
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
Exhibit
No. Title
- ------- -----
<S> <C>
3.1 Articles of Incorporation (filed as Exhibit 3.1 to the Company's Form
10-SB File No. 00-24881, filed September 15, 1998 and included herein
by reference).
3.2 Bylaws (filed as Exhibit 3.2 to the Company's Form 10-SB, File No.
00-24881, filed September 15, 1998 and included herein by reference).
4.1 Form of Warrant (filed as Exhibit 4.1 in the Company's Form SB-2 File
No. 333-68317, filed December 3, 1998 and included herein by
reference).
10.1 Mineral Lease Purchase Agreement dated February 23, 1998 between High
Plains Associates, Inc. and Pennaco Energy, Inc. (filed as Exhibit
10.1 to the Company's Form 10-SB/A File No. 00-24881, filed September
15, 1998 and included herein by reference).
10.2 Letter Agreement dated January 23, 1998 between High Plains
Associates, Inc. and Taylor Oil Properties (filed as Exhibit 10.2 to
the Company's Form 10-SB/A File No. 00-24881, filed September 15, 1998
and included herein by reference).
10.3 Assignment of Option and Exercise of Option dated March 6, 1998
between High Plains Associates, Inc. and Pennaco Energy, Inc. (filed
as Exhibit 10.3 to the Company's Form 10-SB/A File No. 00- 24881,
filed September 15, 1998 and included herein by reference).
10.4 Agreement dated March 6, 1998 between High Plains Associates, Inc. and
Pennaco Energy, Inc. (filed as Exhibit 10.4 to the Company's Form
10-SB/A File No. 00-24881, filed September 15, 1998 and included
herein by reference).
10.5 Pennaco Energy, Inc. 1998 Stock Option and Incentive Plan (filed as
Exhibit 10.5 to the Company's Form 10-SB, File No. 00-24881, filed
September 15, 1998 and included herein by reference).
10.6 Form of Pennaco Energy, Inc. Incentive Stock Option Agreement (filed
as Exhibit 10.6 to the Company's Form 10-SB, File No. 00-24881, filed
September 15, 1998 and included herein by reference).
10.7 Form of Pennaco Energy, Inc. Non-Statutory Stock Option Agreement
(filed as Exhibit 10.7 to the Company's Form 10-SB, File No. 00-24881,
filed September 15, 1998 and included herein by reference).
10.8 Employment Agreement dated June 10, 1998 between Pennaco Energy, Inc.
and Paul M. Rady (filed as Exhibit 10.8 to Company's Form 10-SB, File
No. 00-24881, filed September 15, 1998 and included herein by
reference).
10.9 Employment Agreement dated July 2, 1998 between Pennaco Energy, Inc.
and Glen C. Warren, Jr. (filed as Exhibit 10.9 to Company's Form
10-SB, File No. 00-24881, filed September 15, 1998 and included herein
by reference).
10.10 Secured Promissory Note dated August 13, 1998 from Pennaco Energy,
Inc. to Venture Capital Sourcing, SA (filed as Exhibit 10.10 to the
Company's Form 10-SB/A File No. 00-24881, filed September 15, 1998 and
included herein by reference).
10.11 Second Amendment to Security Agreement dated August 13, 1998 between
Pennaco Energy, Inc. and Venture Capital Sourcing, SA (filed as
Exhibit 10.11 to the Company's Form 10-SB/A File No. 00- 24881, filed
September 15, 1998 and included herein by reference).
10.12 Purchase and Sale Agreement between Pennaco Energy, Inc., as Seller
and CMS Oil and Gas Company, as Buyer, dated October 23, 1998 (filed
as Exhibit 10.12 to the Company's Form 10-SB, File No. 00-24881, filed
September 15, 1998 and included herein by reference).
10.13 Secured Promisory Note dated October 23, 1998 from Pennaco Energy,
Inc. to CMS Oil and Gas Company (filed as Exhibit 10.13 to the
Company's Form 10-SB, File No. 00-24881, filed November 24, 1998 and
included herein by reference).
10.14 Sublease Agreement dated October 23, 1998 between Pennaco Energy, Inc.
and Evansgroup, Inc. (filed as Exhibit 10.14 to the Company's Form
10-SB/A File No. 00-24881 filed December 22, 1998 and included here by
reference).
10.15 Agreement Regarding the Drilling of Coal Bed Methane Wells (filed as
Exhibit 10.15 to the Company's Form 10-SB/A File No. 00-24881, filed
December 22, 1998 and included herein by reference).
10.16 First Amendment to Purchase and Sale Agreement dated November 20, 1998
(filed as Exhibit 10.16 to the Company's Form 10-SB/A File No.
00-24881, filed January 28, 1999 and included herein by reference).
10.17 Second Amendment to Purchase and Sale Agreement dated January 15, 1999
(filed as Exhibit 10.17 to the Company's Form 10-SB/A File No.
00-24881, filed January 28, 1999 and included herein by reference).
16 Letter of David E. Coffey, C.P.A. dated December 18, 1998 (filed as
Exhibit 16 to the Company's Form 10-SB/A File No. 00-24881, filed
December 22, 1998 and included herein by reference).
27 Financial Data Schedule
</TABLE>
31
<PAGE>
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934, the
registrant caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized.
PENNACO ENERGY, INC.
By: /s/ Jeffrey L. Taylor
------------------------------------
Jeffrey L. Taylor, Chairman
of the Board, Director
By: /s/ Paul M. Rady
------------------------------------
Paul M. Rady, President, Chief
Executive Officer, President, Director
By: /s/ Glen C. Warren, Jr.
------------------------------------
Glen C. Warren, Jr., Chief Financial
Officer, Executive Vice President,
Director
By: /s/ Gregory V. Gibson
------------------------------------
Gregory V. Gibson, Vice President,
Legal, Secretary, Director
By:
------------------------------------
Mark A. Erickson, Director
By:
------------------------------------
David W. Lanza, Director
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10K-SB
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 5,622,776
<SECURITIES> 0
<RECEIVABLES> 374,728
<ALLOWANCES> 0
<INVENTORY> 231,116
<CURRENT-ASSETS> 14,409,696
<PP&E> 6,311,853
<DEPRECIATION> 61,607
<TOTAL-ASSETS> 22,025,737
<CURRENT-LIABILITIES> 8,182,814
<BONDS> 5,600,000
0
0
<COMMON> 15,152
<OTHER-SE> 13,827,771
<TOTAL-LIABILITY-AND-EQUITY> 22,025,737
<SALES> 0
<TOTAL-REVENUES> 1,468,493
<CGS> 0
<TOTAL-COSTS> 5,864,966
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 682,400
<INCOME-PRETAX> (5,078,873)
<INCOME-TAX> (1,266,000)
<INCOME-CONTINUING> (3,812,873)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,812,873)
<EPS-PRIMARY> (.34)
<EPS-DILUTED> (.34)
</TABLE>
