<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
/X/ Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended June 30, 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: 0-9474
POTOMAC ENERGY CORPORATION
(FORMERLY MIDWESTERN RESOURCES, INC.)
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
OKLAHOMA 73-1088064
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2601 NORTHWEST EXPRESSWAY, SUITE 1100W
OKLAHOMA CITY, OKLAHOMA 73112-7293
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (405) 840-1427
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or such
shorter period that the registrant was required to file such reports), and has
been subject to such filing requirements for the past 90 days. Yes No X
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
As of September 8, 1998, 7,428,261 shares of issuer's Common Stock, $.01 par
value per share, were outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE
FORMAT (CHECK ONE):
Yes No X
--- ---
<PAGE>
TABLE OF CONTENTS
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Page
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PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . 1
Consolidated Balance Sheets, December 31, 1997 and
June 30, 1998 (Unaudited). . . . . . . . . . . . . . . . . . . . . . . . 2
Consolidated Statements of Operations and Accumulated Deficit for the
Period from Inception (April 7, 1997) to June 30, 1997 and
the Three Months and Six Months Ended June 30, 1998 (Unaudited). . . . . 3
Consolidated Statements of Stockholders' Equity for the
Period from Inception (April 7, 1997) to December 31, 1997 and
the Six Months Ended June 30, 1998 (Unaudited) . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows for the Period from Inception
(April 7, 1997) to June 30, 1997 and the Six Months Ended
June 30, 1998 (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements (March 31, 1998 Information
is Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis or Plan of Operations . . . . . . . . 7
PART II--OTHER INFORMATION
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 2. Changes in Securities and Use of Proceeds. . . . . . . . . . . . . . . . . 16
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . . . . . . 16
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . 16
Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . 16
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
</TABLE>
CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING INFORMATION
Certain statements in this Report and the documents referenced herein
constitute "forward-looking statements" within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended. Certain, but not necessarily all,
of such forward-looking statements can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should" or "anticipates" or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategies that involve risks and
uncertainties. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results, levels of
activity, performance or achievements of Potomac Energy Corporation, or industry
results, to be materially different from any future results, levels of activity,
performance or achievements expressed or implied by such forward-looking
statements. As a result of the foregoing and other factors, no assurance can be
given as to future results, levels of activity and achievements and neither
Potomac Energy Corporation nor any other person assumes responsibility for the
accuracy and completeness of these statements.
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS
POTOMAC ENERGY CORPORATION
(FORMERLY POTOMAC ENERGY (BERMUDA) LTD.)
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ -----------
ASSETS (UNAUDITED)
<S> <C> <C>
Current Assets:
Cash . . . . . . . . . . . . . . . . . . . . . $ 102,782 $ 131,734
Accounts Receivable. . . . . . . . . . . . . . 150,000 --
Marketable Securities. . . . . . . . . . . . . 37,777 --
--------- -----------
Total Current Assets. . . . . . . . . . . $ 290,559 $ 131,734
Property and Equipment, net. . . . . . . . . . . . -- 4,558
Unevaluated Oil and Gas Interests, Full Cost
Method . . . . . . . . . . . . . . . . . . . . . 1,121 1,121
Other Assets . . . . . . . . . . . . . . . . . . . 21,222 21,222
--------- -----------
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . $ 312,902 $ 158,635
--------- -----------
--------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable . . . . . . . . . . . . . . . $ 121,701 $ 15,536
--------- -----------
Total Liabilities . . . . . . . . . . . . $ 121,701 $ 15,536
--------- -----------
Commitments and Contingencies. . . . . . . . . . . -- --
Stockholders' Equity:
Common Stock, $.01 Par Value, 12,000,000 in
1997 and 50,000,000 in 1998 Shares Authorized,
Respectively, and 4,700,000 and 7,629,270
Issued and Outstanding, Respectively. . . . . $ 47,000 $ 76,294
Additional Paid-In Capital . . . . . . . . . . 840,000 1,543,047
Deficit Accumulated During Development Stage . (695,799) (1,476,264)
--------- -----------
Total Stockholders' Equity. . . . . . . . $ 191,201 $ 143,099
--------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . . . . $ 312,902 $ 158,635
--------- -----------
--------- -----------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
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POTOMAC ENERGY CORPORATION
(FORMERLY POTOMAC ENERGY (BERMUDA) LTD.)
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT (UNAUDITED)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(APRIL 7, 1997) THREE MONTHS SIX MONTHS
TO ENDED ENDED
JUNE 30, 1997 JUNE 30, 1998 JUNE 30, 1998
------------- ------------- -------------
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REVENUES
Interest Income. . . . . . . . . . . . . . . $ -- $ 3,015 $ 4,022
---------- ---------- ----------
Total Revenues. . . . . . . . . . . . . $ -- $ 3,015 $ 4,022
---------- ---------- ----------
EXPENSES
Professional Fees and Consulting . . . . . . $ 24,575 $ 530,806 $ 778,684
Rent . . . . . . . . . . . . . . . . . . . . -- 4,061 4,061
Bank Service Charges . . . . . . . . . . . . 66 475 890
Postage and Delivery . . . . . . . . . . . . 44 98 487
Shipping . . . . . . . . . . . . . . . . . . -- -- --
Travel . . . . . . . . . . . . . . . . . . . -- -- --
Telephone. . . . . . . . . . . . . . . . . . 282 332 332
Office Supplies. . . . . . . . . . . . . . . 10 -- --
---------- ---------- ----------
Total Expenses. . . . . . . . . . . . . $ 24,977 $ 535,773 $ 784,465
---------- ---------- ----------
Net Loss - Deficit Accumulated during
Development Stage . . . . . . . . . . . . . . . $ (24,977) $ (532,758) $ (780,443)
---------- ---------- ----------
---------- ---------- ----------
Net Loss per Share . . . . . . . . . . . . . . . $ (0.01) $ (0.06) $ (0.09)
---------- ---------- ----------
---------- ---------- ----------
Weighted Average Number of
Common Shares Outstanding . . . . . . . . . . . 3,100,000 8,579,363 8,579,363
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
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POTOMAC ENERGY CORPORATION
(FORMERLY POTOMAC ENERGY (BERMUDA) LTD.)
