SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB/A
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
or
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-6580
PEASE OIL AND GAS COMPANY
(Name of small business issuer as specified in its charter)
Nevada 87-0285520
State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
751 Horizon Court, Suite 203,
Grand Junction, Colorado 81506
(Address of principal executive offices) (Zip code)
(970) 245-5917
(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
(None)
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock (Par Value $.10 Per Share)
Series A Cumulative Convertible Preferred Stock (Par Value $0.01 Per Share)
Common Stock Purchase Warrants (Expire August 13, 1998)
Title of Class
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [x] No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B, is not contained in this form and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
the Form 10-KSB. [ ]
The issuer's revenues for its most recent fiscal year were $6,165,664.
As of February 21, 1997, Registrant had 8,357,427 shares of its $0.10 par value
Common Stock and 141,822 shares of its $0.01 par value Series A Cumulative
Convertible Preferred Stock outstanding. As of February 21, 1997 the aggregate
market value of the common stock, the Registrant's only class of voting stock,
held by non-affiliates was $23,584,935. This calculation is based upon the
closing sales price of $3.25 per share on February 21, 1997.
<PAGE>
TABLE OF CONTENTS
PART I Page
ITEM 1. BUSINESS. . . . . . . . . . . . . . . . . . . . . . . . . . 1
General. . . . . . . . . . . . . . . . . . . . . . 1
Recent Acquisitions and Development. . . . . . . . 1
Business Strategy. . . . . . . . . . . . . . . . . 2
Operations. . . . . . . . . . . . . . . . . . . . 2
Competition. . . . . . . . . . . . . . . . . . . . 3
Markets. . . . . . . . . . . . . . . . . . . . . . 3
Regulations. . . . . . . . . . . . . . . . . . . . 3
Operational Hazards and Insurance. . . . . . . . . 6
Administration. . . . . . . . . . . . . . . . . . 6
ITEM 2. PROPERTY. . . . . . . . . . . . . . . . . . . . . . . . . . 7
Principal Oil and Gas Interests. . . . . . . . . . 7
Gulf Coast Prospects. . . . . . . . . . . . . . . . 8
Colorado Properties. . . . . . . . . . . . . . . . 9
Utah Properties . . . . . . . . . . . . . 10
Wyoming Properties. . . . . . . . . . . . . . . . . 10
Title to Properties. . . . . . . . . . . . . . . .. 11
Estimated Proved Reserves. . . . . . . . . . . . .. 11
Net Quantities of Oil and Gas Produced . . . . .. 12
Drilling Activity. . . . . . . . . . . .. . . . . . 12
ITEM 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . 12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . 13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . . . . 13
Market Information. . . . . . . . . . . . . . . . . 13
Stockholders. . . . . . . . . . . . . . . . . . . .. 13
Dividends. . . . . . . . . . . . . . . . . . . . . 13
Recent Sales of Unregistered Securities . . . . 14
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS. . . . . . . . . . . . 15
Selected Financial Data. . . . . . . . . . . . . . 15
Results of Operations. . . . . . . . . . . . . . . . 19
ITEM 7. FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . 26
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE. . . . . . . . . . . . . . . . . . . 26
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. . . . . . 26
ITEM 10. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . . . 28
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT30
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . . 32
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. . . . . . . . . . . . . . . 34
<PAGE>
PART I
ITEM 1 - BUSINESS
GENERAL
Pease Oil and Gas Company ("Company"), was incorporated under the laws of the
state of Nevada on September 11, 1968. The Company's address is 751 Horizon
Court, Suite 203, Grand Junction, Colorado 81506 and its telephone number is
(970) 245-5917. The Company is engaged in the oil and gas acquisition,
exploration, development and production business. Historically, the Company's
operations were in the western United States, primarily in Colorado, Nebraska,
Utah, and Wyoming. During 1996 and early in 1997, the Company has taken
initiatives to expand its operations in to the Gulf Coast region of Alabama,
Southern Louisiana and Texas.
On August 23, 1993, the Company acquired Skaer Enterprises, Inc. a Colorado
corporation, its related businesses and related oil and gas properties
(collectively "Skaer"). Skaer was privately owned and operated, and was
considered one of the largest private independent oil and gas companies in
Colorado, operating exclusively in the Denver-Julesburg Basin ("DJ Basin") of
northeastern Colorado. This acquisition substantially expanded the Company's
operations into providing oil field services, oil field supplies, natural gas
processing and natural gas marketing. Skaer was acquired for $12,200,000,
including $300,000 of various costs associated with the acquisition. This
acquisition was financed through: i) the issuance of 900,000 shares of preferred
stock in a public offering which generated net proceeds of $7,965,000; ii) the
issuance of restricted common and preferred stock with an agreed value of
$1,900,000 to the sellers; and iii) a $2,400,000 loan from a bank.
RECENT ACQUISITIONS AND DEVELOPMENTS
As discussed in the following paragraphs, the Company, through a series of
acquisitions and the development of strategic alliances with several private and
public exploration companies, has positioned itself to expand its asset base
into the Gulf Coast Region of Alabama, Southern Louisiana and Texas.
On January 10, 1997, the Company acquired a 7.8125% After Prospect Payout
Working Interest in the East Bayou Sorrel Prospect from third parties for a
total purchase price of $1.75 million. The purchase price consisted of the
issuance of 315,000 shares of the Company's common stock and $875,000 cash. On
March 3, 1997 the Company acquired an additional 10% working interest in this
prospect from unrelated third parties for $2.5 million cash. The prospect
contains a discovery well, the C.E. Schwing #1, which in February 1997 was
producing in excess of 1,400 barrels of oil per day and 1,300 MCF of natural gas
per day with a flowing tubing pressure of 6,300 PSI on a 12/64" choke from a
perforated interval of 13,208 feet to 13,226 feet. The C.E. Schwing #1 went on
production in December 1996. These acquisitions were funded with the Company's
existing working capital and the proceeds generated from a private placement of
common stock during February and March 1997. In that placement, the Company sold
1,500,000 shares of the Company's restricted common stock to accredited
investors for $2.50 per share. The private placement was completed on March 10,
1997 generating net proceeds of approximately $3.3 million.
On February 4, 1997 the Company entered into a definitive agreement with
National Energy Group, Inc. ("NEGX"), a publicly held company headquartered in
Dallas, Texas. NEGX is the operator of the East Bayou Sorrel Prospect. The
Agreement provides the Company the right and obligation to participate with NEGX
in various oil and gas exploration projects over the course of the next two
years. Essentially, the agreement consists of three main elements. First, Pease
has the right and obligation to participate as a 12.5% working interest owner in
NEGX's outlined exploration program. Specifically, there are 10 identified
projects including: Mustang Island located in Nueces County, Texas; Bayou Sorrel
located in Iberville Parish, Louisiana; and Robertsdale located in Baldwin
County, Alabama. Second, subject to certain conditions defined in the agreement,
Pease has the right and obligation to participate in any future prospects
generated under NEGX's exclusive arrangement with Sandefer Oil and Gas, Inc.
("Sandefer"). Sandefer is a private corporation owned and operated by a group of
geologists and geophysicists who generate Gulf Coast, Southern Louisiana and
other wildcat prospects. The East Bayou Sorrel prospect discussed in the
previous paragraph was generated by Sandefer. Third, Pease is entitled to
participate in any third party generated prospects that NEGX participates in
subject to certain conditions as defined in the Agreement.
