<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 September 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 Identification No.)
incorporation or organization)
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 30, 1998, 7,829,270 shares of issuer's Common Stock, $.01 par
value per share, were outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE
FORMAT (CHECK ONE):
Yes No X
--- ---
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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 September 30, 1998
(Unaudited).......................................................................... 2
Consolidated Statements of Operations and Accumulated Deficit for the
Period from Inception (April 7, 1997) to September 30, 1997 and
the Three Months, Six Months and Nine Months Ended September 30,
1998 (Unaudited)..................................................................... 3
Consolidated Statements of Stockholders' Equity for the
Period from Inception (April 7, 1997) to December 31, 1997 and
the Nine Months Ended September 30, 1998 (Unaudited)................................. 4
Consolidated Statements of Cash Flows for the Period from Inception
(April 7, 1997) to September 30, 1997 and the Nine Months Ended
September 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
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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, SEPTEMBER 30,
1997 1998
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ASSETS (UNAUDITED)
<S> <C> <C>
Current Assets:
Cash.............................................................. $ 102,782 $ 347,559
Accounts Receivable............................................... 150,000 --
Marketable Securities............................................. 37,777 --
--------- -----------
Total Current Assets......................................... $ 290,559 $ 347,559
Property and Equipment, net........................................... -- 27,245
Unevaluated Oil and Gas Interests, Full Cost Method................... 1,121 1,121
Other Assets.......................................................... 21,222 21,222
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TOTAL ASSETS.......................................................... $ 312,902 $ 397,147
========= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable.................................................. $ 121,701 $ 14,523
--------- -----------
Total Liabilities............................................ $ 121,701 $ 14,523
--------- -----------
Commitments and Contingencies......................................... -- --
Stockholders' Equity:
Common Stock, $.01 Par Value, 12,000,000 in 1997 and 50,000,000
Shares in 1998 Authorized, Respectively, and 4,700,000 and
7,829,270 Issued and Outstanding, Respectively................. $ 47,000 $ 78,293
Additional Paid-In Capital........................................ 840,000 2,041,025
Deficit Accumulated During Development Stage...................... (695,799) (1,736,694)
--------- - -----------
Total Stockholders' Equity................................... $ 191,201 $ 382,624
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................ $ 312,902 $ 397,147
========= ===========
</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 NINE MONTHS
TO ENDED ENDED
SEPT 30, 1997 SEPT 30, 1998 SEPT 30, 1998
-------------- ------------- -------------
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REVENUES
Income................................................ $ 150,000 $ - $ -
---------- ---------- -----------
---------- ---------- -----------
Interest Income....................................... $ 166 $ 3,007 $ 7,029
---------- ---------- -----------
---------- ---------- -----------
Total Revenues.................................... $ 150,166 $ 3,007 $ 7,029
---------- ---------- -----------
---------- ---------- -----------
EXPENSES
Advertising........................................... $ - $ 4,841 $ 4,841
Auto.................................................. $ - $ 421 $ 421
Bank Charges.......................................... $ 817 $ 155 $ 1,045
Commissions & Fees.................................... $ - $ 75 $ 75
Dues & Subscriptions.................................. $ - $ 4,975 $ 4,975
Employee Benefit Program.............................. $ - $ 363 $ 363
Freight............................................... $ - $ 914 $ 914
Income Tax............................................ $ - $ - $ -
Insurance............................................. $ - $ 3,966 $ 3,966
Legal, Professional, Consulting....................... $ 332,820 $ 123,101 $ 901,795
Lodging............................................... $ - $ 3,855 $ 3,855
Maintenance........................................... $ - $ 3,000 $ 3,000
Meals & Entertainment................................. $ - $ 4,990 $ 4,990
Office Supplies....................................... $ 310 $ 4,443 $ 4,443
Payroll Tax........................................... $ - $ 15,566 $ 15,566
Postage and Delivery.................................. $ 165 $ 669 $ 1,156
Rent & Leases......................................... $ - $ 12,248 $ 16,309
Salaries.............................................. $ - $ 45,173 $ 45,173
SEC Related Expense................................... $ - $ 8,716 $ 8,716
Telephone............................................. $ 912 $ 4,683 $ 5,015
Travel................................................ $ 2,666 $ 9,956 $ 9,956
Other/Miscellaneous................................... $ - $ 11,347 $ 11,347
---------- ---------- -----------
Total Expenses.................................... $ 337,690 $ 263,495 $ 1,047,923
---------- ---------- -----------
---------- ---------- -----------
Net Loss - Deficit Accumulated during
Development Stage....................................... $ (187,524) $ (260,452) $(1,040,894)
---------- ---------- -----------
---------- ---------- -----------
Net Loss per Share........................................ $ (0.06) $ (0.03) $ (0.12)
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Weighted Average Number of
Common Shares Outstanding............................... 3,100,000 8,779,270 8,779,270
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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
--------- ------- ---------- ----------- ---------
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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 16,293 391,025 -- 407,318
Net Loss(Unaudited)................................ -- -- (532,758) (532,758)
--------- ------- ---------- ----------- ---------
June 30, 1998(Unaudited)........................... 7,629,363 $76,293 $1,543,025 $(1,476,242) $ 143,076
--------- ------- ---------- ----------- ---------
--------- ------- ---------- ----------- ---------
Sale of Stock(Unaudited)........................... 200,000 2,000 498,000 -- 500,000
Shares Issued for Services(Unaudited).............. -- -- -- -- --
Net Loss(Unaudited)................................ -- -- -- (260,452) (260,452)
September 30, 1998(Unaudited)...................... 7,829,270 78,293 2,041,025 (1,736,694) 382,623