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK
--------------------------------------------------------------
PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------- ----------- -----
<S> <C> <C> <C> <C> <C>
April 7, 1997. . . . . . . . . . . . . . -- $ -- $ -- $ -- $ --
Sale of Stock. . . . . . . . . . . . . . 2,800,000 28,000 384,000 -- 412,000
Shares Issued for Services . . . . . . . 1,900,000 19,000 456,000 -- 475,000
Net Loss . . . . . . . . . . . . . . . . -- -- -- (695,799) (695,799)
--------- ------- ---------- ------------ ----------
December 31, 1997. . . . . . . . . . . . 4,700,000 $47,000 $ 840,000 $ (695,799) $ 191,201
Sale of Stock(Unaudited) . . . . . . . . 300,000 3,000 72,000 -- 75,000
Shares Issued for Services(Unaudited). . 500,000 5,000 120,000 -- 125,000
Net Loss(Unaudited). . . . . . . . . . . -- -- -- (247,685) (247,685)
--------- ------- ---------- ------------ ----------
March 31, 1998(Unaudited). . . . . . . . 5,500,000 $55,000 $1,032,000 $ (943,484) $ 143,516
Sale of Stock(Unaudited) . . . . . . . . 500,000 5,000 120,000 -- 125,000
Shares Issued for Services(Unaudited). . 1,629,363 16,294 391,047 -- 407,341
Net Loss(Unaudited). . . . . . . . . . . -- -- -- (532,758) (532,758)
--------- ------- ---------- ------------ ----------
June 30, 1998(Unaudited) . . . . . . . . 7,629,363 $76,294 $1,543,047 $(1,476,242) $ 143,099
--------- ------- ---------- ------------ ----------
--------- ------- ---------- ------------ ----------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
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<PAGE>
POTOMAC ENERGY CORPORATION
(FORMERLY POTOMAC ENERGY (BERMUDA) LTD.)
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(APRIL 7, 1997) SIX MONTHS
TO ENDED
JUNE 30, 1997 JUNE 30, 1998
------------- -------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Loss . . . . . . . . . . . . . . . . . . . . . . $(24,967) $ (780,443)
Adjustments to Reconcile Net Loss to
Net Cash Provided by Operations:
Compensation Expense. . . . . . . . . . . . . . . . -- 1,007,341
Increase (Decrease):
Accounts Payable . . . . . . . . . . . . . . . . -- (15,536)
--------- -----------
Net Cash Used by Operating Activities $(24,967) $ 211,362
-----------
Cash Flows from Investing Activities:
Exploration of Oil and Gas Properties:
Purchase of Investments . . . . . . . . . . . $ -- $ (1,121)
Other Assets. . . . . . . . . . . . . . . -- (21,222)
--------- -----------
Net Cash Used by Investing Activities . . . . $ -- $ (22,343)
---------
Cash Flows from Financing Activities:
Sale of Stock . . . . . . . . . . . . . . . . . . . $ 12,000 $ 612,000
Net Cash Provided by Financing Activities . . $ 12,000 $ 612,000
NET INCREASE (DECREASE) IN CASH. . . . . . . . . . . . $ 12,000 $ 119,734
Cash at Beginning of Period. . . . . . . . . . . . . . -- 12,000
--------- -----------
CASH AT END OF PERIOD. . . . . . . . . . . . . . . . . $ 12,000 $ 131,734
--------- -----------
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</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
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POTOMAC ENERGY CORPORATION
(FORMERLY POTOMAC ENERGY (BERMUDA) LTD.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. GENERAL
The Company is a development stage enterprise engaging in acquisition,
exploration and development of oil and gas projects. The Company has yet to
generate any revenue from oil and gas sales and has no assurance of future
revenues from such sales. Oil and gas exploration and development is
speculative in nature and as such involves a high degree of risk.
The consolidated financial statements included in this report have been
prepared by Potomac Energy Corporation (the "Company") pursuant to the rules
and regulations of the Securities and Exchange Commission for interim
reporting and include all adjustments which are, in the opinion of
management, necessary for a fair presentation. These financial statements
have not been audited by an independent accountant. The consolidated balance
sheet at December 31, 1997, has been derived from the audited balance sheet
of the Company.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations for interim reporting. The Company believes that the disclosures
are adequate to make the information presented not misleading. However,
these financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the Annual Report on Form
10-KSB filed by the Company with the Securities and Exchange Commission on
July 2, 1998. The financial data for the interim periods presented may not
necessarily reflect the results to be expected for the full year.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, Potomac Energy (BVI) Ltd, a British Virgin
Island corporation ("Potomac BVI"), and Potomac Exploration Acquisition
Corporation ("Acquisition Corp"). All material intercompany accounts and
transactions have been eliminated.
The Company follows the full-cost method of accounting for oil and natural
gas properties. Under this method, all costs incurred in the acquisition,
exploration and development, including unproductive wells, are capitalized in
separate cost centers for each country. Such capitalized costs include
contract and concession acquisition, geological, geophysical and other
exploration work, drilling, completing and equipping oil and gas wells,
constructing production facilities and pipelines, and other related costs.
The majority of all costs associated with foreign operations are paid in U.S.
dollars as opposed to the local currency of the operations; therefore, the
reporting and functional currency is the U.S. dollar. Gains and losses from
foreign currency transactions are recognized in current net income. Monetary
items are translated using the exchange rate in effect at the balance sheet
date; non-monetary items are translated using historical exchange rates.
Revenues and expenses are translated at the average rates in effect on the
dates they occur. No material gains or losses were incurred during the
periods presented.
The Company's foreign operations are and will be subject to the income tax
laws of the various countries in which it may operate. Branch income from
interests obtained through the association agreements in Columbia, South
America are subject to Colombian corporate income tax as well as remittance
tax.
The Company plans to spend significant amounts on the acquisition and
exploration of properties. These costs may require the Company to raise
additional capital through debt or equity financing. Such additional
financing may require the encumbrance of Company assets or agreements with
other parties where some of the costs of exploration are paid by others in
exchange for an interest in the property. The Company plans to acquire
interests in properties internationally. Such plans have additional risks
because in some cases the country where the acquisition occurs may be
considered politically and/or economically unstable.
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2. POTOMAC ENERGY (BERMUDA) LTD. MERGER
Effective June 17, 1998, Potomac Energy (Bermuda) Ltd. ("Potomac
(Bermuda)") merged with and into Acquisition Corp (the "Merger") and in
connection with the Merger, with the exception of two management members, the
officers and directors of Potomac (Bermuda) became the officers and directors
of the Company. The Merger was accounted for as a reverse acquisition of the
Company by Potomac (Bermuda). The shareholders of Potomac (Bermuda) were
issued 7,050,000 shares of common stock of the Company. Following the
Merger, the Company changed its name to Potomac Energy Corporation. Potomac
(Bermuda) was incorporated April 7, 1997, for the sole purpose of
internationally identifying, investigating, exploring and where determined
advantageous developing, refining and marketing of oil and gas.