1
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BUSINESS STRATEGY
The recent acquisitions and developments are the first steps in transforming the
Company. Its future business strategy is to expand its reserve base and cash
flow by utilizing its existing asset base in the Rocky Mountain Region and
cultivating the recent acquisitions, strategic alliances and opportunities in
the Gulf Coast Region of Alabama, Southern Louisiana and Texas. The Company will
attempt to execute this strategy through:
o Raising significant capital to take advantage of leading edge technologies
such as horizontal drilling and 3-D seismic exploration projects;
o Positioning itself with strategic sources of capital and partners that can
react to opportunities in the oil and gas business when they present
themselves;
o Developing alliances with major oil and gas finders that have been trained
by major oil companies;
o Participating in exploration projects that have opportunities involving
relatively small amounts of capital that could potentially generate
significant rates of return. These projects include areas with large field
potentials in Alabama, Southern Louisiana, Texas and the Gulf of Mexico.
Generally, the exploration projects will target fields with potential
reserves of 10 million barrels of oil or 100 Bcf of gas;
o Implementing the Company's investment strategy to carefully consider,
analyze, and exploit the potential value of the Company's existing assets to
increase the rate of return to its shareholders;
o Reinvesting operating cash flows into development drilling and recompletion
activities; o Continuing the expansion of the Company's operations outside
the D-J Basin; o Continuing the implementation of asset rationalization and
operating efficiencies designed to improve operating margins and lower per
unit operating cost;
o Acquiring properties that build upon and enhance the Company's existing
asset base;
o Developing a long term track record regarding stock price performance and a
reasonable rate of return to shareholders.
The Company recognizes that the ability to implement its business strategies is
largely dependent on the ability to raise additional debt or equity capital to
fund future acquisition, exploration, drilling and development activities. The
Company's Capital resources are discussed more thoroughly in Part II, Item 6, in
Management's Discussion and Analysis.
OPERATIONS
As of December 31, 1996, the Company had varying ownership interests in 189
gross productive wells (174 net) located in five states. The Company operates
179 of the 189 wells, the other wells are operated by independent operators
under contracts that are standard in the industry.
The following table presents information on the Company's major operating areas
as of December 31, 1996:
Net Proved Reserves
STATE REGION Bbls Mcf
CO, WY, NE DJ Basin 996,000 3,950,000
Utah Greater Cisco
and Four Corners 143,000 750,000
Wyoming Big Horn Basin 35,000 -
CO & AR Various 1,000 133,000
------------ -----------
Total 1,175,000 4,833,000
========= =========
It is a primary objective of the Company to operate most of the oil and gas
properties located in the Rocky Mountain Region in which it has an economic
interest. The Company believes, with the responsibility and authority as
operator, it is in a better position to control costs, safety, and timeliness of
work as well as other critical factors affecting the economics of a well.
At the present time, oil and natural gas prospects pursued in the Gulf Coast
region will be pursued by the Company as a non-operator.
2
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COMPETITION
The oil and gas industry is highly competitive in all phases. The Company
encounters strong competition from other independent oil and gas companies in
acquiring economically desirable prospects as well as in marketing production
therefrom and obtaining external financing. Many of the Company's competitors
may have financial resources, personnel resources, and facilities substantially
greater than those of the Company.
Because there has been a decrease in exploration for and development of oil and
gas properties in the United States, there is increased competition for lower
risk development opportunities and for available sources of financing. In
addition, the marketing and sale of natural gas and processed gas are extremely
competitive. Accordingly, the competitive environment in which the Company
operates is unsettled.
MARKETS
Overview - The three principal products currently produced and marketed by the
Company are crude oil, natural gas and natural gas liquids ("NGL's"). The
Company does not currently use commodity futures contracts and price swaps in
the sales or marketing of its natural gas and crude oil.
Crude Oil - Oil produced from the Company's properties is generally transported
by truck to unaffiliated third-party purchasers at the prevailing field price
("the posted price"). Currently, the three primary purchasers of the Company's
crude oil are Total Petroleum, Inc., Texaco Trading and Transportation, Inc. and
Scurlock-Permian Corporation. Together these three purchasers buy more than 80%
of the Company's annual crude oil production. The contracts are month-to-month
and subject to change. The market for the Company's crude oil is competitive and
therefore the Company does not believe that the loss of one of its primary
purchasers would have a material adverse effect on the Company's business
because other arrangements could be made to market the Company's crude oil
products. The Company does not anticipate problems in selling future oil
production since purchases are made based on current market conditions and
pricing. Oil prices are subject to volatility due to several factors beyond the
Company's control including: political turmoil; domestic and foreign production
levels; OPEC's ability to adhere to production quotas; and possible governmental
control or regulation.
Natural Gas - The Company sells its natural gas production in two principal
ways: a.) at the wellhead to various pipeline purchasers or natural gas
marketing companies; and b.) at the tailgate of its Gas Plant to either Public
Service Company of Colorado ("PSCo") or Hewlett-Packard Company ("HP"). The
wellhead contracts have various terms and conditions, including contract
duration. Under each wellhead contract the purchaser is generally responsible
for gathering, transporting, processing and selling the natural gas and natural
gas liquids and the Company receives a net price at the wellhead.
The residue gas sold at the tailgate of the Company's Gas Plant to PSCo is
subject to a month-to-month contract and the Gas sold to HP is subject to a
17-year contract. The gas to both parties is priced on an MMBtu basis at an
index spot price. As a note, the current sales of processed natural gas by the
Company to PSCo is not directly related to the Company's former natural gas
marketing and trading contract which expired July 1, 1996. See "Management's
Discussion and Analysis--Total Revenue."
See Management's Discussion and Analysis--Gas Plant Processing Revenues, for a
discussion of the possibility that the Company might consider shutting down its
Gas Plant.
Natural Gas Liquids - The Company produces two natural gas liquid products at
its Gas Plant, butane-gasoline mix and propane. The butane gasoline mix is sold
to an unaffiliated party at prevailing market prices on a month-to-month basis.
The propane is sold under a month-to-month arrangement with one or more local
propane wholesalers for resale to the local propane market. The Company does not
believe that the loss of the current purchasers of these products would have a
material adverse effect on the Company's business because it believes other,
similar arrangements could be made to market the Company's natural gas liquids.
3
<PAGE>
REGULATIONS
General - All aspects of the oil and gas industry are extensively regulated by
federal, state, and local governments in all areas in which the Company has
operations.
The following discussion of regulation of the oil and gas industry is
necessarily brief and is not intended to constitute a complete discussion of the
various statutes, rules, regulations or governmental orders to which the
Company's operations may be subject.
Price Controls on Liquid Hydrocarbons - There are currently no federal price
controls on liquid hydrocarbons (including oil, natural gas and natural gas
liquids). As a result, the Company sells oil produced from its properties at
unregulated market prices which historically have been volatile.
Federal Regulation of Sales and Transportation of Natural Gas - Historically,
the transportation and sale of natural gas in interstate commerce have been
regulated pursuant to the Natural Gas Act ("NGA"), the Natural Gas Policy Act of
1978 ("NGPA") and regulations promulgated thereunder. The Natural Gas Wellhead
Decontrol Act of 1989 eliminated all regulation of wellhead gas sales effective
January 1, 1993. As a result, the Company's gas sales are no longer regulated.
The transportation and resale in interstate commerce of natural gas produced and
sold by the Company continues to be subject to regulation by the Federal Energy
Regulatory Commission ("FERC") under the NGA. The transportation and resale of
natural gas transported and resold within the state of its production is usually
regulated by the state involved. In Colorado such regulation is by the Colorado
Public Utility Commission. Although federal and state regulation of the
transportation and resale of natural gas produced by the Company currently does
not have any material direct impact on the Company, such regulation does have a
material impact on the market for the Company's natural gas production and the
price the Company receives for its natural gas production. Adverse changes in
the regulation affecting the Company's gas markets could have a material impact
on the Company.
Commencing in the mid-1980's and continuing until the present, the FERC
promulgated several orders designed to correct market distortions and to make
gas markets more flexible and competitive. These orders have had a profound
influence on natural gas markets in the United States and have, among other
things, increased the importance of interstate gas transportation and encouraged
development of a large spot market for gas.