--------- ------- ---------- ----------- ---------
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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 CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(APRIL 7, 1997) NINE MONTHS
TO ENDED
SEPT 30, 1997 SEPT 30, 1998
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Cash Flows from Operating Activities:
Net Loss..................................................... $(187,524) $(1,040,894)
Adjustments to Reconcile Net Loss to
Net Cash Provided by Operations:
Compensation Expense..................................... -- 407,318
Increase (Decrease):
Accounts Receivable.................................... -- 150,000
Increase (Decrease):
Accounts Payable....................................... -- (95,505)
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Net Cash Used by Operating Activities............ $(187,524) $ 388,071
--------- -----------
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................................................ $ 212,000 $ 625,000
Net Cash Provided by Financing Activities........ $ 212,000 $ 625,000
NET INCREASE (DECREASE) IN CASH................................ $ 100,150 $ 244,777
Cash at Beginning of Period.................................... -- 102,782
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CASH AT END OF PERIOD.......................................... $ 100,150 $ 347,559
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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 than 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;
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- - 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
- - 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 1999. 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
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<PAGE>
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.
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
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<PAGE>
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 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
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<PAGE>
export and market the Company's production from Colombia in the event
Ecopetrol should elect to cancel productions purchase contracts which may be
entered into for the purchase of the Company's production.
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 Basin. 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 assigned 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 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
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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 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 Seas, 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 a
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 a 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 to
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<PAGE>
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) to obtain and process
new two-dimensional seismic (75 kilometers on the Montecristo Block 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 Potomac (Bermuda) prior to
the Merger. See "--Background."
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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 September 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 nine months ended
September 30, were $3,007 and $7,029 derived from interest income earned or
accrued on cash. During 1997, Potomac (Bermuda) obtained interests in the
Rosablanca and Montecristo Association Contracts and in connection therewith
Potomac (Bermuda) and PEC incurred $123,101 and $901,795 during the three
months and nine months ended September 30, 1998, respectively, in
professional fees and consulting expenses and incurred miscellaneous expenses
of $140,358 and $146,128 respectively. During the period April 7, 1997
(Inception of Potomac (Bermuda)) through September 30, 1997, Potomac
(Bermuda) incurred professional fees and consulting expenses of $332,820.
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 nine months ended September 30,
1998.
As of September 30, 1998 Seven Seas Petroleum, as operator, has
reviewed and interpreted all of the existing siesmic data originally acquired
with the Assoication Contracts. Seven Seas Petroleum has made an application
for the shooting of additional sieismic data which should be initiated during
the first quarter 1999. As of the nine months ended September 30, 1998 the
Company has paid a total of $82,537.44 to Seven Seas Petroleum per the
existing operating agreement. This total amount is catagorized and included
by the Company in "Professional and Consulting" expense.
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
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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 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 and increase
the costs of exploration and development activities, and because of potential
price declines, increases 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 are 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 RESOURCESY
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 nine months ended September 30, 1998,
net cash used by operating activities totaled $388,071 and net cash provided
by financing activities totaled $22,343. As of September 30, 1998, PEC had
working capital of $347,559 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,
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<PAGE>
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 - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
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."
On September 23, 1998, the Company sold 200,000 shares of its Common
Stock for $2.50 per share for total cash proceeds to the Company of $500,000.
Chemical Trading purchased 20,000 shares, PetroAmerica purchased 120,000
shares, Far River Corp. purchased 40,000 shares and Haldane Counsulting
purchased 20,000 shares. The shares were sold pursuant to Rule 506 of
Regulation D to named corporations, each of which was an accredited investor
within the meaning of Rule 501(a). In connection with the offering and sale
of the Common Stock, an underwriter did not participate in the distribution.
However, the Company did pay 6% commissions in connection with the total sale
of stock or $30,000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
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:
27 Financial Data Schedule.
(b) REPORTS ON FORM 8-K(b).
Not applicable.
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<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: October 15, 1998
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<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 347,559
<INT-BEARING-DEPOSITS> 347,559
<FED-FUNDS-SOLD> 0
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0
0
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</TABLE>