3. JOINT INTEREST OPERATIONS
The Company's subsidiary, Potomac BVI has entered into a joint venture
agreement with Seven Seas Petroleum Colombia (Seven Seas), a branch of Seven
Seas Petroleum, Inc. which is a publically traded Canadian corporation. Seven
Seas has obtained association contracts for oil and gas reserves identified
through preliminary investigation in the Middle Magdalen Valley Basin in
central Colombia, South America. Seven Seas has been accepted by Ecopetrol,
the state owned oil company in Colombia, to administer the association
contracts covering certain properties in Colombia, South America known as the
Rosa Blanca and Montecristo Blocks. Seven Seas owns a 75 percent interest and
Potomac owns a 25 percent interest. Seven Seas is designated as the operator.
Upon the successful negotiation of the Association contracts Seven Seas was
required to pay Potomac a participation fee of $150,000 which was used to
offset geophysical survey costs.
4. EARNINGS PER COMMON SHARE
Earnings per common share were computed using the weighted average number of
common shares outstanding after adding the dilutive effect of the conversion
of stock options.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
BACKGROUND
Potomac Energy Corporation ("PEC" or the "Company") (formerly Midwestern
Resources, Inc.) was formed in 1980 under the laws of the State of Oklahoma
and became inactive and its corporate charter was suspended in 1983. In
March 1998, the Company was reincorporated under the name "Midwestern-Oklahoma
Energy Resources Corporation." Effective June 17, 1998, Potomac Energy
(Bermuda) Ltd., a Bermuda corporation ("Potomac (Bermuda)"), merged with and
into Potomac Exploration Acquisition Corporation, a wholly-owned subsidiary
of the Company ("Potomac Acquisition"), pursuant to a Plan of Reorganization
and Agreement of Merger dated June 12, 1998 (the "Merger"). As a condition
of the Merger, on June 17, 1998, the outstanding Common Stock of the Company
was reverse split on the basis of one share for each 41.40846 outstanding
shares, which resulted in 578,270 shares of Common Stock being outstanding
immediately prior to the Merger (the "Reverse Stock Split"). In consummation
of the Merger, the Company issued 7,050,000 shares of its Common Stock to the
former shareholders of Potomac (Bermuda) and the Company's name was changed
to "Potomac Energy Corporation." The Merger was accounted for as a reverse
acquisition of the Company by Potomac (Bermuda). Potomac (Bermuda) was
formed on April 7, 1997. Immediately prior to the Merger, the Company did
not have any assets or liabilities.
The Company is a development stage company engaged in the exploration
and development of oil and gas properties outside of North America. The
Company, through its subsidiaries, owns interests in a prospective area
located in Colombia, South America, which is in the initial stages of
exploration and development. Prior to the Merger, Potomac (Bermuda) had not
conducted any operations other the acquisition of the interests in the
Rosablanca Association Contract and the Montecristo Association Contract for
exploration and development of the Rosablanca and Montecristo Blocks within
the Middle Magdalena Valley Basin, Colombia, South America. The Rosablanca
and Montecristo Blocks are in the initial stages of exploration. See
"--Middle Magdalena Valley Basin." The Company also may seek to acquire
additional oil and gas exploration opportunities in Colombia which management
believes may have large reserve potential; however, there is no assurance
that additional interests will be acquired or if acquired will be capable of
commercial development and production. All references to the "Company"
includes Potomac Energy Corporation and its subsidiaries, unless the context
indicates otherwise.
EXPLORATION STRATEGY
The Company's oil and gas exploration and development operations are
currently focused entirely on its activities in Colombia, South America.
Such operations are conducted through the Columbian branch of Potomac Energy
(BVI) Ltd., a wholly-owned British Virgin Islands subsidiary corporation
("Potomac (BVI)"). The dependence on the activities in Columbia is likely to
be reflected in both the short-term performance and the Company's long-term
financial results. The Company may serve as operator with respect to those
properties acquired pursuant to association contracts in which the Company
obtains a controlling interest or holds the largest ownership interest;
however, it is anticipated that the Company will also participate in the
development of properties operated by third parties and in some cases may
delegate operations to a third party. The Company's business strategy
includes:
- - Establishing production, cash flow and reserve value by developing proved
undeveloped reserves;
- - Building the Company's base of operations by initially concentrating its
development activities in Colombia;
- - Acquiring additional properties with potential for development drilling to
establish and maintain a significant inventory of undeveloped prospects and
to establish and enhance the Company's foundation for future growth;
- - Serving as operator of its wells to ensure technical performance and reduce
costs;
- - Establish relationships with other oil and gas exploration companies to
access their undeveloped properties, geological data and financial
resources;
- - Managing financial risk and mitigating technical risk by drilling in known
productive trends with multi-geologic potential, diversifying investment
over a number of wells in the Company's primary operating areas, developing
properties that provide a balance between short and long reserve lives, and
establishing and maintaining a balanced reserve profile between oil and
gas; and
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<PAGE>
- - Maintaining low general and administrative expenses.
Oil and gas exploration and development is a speculative business and
involves a high degree of risk. The Company is subject to all the risks
normally incident to drilling for and producing oil and gas, including
hazards such as high-pressured formations, blowouts, cratering, fires,
spills, or other hazards or conditions, any of which could result in damage
to or loss of life or property. In accordance with industry practice, the
Company is not fully insured against these risks nor are all such risks
insurable. Payment of such potential liabilities would reduce the funds
available for exploration, drilling and production and could have a material
adverse effect on the Company.