On April 8, 1992, the FERC issued Order No. 636 requiring material restructuring
of the sales and transportation service provided by interstate pipeline
companies. The primary element of Order No. 636 was the mandatory unbundling of
interstate gas transportation services and storage separately from their gas
sales. The unbundled transportation and storage was required to be offered
without favoring gas bought from the pipeline. Order No. 636 did not require
pipelines to stop buying and reselling gas; to the contrary, it contained
specific provisions to allow pipelines to continue unbundled sales of natural
gas. However, after Order No. 636 there was little reason for a pipeline to
continue selling natural gas and most pipelines moved all or almost all of their
gas purchases and sales to affiliated marketing companies.
Order No. 636 does not regulate gas producers such as the Company. However,
Order No. 636 does appear to have achieved FERC's stated goal of fostering
increased competition within all phases of the natural gas industry. Generally
speaking, this increased competition has driven the price down for natural gas
produced by the Company and other producers in the DJ Basin. It is unclear what
further impact the increased competition will have on the Company as a gas
producer and seller in the future. Increased flexibility and competition
provides greater assurance of access to markets, but has consequently reduced or
restrained prices.
In addition to FERC regulation of interstate pipelines under the NGA, various
state commissions also regulate the rates and services of pipelines whose
operations are purely intrastate in nature. To the extent intrastate pipelines
elect to transport gas in interstate commerce under certain provisions of the
NGPA, those transactions are subject to limited FERC regulation under the NGPA
and may ultimately effect the price of natural gas sold by the Company.
4
<PAGE>
There are many legislative proposals pending in Congress and in the legislatures
of various states that, if enacted, might significantly affect the oil and gas
industry. The Company is not able to predict what will be enacted and thus what
effect, if any, such proposals would ultimately have on the Company.
State and Local Regulation of Drilling and Production - State regulatory
authorities have established rules and regulations requiring permits for
drilling, bonds for drilling, reclamation and plugging operations, limitations
on spacing and pooling of wells, and reports concerning operations, among other
matters. The states in which the Company operates also have statutes and
regulations governing a number of environmental and conservation matters,
including the unitization and pooling of oil and gas properties and
establishment of maximum rates of production from oil and gas wells. A few
states also prorate production to the market demand for oil and gas. These
statutes and regulations limit the rate at which oil and gas could otherwise be
produced or the prices obtained from the Company's properties.
During the 1993 session of the Colorado legislature, a coalition of surface
owner organizations attempted to persuade the legislators to enact a bill
requiring the payment of damages to surface owners. Such legislation could
increase the cost of the Company's operations and erode the traditional rights
of the oil and gas industry in Colorado to make reasonable use of the surface to
conduct drilling and development activities. Although the bill was withdrawn by
the surface owners after it was significantly amended, and no such legislation
has been presented since 1993 (to the Company's knowledge), surface owner groups
have indicated they may seek a statewide constitutional ballot initiative to
mandate compensation to surface owners and will attempt to increase regulation
of the oil and gas industry at the local government level. The involvement of
such local governments could not prohibit the conduct of drilling activities
within their boundaries which were the subject of permits issued by the Colorado
Oil and Gas Conservation Commission ("COGCC") but that they could regulate such
activities under their land use authority. Accordingly, under these decisions,
local municipalities and counties may take the position that they have the
authority to impose restrictions or conditions on the conduct of such operations
which could materially increase the cost of such operations or even render them
entirely uneconomic. In 1993 and 1991 the Cities of Thornton, Broomfield, and
Greeley, the Town of Frederick and Boulder County, enacted such ordinances. The
Company does not have any properties within these boundaries. The Company is not
able to predict which jurisdictions may adopt such regulations, what form they
will take or the ultimate effects of such enactments on its operations. However,
in general these ordinances are aimed at increasing the involvement of local
governments in the permitting of oil and gas operations, requiring additional
restrictions or conditions on the conduct of operations to reduce the impact on
the surrounding community and increasing financial assurance requirements.
Accordingly, the ordinances have the potential to delay and increase the cost,
or even in some cases to prohibit entirely, the conduct of the Company's
drilling activities.
In response to the concerns of surface owner groups, the COGCC has adopted
regulations for the D-J Basin governing notices to and consultation with surface
owners prior to the conduct of drilling operations, imposing specific
reclamation requirements on operators upon the conclusion of operations, and
containing bonding provisions to enforce these new requirements. The COGCC in
1994 modified its rules to require the mandatory installation of surface casing
to depths below known fresh water aquifers in the D-J Basin and is continuing to
consider additional measures for protection of surface owners, enhanced
financial assurance requirements, and modifications to its rules concerning
safety and plugging and abandonment. The rules adopted or modified by the COGCC
to date have not had a material impact on the Company but it is not possible to
predict what additional changes will be made or what their financial or
operational impact will be on the Company.
Under the sponsorship of the Colorado Department of Natural Resources,
legislation was approved in the 1994 session of the Colorado legislature to
enhance the authority of the COGCC to regulate oil and gas operations.
Representatives of the oil and gas industry were involved in the drafting of
this legislation, along with representatives of the agricultural industry, local
governments and environmental groups, and are working closely with the COGCC on
the consideration and drafting of new rules to address the concerns that have
been raised about the effects of oil and gas operations. Although the Company
believes that it generally conducts its operation in accordance with the
procedures contemplated in the pending regulatory initiatives, management is not
able to predict the final form of the initiatives or their impact on the
Company.
5
<PAGE>
Recently, Wyoming increased its bonding and financial requirements for operators
acquiring existing properties. These new requirements are not expected to have a
significant impact on the Company or its operations.
Environmental Regulations - The production, handling, transportation and
disposal of oil and gas and by-products are subject to regulation under federal,
state and local environmental laws. In most instances, the applicable regulatory
requirements relate to water and air pollution control and solid waste
management measures or to restrictions of operations in environmentally
sensitive areas. In connection with its acquisitions, the Company attempts to
perform environmental assessments. However, environmental assessments have not
been performed on all of the Company's properties. To date, expenditures for
environmental control facilities and for remediation have not been significant
in relation to the Company's results of operations. However, it is reasonably
likely that the trend in environmental legislation and regulations will continue
towards stricter standards and may result in significant future costs to the
Company. For instance, efforts have been made in Congress to amend the Resource
Conservation and Recovery Act to reclassify oil and gas production wastes as
"Hazardous Waste," the effect of which would be to further regulate the
handling, transportation and disposal of such waste. If such legislation were to
pass, it could have a significant adverse impact on the operating costs of the
Company, as well as the oil and gas industry in general.
New initiatives regulating the disposal of oil and gas waste are also pending in
certain states, including states in which the Company conducts operations, and
these various initiatives could have a similar impact on the Company. The COGCC
has enacted rules regarding the regulation of disposal of oil field waste,
including waste currently exempt from federal regulation. These rules may
require the termination of production from some of the Company's marginal wells
for which the cost of compliance would exceed the value of remaining production.
In addition, as indicated above, the COGCC has enacted regulations imposing
specific reclamation requirements on operators upon the conclusion of the
operations, and is currently chairing a group including representatives of the
oil and gas industry, environmental groups, surface owners, and local
governments to consider adopting statewide reclamation requirements. The COGCC
is also in the process of preparing new rules governing production pits which
are intended to require closure of unlined pits and certain steel, fiberglass,
cement and other vessels in designated sensitive areas (which will probably
include most of the areas in Colorado that the Company operates) or adequate
proof that such pits or vessels are not leaking. As currently drafted, such
rules would permit operators to comply over a period of at least two years. The
COGCC proposals will be subject to review and comment of water quality agencies
and other interested parties and thus may change from the approach described
above. Management believes that compliance with current applicable laws and
regulations or with proposals in their present form could possibly have a
material adverse impact on the Company, but management is unable to predict the
final form of the pending regulations or their potential impact on the Company.