The Company has expended, and plans to continue to expend, significant
amounts of capital on the acquisition and exploration of its oil and gas
interests. Even if the results of such activities are favorable, subsequent
drilling at significant costs must be conducted on a property to determine if
commercial development of the property is feasible. Oil and gas drilling may
involve unprofitable efforts, not only from dry holes but from wells that are
productive but do not produce sufficient net revenues to return a profit
after drilling, operating and other costs. It is difficult to project the
costs of implementing an exploratory drilling program due to the inherent
uncertainties of drilling in unknown formations, the costs associated with
encountering various drilling conditions, such as high-pressured zones and
tools lost in the hole, and changes in drilling plans and locations as a
result of prior exploratory wells or additional seismic data and
interpretations thereof. The marketability of oil and gas which may be
acquired or discovered by the Company will be affected by the quality and
viscosity of the production and by numerous factors beyond its control,
including market fluctuations, the proximity and capacity of oil and gas
pipelines and processing equipment, government regulations, including
regulations relating to prices, taxes, royalties, land tenure, importing and
exporting of oil and gas and environmental protection. There can be no
assurance the Company will be able to discover, develop and produce
sufficient reserves in Colombia or elsewhere to recover the costs and
expenses incurred in connection with the acquisition, exploration and
development thereof and achieve profitability.
COLOMBIA--OVERVIEW
The Company's success currently depends entirely on its drilling and
exploration activities in Colombia. This dependence is likely to be
reflected in both the short-term performance and the Company's long-term
financial results. The Company's principal asset is a 25 percent interest in
the Association Contracts that relate to Rosablanca and Montecristo Blocks
located in the Middle Magdalena Valley Basin in and around Bogota, Colombia,
South America (the "Rosablanca and Montecristo Association Contracts"). As
of the date of this Report, a well has not been drilled on either of the
Rosablanca and Montecristo Blocks. The Rosablanca and Montecristo
Association Contracts were issued by Empresa Colombiana de Petroleos
("Ecopetrol"), the state-owned Colombian oil company, in November 1997, and
provide generally for a six-year exploration phase followed by a 22-year
production period, with partial relinquishments of acreage, excluding
commercial fields, required commencing at the end of the sixth year of the
Rosablanca and Montecristo Association Contracts. The Company currently
intends to participate in the drilling of the initial well on the Magdalena
Valley Basin before the end of 1998. See "--Magdalena Valley
Basin--Rosablanca and Montecristo Association Contracts."
The Rosablanca and Montecristo Association Contracts entitle the Company
to engage in exploration, development and production activities on
approximately 695,000 acres (173,750 net acres) located in the Middle
Magdalena Valley Basin, before any relinquishment to Ecopetrol.
Colombia is the fourth largest country in South America, with a total
land area of more than 1,038,700 square kilometers, with a population of 35.9
million people (1993 census). The official language is Spanish and the
official currency is the Colombian peso. Colombia has a democratic form of
government. While Colombia experiences insurgency and national political
protests, the Colombian economy has been among the best performers in Latin
America during the past 20 years. According to publicly available
information, Colombia's Gross Domestic Product ("GDP") has grown by an
average of four percent annually in the last 10 years, approximately twice
the average for Latin America. Colombia is the only country in South America
that did not have a single year of negative GDP or declining per capita
income growth in the 1980s and the 1990s. Colombia recently introduced
legislation to attract foreign investment in energy projects. The measures
include the exemption of new oil operations from the $1 per barrel tax which
was levied in 1992 to finance protection of oil operations.
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<PAGE>
According to publicly available information, the United States is
Colombia's largest trading partner, accounting for more than 43 percent of
that country's total imports and 38 percent of its total exports. The United
States is also the top provider of eight of Colombia's 15 largest imports.
United State oil companies now account for 11 of the 18 largest foreign oil
concerns operating in Colombia. Colombia is Latin America's third leading
crude exporter to the United States, after Venezuela and Mexico.
Colombia is the only country in South America that has seaports on both
the Pacific and Atlantic Oceans, which provide access to major oil markets.
The country has three main crude oil export pipelines leading to the port of
Covenas in Colombia. The pipeline from Cano Limon has a maximum capacity of
200,000 barrels of oil per day ("BOPD"), and two pipelines from Vasconia with
300,000 and 500,000 BOPD capacities.
The geology of Colombia has been studied since the mid-1800s and has
continued to the present, amassing some detail of the tectonic framework and
related stratigraphy. During the evolution of the geological knowledge of
Colombia, oil and natural gas exploration has been pursued in the Llanos,
Putumayo and Magdalena basins. Exploration in the Magdalena Valley Basin
began in 1918 with the drilling of the Guataqui wells in the Girardot
subbasin, followed in 1951 by the Ortega discovery. Since the mid-1980's the
oil industry has been the single largest component of economic growth, with
total Colombian oil reserves currently estimated to be approximately 3.7
billion barrels of recoverable oil. As of December 1993, 210 exploratory
wells had been drilled, resulting in the discovery of 30 fields.
Two major physiographic features dominate the geography of Colombia. To
the west lie the Andes mountains, which, north of the Ecuador border,
bifurcate into three ranges, the Western, Central and Eastern Cordillera,
extending toward the Caribbean coast. These ranges are separated by the Cauca
and Magdalena valleys, respectively. To the east lies the Llanos, a savanna
within the bounds of the Orinoco Basin, which extends over the remainder of
the country.
Association contracts acquired from Empresa Colombiana de Petroleos, the
Colombian national oil company ("Ecopetrol"), after being approved by all
proper Colombian governmental authorities as well as the board of Ecopetrol,
are mutually executed by the parties and subsequently recorded as a public
deed in Colombia. Therefore, ownership of an association contract is of
public record and protected by Colombian law.
RISKS INHERENT IN FOREIGN OPERATIONS
There are risks inherent in the fact that the Company has acquired and
intends to continue to acquire interests in oil and gas properties located
outside of North America in some cases in countries which may be considered
politically and economically unstable.
Foreign properties, operations or investments may be adversely affected
by local political and economic developments, exchange controls, currency
fluctuations, royalty and tax increases, retroactive tax claims,
renegotiation of contracts with governmental entities, expropriation, import
and export regulations and other foreign laws or policies governing
operations of foreign-based companies, as well as by laws and policies of the
United States affecting foreign trade, taxation and investment. In addition,
as the Company's operations are governed by foreign laws, in the event of a
dispute, the Company may be subject to the exclusive jurisdiction of foreign
courts or may not be successful in subjecting foreign persons to the
jurisdiction of courts in the United States. The Company may also be
hindered or prevented from enforcing its rights with respect to a
governmental instrumentality because of the doctrine of sovereign immunity.
The Company's business is subject to political risks inherent in all
foreign operations. While Colombia has no history of nationalizing its
business nor expropriation of foreign assets, the Company's oil and gas
operations are subject to certain risks, including: (i) loss of revenue,
property, and equipment as a result of unforeseen events such as
expropriation, nationalization, war and insurrection, (ii) risks of increases
in taxes and governmental royalties, (iii) renegotiation of contracts with
governmental entities, and (iv) changes in laws and policies governing
operations of foreign-based companies in Colombia. Guerrilla activity in
Colombia has disrupted the operation of oil and gas projects in certain areas
in Colombia but has not affected the Company's interest in the Rosablanca
and Montecristo Association Contracts. The Colombian government continues
its efforts through negotiation and legislation to reduce the problems and
effects of insurgent groups, including regulations containing sanctions such
as impairment or loss of contract rights on companies and contractors if
found to be giving aid to such groups. The associate parties will
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continue to cooperate with the government, and do not expect that future
guerrilla activity will have a material impact on the exploration and
development of the Rosablanca and Montecristo Association Contracts.
However, there can be no assurance that such activity will not occur or have
such an impact and no opinion can be given on what steps the government may
take in response to any such activity. Colombia is among several nations
whose progress in stemming the production and transit of illegal drugs is
subject to annual certification by the President of the United States. As of
the date of this Report, Colombia has received such certification. The
consequences of the failure to receive certification generally include the
following: all bilateral aid, except anti-narcotics and humanitarian aid, has
been or will be suspended; the Export-Import Bank of the United States and
the Overseas Private Investment Corporation will not approve financing for
new projects in Colombia; United States representatives at multilateral
lending institutions will be required to vote against all loan requests from
Colombia, although such votes will not constitute vetoes; and the President
of the United States and Congress retain the right to apply future trade
sanctions. Each of these consequences of the failure to receive such
certification could result in adverse economic consequences in Colombia and
could further heighten the political and economic risks associated with the
Company's operations in Colombia.
JOINT VENTURE ARRANGEMENTS
As a means of diversifying exploration risks, the Company has and
expects to continue to enter into joint venture arrangements for the
exploration and development of properties acquired under association
contracts initially obtained by the Company or acquire only partial interests
in oil and gas properties through joint venture agreements with other oil and
gas corporations that may, by the terms of such joint venture agreements, be
the operators of such properties and joint ventures. Although the Company
can take certain steps to determine if the risk of the exploration activities
to be conducted by the designated operator of such joint ventures is
appropriately spread over a number of prospects within a contract area of an
association contract, there can be no assurance that the risk will be so
allocated, that the exploration activities will be carried out by the
operator in a manner deemed appropriate by the Company or that the activities
will be successful. In addition, the Company's ability to continue its
exploration and development activities may be dependent upon the decision of
its joint venture partner or partners to continue exploration and development
activities and to finance their respective portions of the costs and expenses
of the joint venture exploration activities. If the Company's joint venture
partners do not elect to continue and to finance their obligations to the
joint venture, the Company may be required to accept an assignment of the
partners' interests therein and assume their financing obligations of further
development or relinquish the Company's interest in the joint venture or the
association contract.
MARKETS
In the event the Company's exploration and development drilling
activities result in the discover and production of oil and gas and upon
Ecopetrol's declaration of the commerciality of the Company's discovery, oil
produced from the Rosablanca and Montecristo Blocks may be sold to Ecopetrol
or to third parties provided that 75 percent of the purchase price is paid in
United States currency and the remainder in Colombian pesos. In the event
the production is required to satisfy internal demand for oil in Colombia,
the Company may be required to sell some or all of its production to
Ecopetrol at prevailing market prices. It is anticipated that any oil and
gas production of the Company from its Colombian operations will be sold to
Ecopetrol under contracts that provide for cancellation by either party with
notice. In the event of cancellation by Ecopetrol, the Company would be
required to arrange for the export and sale of its production.
Since the early 1970's the market price for crude oil has been
significantly affected by policies adopted by the member nations of the
Organization of Petroleum Exporting Countries ("OPEC"). Members of OPEC
establish prices and production quotas among themselves for petroleum
products from time to time with the intent of controlling the current global
supply and consequently price levels. The Company is unable to predict the
effect, if any, which OPEC policy or price changes would have on any decision
of Ecopetrol to continue or cancel production purchase contracts with the
Company or the effect such policies and price changes might have on the
ability of the Company to otherwise profitable export and market the
Company's production from Colombia in the event Ecopetrol should elect to
cancel productions purchase contracts with may be entered into for the
purchase of the Company's production.
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Changes in natural gas and crude oil prices significantly affect the
revenues and cash flows of the Company attributable to oil and gas production
and the value of its oil and gas properties. Declines in the prices of crude
oil and natural gas could have a material adverse effect on the business and
financial condition of the Company. The Company is unable to predict whether
the prices of crude oil and natural gas will rise, stabilize or decline in
the future.
REGULATION
The Company's operations are subject to regulations imposed by the local
regulatory authorities including, without limitation, currency regulation,
import and export regulation, taxation and environmental controls. The
regulations also generally specify, among other things, the extent to which
properties may be acquired or relinquished, permits necessary for drilling of
wells, spacing of wells, measures required for preventing waste of oil and
gas resources and, in some cases, rates of production and sales prices to be
charged to purchasers. Specifically, Colombian operations are governed by a
number of ministries and agencies including Ecopetrol, the Ministry of Mines
and Energy, and the Ministry of the Environment. It is possible that the
administration and enforcement of current environmental laws and regulations
or the passage of new environmental laws or regulations in Colombia could
result in substantial costs and liabilities in the future or in delays in
obtaining the necessary permits to conduct and expand the Company's
operations in such country. The Company has experienced and may continue to
experience delays in obtaining the necessary environmental permits to expand
its operations in Colombia.
MIDDLE MAGDALENA VALLEY BASIN
The Company has identified and completed the preliminary investigation
of oil and gas reserves existing in the Middle Magdalena Valley Basin in and
around Bogota, Colombia. The Company has acquired a 25 percent interest in
the Rosablanca and Montecristo Association Contracts on a joint-venture basis
granting rights to develop oil and gas in certain specified properties known
as the Rosablanca and the Montecristo Blocks (sometimes referred to as the
Rosablanca II Block) located in the Middle Magdalena Valley Basin. The
Rosablanca Block covers approximately 326,000 acres and the Montecristo Block
covers approximately 375,000 acres.