Wyoming has recently established more stringent environmental regulations to
ensure compliance with federal regulations. These new regulations are not
expected to have a significant impact on the Company or its operations.
The Company believes that its operations comply with all applicable legislation
and regulations in all material respects, and that the existence of such
regulations has had no more restrictive effect on the Company's method of
operations than other similar companies in the industry. Although the Company
does not believe its business operations presently impair environmental quality,
compliance with federal, state and local regulations which have been enacted or
adopted regulating the discharge of materials into the environment could have an
adverse effect upon the capital expenditures, earnings and competitive position
of the Company, the extent of which the Company now is unable to assess.
OPERATIONAL HAZARDS AND INSURANCE
The Company's operations are subject to the usual hazards incident to the
drilling and production of oil and gas, such as blowouts, cratering, explosions,
uncontrollable flows of oil, gas or well fluids, fires, pollution, releases of
toxic gas and other environmental hazards and risks. These hazards can cause
personal injury and loss of life, severe damage to and destruction of property
and equipment, pollution or environmental damage and suspension of operations.
6
<PAGE>
The Company maintains insurance of various types to cover its operations. The
Company's insurance does not cover every potential risk associated with the
drilling and production of oil and gas. In particular, coverage is not
obtainable for certain types of environmental hazards. The occurrence of a
significant adverse event, the risks of which are not fully covered by
insurance, could have a material adverse effect on the Company's financial
condition and results of operations. Moreover, no assurance can be given that
the Company will be able to maintain adequate insurance in the future at rates
it considers reasonable.
ADMINISTRATION
Office Facilities - The Company currently rents approximately 4,000 square feet
in an office facility in Grand Junction, Colorado owned by an unrelated party.
The rental rate is $31,440 per year through June 30, 2000.
Employees - As of February 21, 1997, the Company had 35 full time employees,
none of whom is covered by a collective bargaining agreement. The Company
considers its relations with its employees satisfactory.
ITEM 2 - PROPERTIES
PRINCIPAL OIL AND GAS INTERESTS
Developed Acreage - The Company's producing properties as of December 31, 1996
are located in the following areas shown in the table below:
<TABLE>
<CAPTION>
OIL GAS Developed Acreage
Gross Net(2) Gross Net(2) Gross Net(2)
Fields .................. State Wells(1) Wells(1) Wells(1) Wells Acreage Acreage
- ------------------------- -------- ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Loveland Field .......... Colorado 88 87 5,083 5,047
Lower Horse Draw Field .. Colorado 2 1 400 204
North Minto Field ....... Colorado 3 3 440 432
Pod Field ............... Colorado 6 6 600 600
Yenter Field ............ Colorado 6 6 1,655 1,655
Johnson's Corner ........ Colorado 5 4 1,122 1,122
West Peetz Field ........ Colorado 5 4 785 785
Cisco Dome .............. Utah 1 1 38 31 8,877 8,267
Cowboy .................. Utah 4 4 1,200 1,199
Enos Creek .............. Wyoming 2 1 280 215
Other Fields ............ CO/NB/UT 25 23 4 3 6,443 4,543
------ ------ ------ ------ ------ ------
Totals ................ 147 140 42 34 26,885 24,069
====== ====== ====== ====== ====== ======
</TABLE>
Footnotes
(1) Wells which produce both gas and oil in commercial quantities are
classified as "oil" wells for disclosure purposes.
(2) "Net" wells and "net" acres refer to the Company's fractional
working interests multiplied by the number of wells or number of
acres.
The majority of the Company's producing oil and gas properties are located on
leases held by the Company for as long as production is maintained.
Undeveloped Acreage - The Company's gross and net working interests in leased
undeveloped acreage in the Rocky Mountain Region as of December 31, 1996 is 406
and 366 acres, respectively. All these properties are located in Colorado and
will expire at various times in 1997 unless production has been obtained. The
Company's
7
<PAGE>
gross and net working interests in leased and developed acreage in Louisiana as
of December 31, 1996 is 1600 and 100 acres respectively. This consists of one
property and will expire in 1998 unless production has been obtained.
GULF COAST PROSPECTS
Overview - In 1997 and 1998, the Company will be directing a significant portion
of its resources to the Gulf Coast region, which is currently one of the most
actively explored areas in the United States. The Company's strategy for
entering the Gulf Coast area is to team up with the best oil and gas finders in
any specific area. The Company is focusing in South Louisiana, shallow Texas
State waters and specific areas where the Company believes it has strategic
advantage including Alabama and certain Texas areas., The parameters in general
are that the target reserves are 100 BCFG and/or 10 million bbls. oil. With this
strategy in mind, the Company is typically drilling to deeper horizons which
significant reserves have been found at shallower depths.
Currently, three prospects are in the process of drilling or are expected to
commence drilling in the first quarter of 1997. These include East Bayou Sorrel,
South Lake Arthur and Brazos Block 480. A brief description of these prospects
follows.
East Bayou Sorrel and Bayou Sorrel Area: This exploration prospect was generated
by Sandefer Oil and Gas. The initial exploratory location was selected with the
use of reprocessed 2D seismic data. The well, Schwing #1, was drilled in the
East Bayou Sorrel field, Iberville Parish, LA, to a total depth of 13,200 ft.
Upon test it flowed at a sustained rate of 1,026 barrels of oil and 980 Mcf of
gas per day with a flowing tubing pressure of 6,670 psi on an 8/64" choke. In
February 1997, the well was producing at or near the maximum allowable rate of
1,400 barrels of oil per day on a restricted choke.
In January 1997, the Company purchased a 7.8125% after prospect payout working
interest in the area of mutual interest (AMI) which includes the East Bayou
Sorrel Prospect. The Company acquired an additional 10% working interest in this
prospect in February 1997. The operator has identified seven productive zones in
the Schwing #1 well of which only one was tested and is on production.
Additional pay sands may be discovered in the second well, which is expected to
commence drilling operations in March 1997.
National Energy has planned a 33-square mile 3D seismic exploration program over
the Bayou Sorrel AMI area. The seismic program will commence in 1997. The 3D
data will compliment an already extensive database of reprocessed 2D seismic
data and a number of existing well logs. The Company's participation in the
Bayou Sorrel drilling and 3D seismic exploration program are expected to provide
significant exposure to potential productive drilling opportunities. The 3D
interpretation should help define the potential of the upper Marg vag pay zone
sandstone. It is believed that a productive section of a proven producing
formation will be found in Bayou Sorrel based on the existing 2D and well log
data. Because the formation is a profile producer in the region, Bayou Sorrel is
a potential large reserve prospect. Sandefer Oil and Gas and NEGX have also
identified two other fault blocks suitable for drilling from existing data and
will focus on this area with the 3D seismic exploration program which will give
the Company additional opportunities to participate in high potential reserve
projects.
South Lake Arthur - South Lake Arthur is located in Jefferson Davis Parish,
Louisiana. It is a four-way dip closure. Sandefer Oil and Gas has previously
drilled this prospect to 17,375 feet but the well was subsequently abandoned. In
reviewing the well data of this and other nearby wells, it was determined that
the well was most likely not tested sufficiently and inadequately completed.
Sandefer geologists believe this well would have been found to be a producer if
it had been properly tested. NEGX acquired this lease from Sandefer and planned
a well near the original Sandefer well. The well is currently being drilled. The
Company is participating at 1/16 of the working interest under its agreement
with NEGX. A very large gas field is in close proximity. A productive sandstone
formation underlies the prospect at a depth of between 18,000 feet and 20,000
feet. A large multi-national natural resources firm has announced plans to drill
to the same formation in the area, which may reveal the potential of this deep
play and influence future participation in this prospect.