Oil and gas reserves have been investigated and explored in the
Magdalena Valley Basin since as early as 1940. The first commercial field
was established by Trocco Oil in 1951 with proven recoverable reserves in
excess of 800 million barrels. Through the use of advanced technologies and
exploration techniques such as seismic, gravimetric and magneto metric
surveys, combined with now historically proven data and exploratory drilling,
additional potentially large reserves have been identified and recovered
throughout the Middle Magdalena Valley Basis. Several independent oil
companies such as Trident Energy, Harken Oil and Gas, and Seven Seas along
with major oil and gas producers such as Exxon, Inc., and Texaco, Inc., have
made important recent discoveries that have drawn international attention to
all of Central and South America.
To date, approximately 1,300 kilometers of 2-D seismic data has been
acquired on the Rosablanca Block and the Montecristo Block. Based on
analysis and processing of such data, it is estimated that combined
anticipated recoverable oil reserves from the Rosablanca and Montecristo
Blocks exceed one billion barrels.
Pursuant to agreement dated February 27, 1997 (the "GHK Agreement"),
Omnipresent Exploration and Production Corporation (formerly Potomac Energy
Corporation and predecessor in interest of Potomac (Bermuda)) and GHK
Company, L.L.C., an Oklahoma limited liability company ("GHK"), agreed to
jointly acquire and develop any association contracts related to the
Rosablanca Block and the Montecristo Block acquired by Potomac (Bermuda) or
GHK. Under the GHK Agreement, the applications to acquire the association
contract was assign to GHK for the purpose of allowing the association
contracts on the specified blocks to be acquired by GHK. With respect to any
association contract obtained, GHK agreed to assign a 25 percent interest in
such association contract to Potomac Energy (BVI) Ltd., a British Virgin
Islands wholly-owned subsidiary corporation of the Company ("Potomac (BVI)).
GHK is proposed to be designated as operator under the association contracts
obtained. The GHK Agreement further provides that (i) upon issuance of the
association contracts, GHK will to pay Potomac (Bermuda) US$150,000, (ii) GHK
will provide any initial guarantee for the performance of exploratory
activity under the association contracts as required by Ecopetrol, (iii)
following issuance of each such association contract, Potomac (Bermuda) will
have three months to (A) qualify Potomac (BVI) to do business in Colombia,
(B) reimburse GHK 25 percent of any initial guarantees required by Ecopetrol,
and (C) demonstrate financial capability to pay 25 percent of the costs to
perform
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the first year obligations of the association contract, and (iv) cause
Potomac (BVI) to enter into an International Operating Agreement with
accounting procedure for each contract area naming GHK's branch company as
operator. In the event the Company is unable, within the three-month period,
to pay its 25 percent share of the guarantee or demonstrate financial ability
to pay 25 percent of the costs to perform the first year obligations of the
association contract, the Company will forfeit all rights to its interest in
the association contract. Pursuant to the Merger, Potomac Acquisition
acquired and assumed all obligations of Potomac (Bermuda) under the agreement
with GHK. Following execution of the GHK Agreement, it was assigned and
transferred to Seven Seas Petroleum, Inc. ("Seven Seas") and to Potomac
(BVI). As of the date of this Report, Potomac (BVI) is qualified to do
business in Colombia.
ROSABLANCA AND MONTECRISTO ASSOCIATION CONTRACTS. On November 19, 1997,
the Association Contracts related to the Rosablanca Block and Montecristo
Block (the "Rosablanca and Montecristo Association Contracts") were awarded
to the Colombian branch of Seven Seas and the Company became entitled to
receive a 25 percent interest in the Association Contracts, subject to the
GHK Agreement. In connection with obtaining the Rosablanca and Montecristo
Association Contracts, Seven Seas was not required to provide any form of
financial guarantee of performance of the other Rosablanca and Montecristo
Association Contracts.
The Rosablanca and Montecristo Association Contracts provide generally
for a three-to-six year exploration phase followed by a 22-year production
period, with partial relinquishments of acreage, excluding commercial fields,
required commencing at the end of the sixth year of each contract. Under the
terms of each contract, Seven Seas and the Company are required over a
three-to-six-year period to undertake and complete certain work commitments
involving exploration and development of the Rosablanca Block and the
Montecristo Block. Seven Seas and the Company are required during the first
two years of the contracts to reprocess existing seismic date (300 kilometers
on the Rosablanca Block and 500 kilometers on the Montecristo Block), acquire
and interpret landstat images and perform surface geological and geochemical
work, and shoot and evaluate 100 kilometers of new two dimensional seismic
and, at the election of the Company and Seven Sears, during the third year to
drill one exploratory well. In the event after the first two years, the
Company and Seven Seas elect to drill an exploratory well, they will be
required to relinquish and reduce their interest in the block to not more
than 247,100 acres (100,000 hectares). The contract will terminate at the
end of the third year, unless an extension is granted by Ecopetrol pursuant
to application or a commercial field has been discovered. The exploration
period may be further extended beyond the third year upon annual application
to and approval by Ecopetrol for up to three years. During each year of this
extension, Seven Seas and the Company will be required to drill one
additional exploratory well that penetrates an hydrocarbon producing
formation. In the event such work commitments are not completed as required,
the contract rights will be forfeited. Furthermore, if a commercial field is
discovered during the initial three-year period of the contract or any
extension thereof, the block or contract area will be reduced 50 percent, two
years thereafter will be reduced 50 percent of the remaining block or
contract area and two years thereafter will be further reduced to the
commercial fields that are producing or under development plus a reserve belt
2.5 kilometers wide surrounding each Commercial Field within the block or
contract area. Upon application to and approval by Ecopetrol, the period for
retention of the block or contract area may be extended for up to four years.
Under the terms of the contracts, Ecopetrol will receive a royalty equal
to 20 percent of production (after pipeline tariffs are deducted) on behalf
of the Colombian government and, in the event a commercially feasible
discovery is made, Ecopetrol will acquire a 50 percent interest in the
remaining production, bear 50 percent of the development costs, and reimburse
Seven Seas, the Company and other joint venture partners, from Ecopetrol's
share of future production, for 50 percent of the costs of certain
exploration activities. Upon acceptance of a field as commercial, Ecopetrol
will acquire a 50 percent interest therein and the interests of the other
parties to the contract, including the Company, will be reduced by 50
percent; all decisions regarding the development of a commercial field will
be made by an Executive Committee consisting of representatives of the
parties to the contract who will vote in proportion to their respective
interests in such contract. Decisions of the Executive Committee will be
made by the affirmative vote of the holders of over 50 percent of the
interests in the contract.
If any commercial field in the respective contract areas produces in
excess of 60 million barrels, Ecopetrol's interest in production and costs
for such contract area increases from 50 percent to 75 percent as the ratio
of the accumulated income attributable to Seven Seas, the Company or any
other joint venture partner other than Ecopetrol
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to the accumulated development, exploration and operating costs of such
parties (less any expenses reimbursed by Ecopetrol) increases from one to one
to two to one.
Under the terms of the association contracts, in the event a discovery
is made and is not deemed to be commercially feasible by Ecopetrol, Seven
Seas and the Company may expend up to $2 million over a one-year period to
further develop the field, 50 percent of which will be reimbursed if
Ecopetrol subsequently accepts the commercial feasibility thereof. If
Ecopetrol does not declare the field commercial, the joint venture may
continue to develop the field at its own expense. In such event, Ecopetrol
will have the right to acquire a 50 percent interest therein upon payment of
200 percent of the amounts expended by the joint venture, which payment may
be made out of Ecopetrol's share of future production.
The Company's net income, as defined under Colombian law, from Colombian
sources is subject to Colombian corporate income tax at a rate of 35 percent.
An additional remittance tax is imposed upon remittance of profits abroad at
a rate of five percent.
PLAN OF DEVELOPMENT
Seven Seas and the Company have established a 24-month plan of
development of the Rosablanca and Montecristo Blocks. Under this plan, in
addition to the minimum work commitments under the Rosablanca and Montecristo
Association Contracts (the cost of which is estimated to be approximately
$750,000), Seven Seas and the Company propose to (i) the obtain and process
new two-dimensional seismic (75 kilometers on the Montecristo Blaock and 50
kilometers on the Rosablanca Block) at an estimated cost of $550,000, (ii)
identify and drill one exploratory well on the Rosablanca Block at an
estimated cost of $500,000, (iii) drill one horizontal well on the Rosablanca
Block at an estimated cost of $1,750,000, (iv) drill three additional
horizontal wells on the Rosablanca Block at an estimated cost of $3,750,000,
and (v) reenter and deepen an existing well on the Montecristo Block at an
estimated cost of $500,000. In addition, the Company plans on participating,
on a joint-venture basis, in the reworking of existing wells with a major oil
company on blocks outside the Rosablanca and Montecristo Blocks at an
estimated cost of $4,000,000. The timing and undertakings under the
development plan will depend upon a number of factors, most of which will not
be within the control of the Company, including availability of capital
resources of the Company and its joint venture partners, the results of
geological and geophysical surveys and analysis, the expected or actual
results of each development undertaking or operation which in large part may
be affected by the anticipated or current cost of such operations and the
prices of crude oil and natural gas, general domestic and international
economic conditions within and without the oil and gas industry, and
Columbian legal and regulatory compliance. Therefore, this can be no
assurance that such plan of development will be successful or will be
completed as anticipated as of the date of this Report.
RESULTS OF DEVELOPMENT STAGE OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS REPORT.
Potomac (Bermuda) was formed on April 7, 1997. Prior to the Merger, PEC
was inactive and did not have any assets or liabilities. Effective June 17,
1998, Potomac (Bermuda) merged with and into Potomac Acquisition and became a
wholly-owned subsidiary of PEC. The Merger was accounted for as a reverse
acquisition of PEC by Potomac (Bermuda) under the purchase method of
accounting. Therefore, the following discussion and analysis of results of
operations discussed below are only those of to Potomac (Bermuda) prior to
the Merger. See "--Background."
Each of Potomac (Bermuda) prior to the Merger and PEC following the
Merger is a development stage company that during the period April 7, 1997
(Inception of Potomac (Bermuda)) through June 30, 1998, did not have any
revenue from oil and gas sales. There is no assurance that the Company will
have revenues from oil and gas sales in the future. The only revenues
received by Potomac (Bermuda) during the three months and six months ended
June 30, 1998, were $4,022 and $37,777 derived from interest income earned or
accrued on cash and cash and marketable securities. During 1997, Potomac
(Bermuda) obtained interests in the Rosablanca and Montecristo Association
Contracts and in connection therewith Potomac (Bermuda) and PEC incurred
$530,806 and $775,694 during the three months and nine months ended June 30,
1998, respectively, in professional fees and consulting
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expenses and incurred miscellaneous expenses of $4,966 and $5,770,
respectively. During the period April 7, 1997 (Inception of Potomac
(Bermuda)) through June 30, 1997, Potomac (Bermuda) incurred professional
fees and consulting expenses of $24,575. Other than the activities associated
with obtaining the Rosablanca and Montecristo Association Contracts, Potomac
(Bermuda) and PEC did not conduct any operating activities during 1997 and
the six months ended June 30, 1998.
YEAR 2000 COMPUTER SYSTEM COMPLIANCE
The Company's computer systems are year 2000 compliant. The Company's
computer systems which employed two digit year date format rather than four
digit date format have been programed to comply with year 2000 requirements
on a system-by-system basis.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
In June 1997, The Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income," which requires the reporting
of all items of income that are recognized under accounting standards as
components of comprehensive income, consisting of both net income and those
items that bypass the income statement and are reported in the balance within
a separate component of stockholders' equity, be reported in a financial
statement and displayed with the same prominence as other financial
statements. This statement is effective for financial statements of the
Company for the year ending December 31, 1998. Management of the Company
believes that adoption of SFAS No. 130 will not have a material effect on the
Company's financial statements.
In June 1997, FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which modifies segment reporting
requirements and establishes certain criteria for reporting disclosures
concerning a company's products and services, geographic areas and major
customers in annual and interim financial statements. This statement is
effective for financial statements of the Company for the year ending
December 31, 1998. Management of the Company believes that adoption of SFAS
No. 131 will not have a material effect on the Company's financial
statements, other than possibly the disclosure related to the Company's
services, geographic service area and major customers.
In February 1998, FASB issued SFAS No. 132, "Employers' Disclosure about
Pensions and Other Postretirement Benefits," which requires disclosures
related to employer's obligations related to pension and other retirement
benefits. This statement is effective for financial statements of the Company
for the year beginning after December 15, 1997. Management of the Company
believes that adoption of SFAS No. 132 will not have a material effect on the
Company's financial statements.
Furthermore, in June 1998, FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which requires disclosures
related to trading and holding of derivative instruments and the conduct of
hedging activities. This statement is effective for financial statements of
the Company for the year beginning after June 15, 1999. Management of the
Company believes that adoption of SFAS No. 133 will not have a material
effect on the Company's financial statements.