Brazos Block 480 Prospect - Brazos Block 480 is the only offshore prospect in
which the Company is presently participating. This prospect, located within a
prolific gas producing geologic trend of offshore Texas, is believed to be
analogous to Amoco's Matagorda Block 519 Field which produced over 120 BCFG from
November 1985 through
8
<PAGE>
September 1995. A well is scheduled to commence drilling operations in April
1997, at a site located adjacent to Cove Field about eight miles offshore in
approximately 60 feet of water. The prospect is tightly controlled by numerous
2D seismic lines. A nine-square mile 3D seismic survey has also been shot and
interpreted.
COLORADO PROPERTIES
Overview - The Denver-Julesburg ("DJ") Basin encompasses most of northeast
Colorado and parts of southeast Wyoming, southwest Nebraska and western Kansas.
Oil and gas are produced mainly from Cretaceous sandstones and limestones, with
the "D" and the "J" sandstones being the most prolific producers in the Basin at
depths ranging in general from approximately 5,000 feet to approximately 7,500
feet. The Company's activities have focused on the historically better producing
zones, the "D" and the "J" sandstones and the Niobrara formation. At December
31, 1996, 84% of the Company's reserves were in the DJ Basin. A summary of the
notable fields in the DJ Basin are as follows:
Loveland Field, Larimer and Weld Counties - Loveland Field is located near the
City of Loveland, Colorado, 40 miles north of Denver. The area is producing both
oil and gas at an average rate in 1996 of approximately 248 barrels of oil
equivalent ("BOE") per day (205 BOE net to the Company). Loveland Gas Plant and
associated Pease facilities are located near the center of the field. Johnson's
Corner Field is located just 4 miles east of Loveland Field. Together, the
Loveland Field, Johnson's Corner Field and Loveland Gas Plant constitute more
than half of Pease's total Rocky Mountain assets.
All of the Company's gas production from the Loveland and Johnson's Corner
fields is processed in the Company's Loveland Gas Plant, which has a rated
capacity of approximately 6,000 Mcf per day. Pipeline systems are in place to
gather gas from the Loveland and Johnson's Corner fields. There is also an
interconnect into the Wattenberg pipeline system of K N Energy, which gives the
gas plant access to third-party gas from the extensive Wattenberg field complex.
Approximately 1,000 Mcf of gas per day from the Loveland and Johnson's Corner
fields is currently processed through the Loveland gas plant. The natural gas
produced from the Loveland area is extremely rich in liquid composition with an
average heat content of 1,430 BTU per cubic foot. The ability of the gas plant
to recover natural gas liquids, such as propane and natural gasolines (B-G Mix),
from the gas enhances the value of gas production and significantly increases
the economic viability of additional development in the Loveland and Johnson's
Corner fields.
Among the existing wells, numerous opportunities exist to recomplete in certain
behind-pipe zones using newer stimulation technologies. In many wells, Codell
sandstone and Timpas limestone reserves remain behind-pipe which is available
for production upon recompletion of existing well bores. Among the wells that
have been completed in these zones, the Company believes that original
completions were often inadequate because of limited stimulation. Of the three
benches (separate sedimentary levels) of the Niobrara Formation, the upper bench
has been completed in most wells whereas the middle and lower benches are
available for production upon recompletion in many wells. Currently, a program
is being implemented to recomplete several selected wells.
Johnson's Corner Field, Larimer County, Colorado - Johnson's Corner Field is an
extension of the Wattenberg Field with Muddy "J" Sandstone gas production. The
wells produce approximately 40 BOE per day from the "J" sand. One well has also
been completed in the Codell and Niobrara formations and oil production from all
three zones is commingled. Recently two wells were recompleted in Codell
sandstone and the initial results are promising. In addition, the Company
believes there are several additional in-fill development locations.
West Peetz Field, Logan County, Colorado - The Company operates 5 wells in two
leases in the West Peetz field. The wells currently produce about 20 BOPD from
the J sand. A detailed geological and engineering evaluation of the field in
early 1995 suggested that West Peetz field can be produced profitably for many
years to come and the field has an excellent potential for secondary recovery. A
low-cost simple water injection plan has been recommended and is currently under
consideration.
Pod Field, Washington County, Colorado - In Pod Field, the Company has a 100%
working interest and operates five wells which produce from the "J" sand. A
geological and engineering evaluation of the field conducted in 1995
9
<PAGE>
indicates the potential presence of undeveloped gas reserves in the Niobrara
Formation. However, further study will be necessary before any action will be
taken.
Yenter Field, Logan County, Colorado - Yenter Field is a structural trap which
has produced more than 10 MMBO and 24 BCFG since the 1950s from the "J" sand.
Approximately 80% of wells in the field have been plugged and abandoned. The
Company owns and operates five wells with production of about 35 barrels of oil
per day ("BOPD"). Water produced with oil from these five wells is injected back
into the reservoir to help maintain reservoir pressures for continued
production. The Company has conducted a complete geological and engineering
study of Yenter Field, which has identified undeveloped potential in additional
sandstone reservoirs and recommended reworking "J" sandstone wells which have
been shut in since the mid 1970s, and upgrading the pressure maintenance
program. The Company desires to acquire additional acreage in the field to
implement a secondary recovery program possibly with horizontal wells.
North Minto Field, Logan County, Colorado - North Minto is a "J" Sandstone field
and was unitized for secondary recovery in 1989. One well was producing
approximately 8 BOPD during 1993. The injection well had been shut-in during
October 1992. The Company completed geologic and engineering reviews of the
field after the acquisition and consequently re-established the injection
program which increased production to 32 BOPD. In 1996, the Company restored one
well back into production to benefit from the waterflood. Additional leases have
been acquired as a result of this study and two additional drill sites have
reserve potential in the North Minto Unit.
Lower Horse Draw Field, Rio Blanco County, Colorado - The Company has interests
in two wells that produce gas from the Mancos B fractured silty shale in the
Lower Horse Draw Field. Proved developed reserves include 162,000 Mcf of gas net
to the Company.
UTAH PROPERTIES
Cisco Dome Area, Grand County, Utah - In April 1995, the Company purchased an
80% working interest in approximately 8,877 acres in the Cisco Dome Field. The
Cisco Dome Field is located adjacent to the Calf Canyon Field. The property in
the Cisco Dome Field contains 39 wells of which 21 are currently producing gas
from intervals ranging from 2,000 to 3,200 feet. The average aggregate
production from these properties is approximately 400 Mcf and 7 bbls of oil per
day. The Company is presently working to recomplete several wells in behind-pipe
zones to take advantage of current gas prices in the market. Among the
recompleted wells, one is producing 250 Mcf per day. The company expects that
after finishing the recompletion program, daily gas production can be
significantly increased. Management of the Company has extensive knowledge and
experience with operations in and near this field. Cisco Dome field is large and
geologically complex. There are numerous locations on the Company's acreage
available for additional drilling. A geological and engineering study is
currently being conducted to seek further development opportunities in the
existing wells as well as to delineate optimal drilling locations.
Cowboy Field, San Juan County, Utah - The Company has a 100% interest in four
oil wells in Cowboy Field in southeast Utah. The field is within the Paradox
Basin and production is from the Pennsylvanian Ismay Formation. The Company has
behind pipe potential and at least one development drillsite.
WYOMING PROPERTIES
Enos Creek Field, Hot Springs County, Wyoming - Enos Creek Field is located in
the southwestern Big Horn Basin of central Wyoming. In early 1992, the Company
entered into a farmout agreement with an industry partner to co-develop Enos
Creek Prospect. During the summer of 1992, the Company and its partners drilled
a side track well from an existing wellbore targeted at a separate fault block
in the geologic structure. The well penetrated three oil zones while drilling,
one in the Curtis Formation and two in the Phosphoria Formation.