EFFECTS OF OIL AND GAS PRICE FLUCTUATIONS
In the event the Company's exploration activities result in significant
production of crude oil or natural gas, the Company's operations and the
value of its oil and gas assets, including producing and non-producing
assets, will be subject to the effects of fluctuations in crude oil and
natural gas prices. As a result of the instability and volatility of prices
and the surplus of crude oil and natural gas, and current market conditions
within the oil and gas industry, financial institutions have become more
selective in the energy lending area and have reduced the percentage of
existing reserves that may qualify for the borrowing base to support energy
loans.
In the future, the Company anticipates that its principal source of cash
flows, if any, will be from the production and sale of crude oil and natural
gas reserves which are depleting assets. Cash flows from oil and gas
production sales depends upon the quantity of production and the price
obtained for such production. Generally, an increase in prices allows a
company to finance its operations to a greater extent with internally
generated funds, may allow a company to obtain equity financing more easily
or on better terms and lessens the difficulty of attracting
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financing alternatives available to a company from industry partners and
non-industry investors. However, price increases heighten the competition
for oil and gas association contracts, leases and other contractual
arrangement, increase the costs of exploration and development activities,
and because of potential price declines, increase the risks associated with
the purchase of producing properties while prices are at higher levels.
A decline in oil and gas prices (i) reduces internally generated cash
flows which in turn reduces the funds available for exploration for and
replacement of oil and gas reserves, (ii) increases the difficulty of
obtaining equity financing and worsens the terms on which such financing may
be obtained, (iii) reduces the number of available oil and gas properties on
reasonable economic terms, (iv) may result in the expiration of oil and gas
contractual interests based upon the potential oil and gas reserves in
relation to exploration and development costs, (v) results in marginally
productive oil and gas wells being abandoned as non-commercial wells, and
(vi) increases the difficulty of attracting financing alternatives available
from industry partners and non-industry investors. However, price declines
reduce the competition for oil and gas interests and, correspondingly, reduce
the prices paid for such interests or result in obtaining such interests on
more favorable terms. Furthermore, exploration and production costs generally
decline, although the decline may not be at the same rate of decline of oil
and gas prices.
SEASONALITY
It is anticipated that the results of operations of the Company will be
somewhat seasonal due to seasonal fluctuations in the price for crude oil and
natural gas. Historically, crude oil prices have been generally higher in
the third and fourth quarters and natural gas prices have been generally
higher in the fourth quarter. Due to these seasonal price fluctuations, it
is anticipated that results of operations for individual quarterly periods
may not be indicative of results which may be realized on an annual basis.
INFLATION AND CHANGES IN PRICES
Inflation principally affects the costs required to drill, complete and
operate oil and gas wells. In recent years inflation has had a minimal
effect on such costs. However, increases and decreases in drilling
activities, which generally a linked to crude oil and natural gas price
increases and decreases, have resulted in the increase and decrease of
drilling and exploration costs on an industry-wide basis.
LIQUIDITY AND CAPITAL RESOURCES
Potomac (Bermuda) has financed its development state activities through
the sale of equity securities and does not have any borrowing facilities or
arrangements in place to fund its capital commitments. During 1997, net cash
used by operating activities totaled $249,098, net cash used by investing
activities totaled $60,120 and net cash provided by financing activities
totaled $412,000. During the six months ended June 30, 1998, net cash used
by operating activities totaled $211,362 and net cash provided by financing
activities totaled $22,343. As of June 30, 1998, PEC had working capital of
$126,198, compared to working capital of $168,858 at December 31, 1997.
Under the terms of the Rosablanca and Montecristo Association Contracts,
the Company has certain minimum work commitments on a joint venture basis
with Seven Seas, the Company's share of such costs is estimated to be
approximately $750,000. In addition to the minimum work commitments, the
Company has established a 24-month plan of development of the Rosablanca and
Montecristo Blocks at an estimated cost of $6,950,000. See " --Middle
Magdalena Valley Basin--Plan of Development." The Company anticipates that
the costs of development of the Rosablanca and Montecristo Blocks will be
funded with proceeds from the sale of equity and debt securities and,
although unlikely, borrowings. There is no assurance that such funding will
be available or on terms acceptable to the Company, in which event the
Company may forfeit its interests in the Rosablanca and Montecristo Blocks.
PART II
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
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Effective June 17, 1998, Potomac Energy (Bermuda) Ltd., a Bermuda
corporation ("Potomac (Bermuda)"), merged with and into Potomac Exploration
Acquisition Corporation, a wholly-owned subsidiary of the Company ("Potomac
Acquisition"), pursuant to a Plan of Reorganization and Agreement of Merger
dated June 12, 1998 (the "Merger"). As a condition of the Merger, on June
17, 1998, the outstanding Common Stock of the Company was reverse split on
the basis of one share for each 41.40846 outstanding shares, which resulted
in 579,270 shares of Common Stock being outstanding immediately prior to the
Merger. In consummation of the Merger, the Company issued 7,050,000 shares
of its Common Stock to the former shareholders of Potomac (Bermuda) and the
Company's name was changed to "Potomac Energy Corporation."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
2.1 Plan of Reorganization and Agreement of Merger among Registrant,
Potomac Exploration Acquisition Corporation and Potomac Energy
(Bermuda) Ltd., dated June 12, 1998, incorporated by reference to Form
10-KSB filed with the Commission on July 2, 1998.
10.1 Association Contract between Empresa Colombiana De Petroleos and Seven
Seas Petroleum Colombia, the Rosablanca sector, dated November 19,
1997, incorporated by reference to Form 10-KSB filed with the
Commission on July 2, 1998.
10.2 Association Contract between Empresa Colombiana De Petroleos and
Seven Seas Petroleum Colombia, the Montecristo sector, dated
November 19, 1997, incorporated by reference to Form 10-KSB filed
with the Commission on July 2, 1998.
10.3 Letter of Intent between Potomac Energy Corporation and The GHK
Company L.L.C., dated February 27, 1997, incorporated by reference to
Form 10-KSB filed with the Commission on July 2, 1998.
27 Financial Data Schedule.
(b) REPORTS ON FORM 8-K.
Not applicable.
-16-
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
POTOMAC ENERGY CORPORATION
(Formerly Midwestern Resources, Inc.)
(Registrant)
By: /s/ CARL W. SWAN
---------------------------------
Carl W. Swan, Chief Executive
Officer
Date: September 8, 1998
-17-
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