The well is currently producing from the Phosphoria Formation. The Company
intends to recomplete a well adjacent to existing well in the Tensleep Formation
sometime in the future.
10
<PAGE>
TITLE TO PROPERTIES
As is customary in the oil and gas industry, only a perfunctory title
examination is conducted at the time oil and gas leases are acquired by the
Company. Prior to the commencement of drilling operations, a thorough title
examination is conducted. The Company believes that title to its properties is
good and defensible in accordance with standards generally accepted in the oil
and gas industry, subject to such exceptions, which in the opinion of counsel,
are not so material as to detract substantially from the property economics. In
addition, some prospects may be burdened by customary royalty interests, liens
incident to oil and gas operations and liens for taxes and other governmental
charges as well as encumbrances, easements and restrictions. The Company does
not believe that any of these burdens will materially interfere with the use of
the property.
ESTIMATED PROVED RESERVES
The oil and gas reserve and reserve value information is included in Part II,
Item 7 at footnote 12 of the consolidated financial statements, titled
Supplemental Oil and Gas Disclosures. This information is prepared pursuant to
Statement of Financial Accounting Standards No. 69, which includes the estimated
net quantities of the Company's "proved" oil and gas reserves and the
standardized measure of discounted future net cash flows. The reserve
information is based upon an engineering evaluation by McCartney Engineering,
Inc. The estimated proved reserves represent forward-looking statements and
should be read in connection with the disclosure on forward-looking statements
included herein under Item 6 in Managements' Discussion and Analysis.
The Company has not filed any reports containing oil and gas reserve estimates
with any federal authority or agency other than the Securities and Exchange
Commission and the Department of Energy. There were no differences in the
reserve estimates reported to these two agencies.
All of the Company's oil and gas reserves are located in the Continental United
States. The Table below sets forth the Company's estimated quantities of proved
reserves, and the present value of estimated future net revenues discounted by
10 percent per year using prices being received by the Company at the end of
each of the last three fiscal years on a non-escalated basis. The prices used at
December 31, 1996 were $24.43 per barrel of oil and $3.73 per MCF of natural
gas:
December 31,
1996 1995 1994
---------- ---------- -----------
Estimated Proved Oil Reserves (Bbls) 1,175,000 1,294,000 1,352,000
Estimated Proved Gas Reserves (Mcf) 4,833,000 5,851,000 5,724,000
Estimated Future Net Revenues (before the
estimated future income taxes) $ 26,506,000 $15,480,000 $14,016,000
Present Value of Estimated Future
Net Revenues (before the estimated
future income tax expenses) $ 15,641,000 $ 9,616,000 $ 8,519,000
The table above does not include the reserve values associated with the Gas
Plant. The Gas Plant reserves are disclosed in Part II, Item 7 of footnote 12.
No reserves have been estimated for the Company's interest in the East Bayou
Sorrel Prospect which was acquired subsequent to the Company's last fiscal year
end and will not be estimated until at least a developmental well is drilled on
the property in 1997. Other than that, there has been no major discovery or
other favorable or adverse event that is believed to have caused a significant
change in the estimated quantities of proved reserves subsequent to December 31,
1996. However, the prices for oil and gas have decreased as of the date of this
report below those used for the reserve estimates. The Company's reserves for
its oil and gas properties at December 31, 1996, discounted at 10%, using the
average sales prices in 1996 ($20.35 per bbl. of oil and $1.26 per Mcf of gas)
are approximately 47% lower, or $7.3 million dollars.
11
<PAGE>
NET QUANTITIES OF OIL AND GAS PRODUCED
The Company's net oil and gas production for each of the last three years (all
of which was from properties located in the United States) was as follows:
Year Ended December 31,
1996 1995 1994
--------- --------- -------
Oil (Bbls) 100,000 121,000 155,000
Gas (Mcf) 412,000 497,000 543,000
The average sales price per barrel of oil and Mcf of gas, and average production
costs per barrel of oil equivalent ("BOE") excluding depreciation, depletion and
amortization were as follows:
Average Sales Prices Average
Year Ended Production
December 31 Oil (Bbls) Gas (Mcf) Per BOE Cost Per BOE
----------- ----------- ----------- -------- ------------
1996 $20.35 $1.26 $15.10 $8.46
1995 $16.77 $1.18 12.85 $7.92
1994 $15.94 $1.36 13.09 $8.90
The above table represents activities related only to oil and gas production. It
does not include any value from the natural gas liquids extracted by the Gas
Plant.
DRILLING ACTIVITY
The following table summarizes the Company's oil and gas drilling activities,
all of which were located in the continental United States, during the last
three fiscal years:
Year Ended December 31,
1996 1995 1994
---- ----- -------
Wells Drilled ..... Gross Net Gross Net Gross Net
Exploratory
Oil .......... - - - - - -
Gas .......... - - - - - -
Non-productive 1 .19 1 .25
--- ----- ---- ----- --- ----
Total .... 1 .19 - - 1 .25
=== ===== ==== ===== === ====
Development
Oil .......... 1 1 - - 4 3.92
Gas .......... - - - - - -
Non-productive - - - - - -
--- --- ---- ---- ----- -----
Total .... 1 1 4 3.92
=== === ===== ==== ===== =====
The Company was not participating in any drilling activity at December 31, 1996.
However, the Company is participating to the extent of a 6.25% working interest
in the E. Winn #1 well, a 17,375 foot Miogyp Sand test, in the South Lake Arthur
Prospect, located in Jefferson Davis Parish, Louisiana, that commenced drilling
operations on January 9, 1997. Total depth is expected to be reached sometime in
April 1997. This prospect consists of approximately 1,600 gross acres.
ITEM 3 - LEGAL PROCEEDINGS
The Company may from time to time be involved in various claims, lawsuits,
disputes with third parties, actions involving allegations of discrimination, or
breach of contract incidental to the operation of its business. At December 31,
1996 and as of the date of this report, the Company was not involved in any
litigation which it believes could have a materially adverse effect on its
financial condition or results of operations.
12
<PAGE>
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's Security holders during the
fourth quarter ending December 31, 1996.
Part II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information - The Company's Common Stock has been quoted on the
NASDAQ Small-cap Market, under the symbol WPOG, since July 1980. The Company's
Preferred Stock, has traded on the NASDAQ Small-cap Market under the symbol
WPOGP since August 1993.
Bid Quotations - The following table shows the range of high and low bid
quotations for each quarterly period since January 1, 1995, as reported by the
National Association of Securities Dealers, Inc. (such quotations represent
prices between dealers and do not include retail markups, markdowns, or
commissions and do not necessarily represent actual transactions.):
Bid Prices
Common Stock Preferred Stock
Quarter Ended High Low High Low
------------------ ------- -------- -------- -----
December 31, 1996 3 5/16 2 1/16 10 3/4 6
September 30, 1996 2 1/8 1 7/32 6 3/4 5 1/4
June 30, 1996 1 11/16 1 5/64 7 4 1/4
March 31, 1996 1 3/8 19/32 5 3-1/2
December 31, 1995 9/16 13/32 4 5/8 3 7/8
September 30, 1995 7/8 1/2 4 5/8 4 5/8
June 30, 1995 31/32 5/8 5 7/8 4 3/4
March 31, 1995 2 3/32 1 3/4 5 7/8 3 5/8
(b) Stockholders - As of February 21, 1997 the Company had 978 holders of record
of the Company's Common Stock and 17 holders of record of the Company's
Preferred Stock. This does not include the holders whose shares are held in a
depository trust in "street" name. As of February 21, 1997 at least 5,306,000
shares (or 62%) of the issued and outstanding common stock and at least 134,000
shares (or 95%) of the issued and outstanding preferred stock was held in a
depository trust in "street" name.
(c) Dividends - The Company has not paid cash dividends on its Common Stock in
the past and does not anticipate doing so in the foreseeable future. The Company
is precluded from paying dividends on its Common Stock so long as any dividends
on the Preferred Stock are in arrears.
Holders of shares of Preferred Stock are entitled to receive, when, as and if
declared by the Board of Directors out of funds at the time legally available
therefor, cash dividends at an annual rate of 10% (equal to $1.00 per share
annually), payable quarterly in arrears. Cumulative dividends accrue and are
payable to holders of record as they appear on the stock books of the Company on
such record dates as are fixed by the Board of Directors.
The Preferred Stock was issued in August 1993 and the Company declared and paid
five consecutive dividends for the quarters ended September 30, 1993 through
September 30, 1994. In December 1994, the Board of Directors voted not to
declare the quarterly cash dividend to holders of the Company's Preferred Stock
for the fourth quarter of 1994. The decision to not pay the quarterly dividend
was a result of the Company's continuing operating losses, the cash and working
capital position, and the Company's belief that its primary lender would not
approve the payment thereof. In March 1995, the Board of Directors voted to
suspend payment on any future Preferred Stock dividends indefinitely. However,
pursuant to the terms of the Preferred Stock, dividends will continue to accrue
on a quarterly basis. Dividends paid in the future, if any, on the Preferred
Stock will be contingent on many factors
13
<PAGE>
including, but not limited to, whether or not a dividend can be justified
through the cash flow and earnings generated from future operations.
The Preferred Stock will have priority as to dividends over the Common Stock and
any series or class of the Company's stock hereafter issued, and no dividend
(other than dividends payable solely in Common Stock or any other series or
class of the Company's stock hereafter issued that ranks junior as to dividends
to the Preferred Stock) may be declared, paid or set apart for payment on, and
no purchase, redemption or other acquisition may be made by the Company of, any
Common Stock or other stock unless all accrued and unpaid dividends on the
Preferred Stock have been paid or declared and set apart for payment.
(d) Recent Sales of Unregistered Securities - During the fiscal year ended
December 31, 1996, the Company issued and sold the following securities without
registration under the Securities Act of 1933, as amended.
1. Between June 1996 and November 15, 1996, the Company issued
$5,000,000 in collateralized convertible 10% debentures and warrants to
purchase up to 2,500,000 shares of the Company's common stock at $1.25 per
share. The securities were offered and sold as units, with each unit
consisting of $50,000 in debentures and warrants to purchase 25,000 shares.
The securities were sold by the Company and by 12 broker\dealers registered
as such with the Securities and Exchange Commission and who are members of
the National Association of Securities Dealers, Inc. The securities were
sold to 105 private investors each of whom qualified as an accredited
investors as such term is defined in Regulation D adopted by the Securities
and Exchange Commission under the Securities Act. The Company received $5.0
million for the securities and paid total underwriting discounts and
commissions of $547,000. The debentures sold by the Company are convertible
into common stock of the Company at the election of the holder at the rate
of one share of common stock for each $3.00 in principal amount of
debenture, or a total of 1,666,666 shares upon conversion of all debentures
issued. The warrants included in the units are exercisable at any time by
the holder and may be called for redemption by the Company at $0.10 per
share upon 45 days notice if the reported market price for common stock of
the Company is at least $3.00 per share for a period of 10 consecutive
trading days or more. The Company relied upon Section 4(2) of the Securities
Act and Rule 506 of Regulation D in claiming exemption from the registration
requirements of the Securities Act for the securities issued.
2. On March 9, 1996, the Company issued 38,050 shares of its common
stock to 22 persons who were employees or directors of the Company in lieu
of cash for services to the Company valued at $38,050 for financial
reporting purposes.
3. In March 1996 the Company issued warrants entitling the holders
to purchase up to 1,000,000 shares of the Company's common stock at $0.75
per share to 14 persons in connection with a consulting agreement between
the Company and Beta Capital Corp., with whom the Company has a consulting
agreement. Issuance of the warrants was required by the consulting agreement
and the exercise price of the warrants was equal to the reported market
price for the Company's common stock at the time the Company became
obligated to issue the warrants. For financial reporting purposes, these
warrants were valued at $294,000. The warrants are exercisable for five
years from the date of issuance.
4. On May 13, 1996, the Company issued 82,353 shares of its common
stock to three holders who elected to convert $70,000 in principal amount of
outstanding convertible debentures originally issued in a private placement
in 1991.
5. On August 13, 1996, the Company issued 15,000 shares of its
common stock to a consultant of the Company in lieu of cash for consulting
services to the Company valued at $22,977 for financial reporting purposes.
6. On December 16, 1996, the Company issued 60,000 shares of its
common stock to Willard H. Pease, Jr., the President of the Company, upon
conversion of a promissory note of the Company in the principal amount of
$60,000 issued to Mr. Pease in 1994 in payment of certain obligations.
14
<PAGE>
7. Between November 22, 1996 and December 13, 1996, the Company
issued 50,000 shares of its common stock upon exercise of three warrants
held by two persons. The warrants were exercised at $0.85 per share for
total proceeds to the Company of $42,500. The warrants had been issued in a
private transaction in 1995 as compensation to a consultant.
8. On December 16 and 17, 1996, the Company issued 17,500 shares of
its common stock upon exercise of two warrants held by two persons. The
warrants had been issued in the private placement of securities described in
subparagraph 1 above. The Company received proceeds of $21,875 upon exercise
of the warrants.
9. On December 16, 1996, 13,440 shares of common stock were issued
to eight nonemployee-directors of the Company in lieu of cash for services
to the Company valued at $24,261 by the Company for financial reporting
purposes.
10. Effective November 15, 1996, the Company issued warrants to
purchase up to 223,500 shares of common stock at $2.00 per share to 12
broker\dealers as partial compensation to such persons for sale of the
securities in the private offering described in subparagraph 1 above. The
warrants are exercisable upon issuance and expire if not exercised three
years after issuance.
11. On March 9, 1996, the Company issued warrants to purchase
40,000 shares of common stock at $0.75 per share to one person in lieu of
cash for consulting services provided to the Company valued at $22,400 for
financial reporting purposes. The warrants may be exercised at any time
before March 9, 2001.
As to each issuance of securities identified above, the Company relied upon
Section 4(2) of the Securities Act in claiming exemption from the registration
requirements of the Securities Act. All the persons to whom the securities were
issued had full information concerning the business and affairs of the Company
and acquired the shares for investment purposes. Certificates representing the
securities issued bear a restrictive legend and stop transfer instructions have
been entered prohibiting transfer of the securities except in compliance with
applicable securities laws.
15
<PAGE>
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS
SELECTED FINANCIAL DATA
Statement of Operations Data: Year Ended December 31,
1996 1995
------------ ---------
Oil and gas sales $2,546,676 $ 2,623,782
Natural gas marketing and trading 2,067,379 3,872,565
Gas plant processing revenue 818,356 1,135,050
Total revenue 6,165,664 9,031,816
Net loss (1,411,582) (765,436)
Preferred Stock Dividends:
Declared - -
Converted (22,750) (117,000)
In arrears (179,938) (202,688)
Non-cash inducement - (1,523,906)
------------- -----------
Net loss applicable
to common stockholders $(1,614,270) $(2,609,030)
=========== ===========
Per Share Data: 1996 1995
-------------- -----------
Before non-cash inducement charge $ (0.22) $ (0.18)
Effect of non-cash inducement charge - (0.24)
-------------- -----------
Net loss per
common share $ (0.22) $ (0.42)
============== =============
Cash dividends declared per common share $ - $ -
============== =============
Balance Sheet Data: As of December 31,
1996 1995
---------------- ---------
Working capital (deficit) $ 1,907,694 $ (500,180)
Total assets $ 14,888,754 $13,439,726
Long-term liabilities $ 3,543,863 $ 1,602,811
Stockholder's equity $ 10,191,963 $ 9,017,262
Disclosure Regarding Forward-Looking Statements
This report on Form 10-KSB includes "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of historical
facts included in this report, including, without limitation, statements under
"Business and Properties" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" regarding the Company's financial position,
reserve quantities and net present values, business strategy, plans and
objectives of management of the Company for future operations and capital
expenditures, are forward-looking statements and the assumptions upon which such
forward- looking statements are based are believed to be reasonable. The Company
can give no assurance that such expectations and assumptions will prove to have
been correct. Reserve estimates of oil and gas properties are generally
different from the quantities of oil and natural gas that are ultimately
recovered or found. This is particularly true for estimates applied to
exploratory prospects. Additionally, any statements contained in this report
regarding forward-looking statements are subject to various known and unknown
risks, uncertainties and contingencies, many of which are beyond the control of
the Company. Such things may cause actual results, performance, achievements or
expectations to differ materially from the anticipated results, performance,
achievements or expectations. Factors that may affect such forward-looking
statements include, but are not limited to, the Company's ability to generate
additional capital, risks inherent in oil and gas acquisitions, exploration,
drilling, development and production, price volatility of oil and gas,
competition, shortages of equipment, services and supplies, government
regulation, environmental matters, financial condition of the other companies
participating in the exploration, development and production of oil and gas
programs and other matters. All written and oral forward-looking statements
attributable to the Company or persons acting on its behalf subsequent to the
date of this report are expressly qualified in their entirety by this
disclosure.
16
<PAGE>
Liquidity and Capital Resources
At December 31, 1996, the Company's cash balance was $1,995,860 with a positive
working capital position of $1,907,694, compared to a cash balance of $677,275
and a working capital deficit of $500,180 at December 31, 1995. The change in
the Company's cash balance is summarized as follows:
Cash balance at December 31, 1995 $ 677,275
Cash used in operating activities (143,615)
Capital expenditures (1,403,413)
Proceeds from the sale of property
and equipment 163,821
Redemption of certificate of deposit 53,500
Payments on long-term debt (1,795,670)
Net proceeds from issuance of
convertible debt 4,323,992
Proceeds from common stock
subscription receivable and warrant exercises, net 119,970
------------
Cash balance at December 31, 1996 $ 1,995,860
============
The significant improvement in the Company's cash balance and working capital
position is directly related to: a) the proceeds received from the private
placement of convertible debentures; and b) the repayment of the entire balance
of outstanding debt with Colorado National Bank ("CNB"). In November 1996, the
Company completed a private placement of $5,000,000 of collateralized
convertible debentures and warrants to purchase up to 2,500,000 shares of stock,
sold in "Units", which generated net cash proceeds of $4,300,000. Each Unit sold
for $50,000 and consisted of one $50,000 five-year 10% collateralized
convertible debenture and warrants to purchase 25,000 shares of the Company's
common stock at $1.25 per share. The estimated fair value of the detachable
warrants of 41,829,000 has been treated as a discount which is being amortized
using the interest method. After considering the discount and other debt
issuance costs, the effective interest rate is 22% for these debentures. The
debentures are collateralized by a first priority interest in certain oil and
gas properties owned and operated by the Company. The debentures are
convertible, at the holders option, into the Company's common stock for $3.00
per share and may be redeemed by the Company, in whole or in part, beginning at
a premium of 110% of the original principal amount and are subject to adjustment
beginning on April 25, 1999. Interest on the debentures is payable quarterly and
the entire principal balance will be due on April 15, 2001. The warrants are
currently exercisable and will expire on July 31, 2001. The Company is entitled
to call the warrants at any time after February 15, 1997 at a price of $0.10 per
warrant. (As discussed later in this section, the Company initiated a call on
these warrants on February 28, 1997.) In a registration statement effective
February 10, 1997, the Company registered for resale: (1) the shares of common
stock into which the debentures may be converted; and (2) the shares of common
stock issuable upon exercise of the warrants.
The completion of that private placement and repayment of the entire balance of
outstanding debt with CNB with a portion of the proceeds thereof, significantly
improved the Company's working capital position and provided the funds necessary
to pursue additional acquisition, drilling and development activities on a
limited basis. Recently, the Company has charted a course of action to maintain
its existing asset base in the Rocky Mountain region and expand into the Gulf
Coast region of Alabama, Southern Louisiana and Texas through a series of
acquisitions and strategic alliances which is discussed more thoroughly in the
following paragraphs. However, this new course of action will require the
Company to seek a significant amount of additional capital to fully fund and
implement that plan.
On February 4, 1997, the Company signed a definitive agreement with National
Energy Group, Inc. ("NEGX"), a publicly held Company, headquartered in Dallas,
Texas. The agreement provides the Company the right and obligation to
participate with NEGX in various oil and gas exploration projects over the
course of next two years. Essentially, the agreement consists of three main
elements. First, the Company has the right and obligation to participate as a
12.5% working interest owner in NEGX's outlined program which consists of 10
identified projects in Alabama, Southern Louisiana, and Texas. Second, subject
to certain conditions defined in the agreement, the Company has the right and
obligation to participate in any future projects generated under NEGX's
exclusive arrangement with Sandefer Oil and Gas Company, Inc. ("Sandefer").
Sandefer is a private corporation owned and
17
<PAGE>
operated by a group of geologists and geophysicists who generate Gulf Coast,
Southern Louisiana and other wildcat prospects. Third, the Company is entitled
to participate in any other third party generated prospects that NEGX
participates in subject to certain conditions as defined in the agreement.
Pursuant to the terms of the agreement with NEGX, the Company's minimum
obligation is at least $5.0 million per year in dry hole, or drilling, costs.
Additional costs will be incurred for completion and development of successful
projects. Accordingly, the Company anticipates the actual obligation will be
higher assuming that a reasonable amount of success is achieved with the
underlying prospects. If all the prospects prove to be productive (which the
Company believes is unlikely as the drilling program is a wildcat exploration
program), the total obligation to the Company for 1997 could be in excess of
$20.0 million.
If all the contemplated exploratory prospects are successful and the properties
are eventually fully developed, the net reserves attributable to the Company's
interest would be several times the Company's present reserves. The Company's
current reserves are approximately 2 million barrels of oil (or equivalent).
Accordingly, the agreement with NEGX provides the Company with an exploration
program that has the potential to significantly increase its existing reserves
and future cash flow.
In order to fund the obligation with NEGX the Company intends to seek additional
financing. The Company intends to pursue additional equity through exercise of
outstanding warrants, private equity placements, and/or other potential
financing vehicles. Specifically, in December 1996, the Company initiated a
warrant call underlying warrants to purchase 250,000 shares of the Company's
common stock held by 11 persons that were exercisable at $1.25 per share. These
warrants were issued as part of a "Unit" of common stock and warrants issued in
a private placement during 1995. All the holders of the warrants elected to
exercise their warrants prior to redemption by the Company. Exercise of the
warrants generated net cash proceeds of $290,000 in January 1997.
Also, during February and early March, 1997, the Company completed a private
placement of 1,500,000 shares of common stock for proceeds of $3.75 million as
described below. On February 28, 1997, the Company initiated a call of the
warrants that were attached to the convertible debentures issued in the private
placement which was completed in 1996. The warrants were held by approximately
105 persons and are exercisable for $1.25 per share. Pursuant to the terms of
the warrant, the holders have forty-five days after the call notice (or until
April 15, 1997) to exercise their warrants or they will be redeemed by the
Company for $.10 per warrant. If all the warrants are exercised (which the
Company believes is likely based on the market price of the Company's common
stock as of the date of this report), it will generate net proceeds to the
Company of approximately $2.9 million. The proceeds generated from these warrant
calls should cover the Company's working capital needs, including the
anticipated exploration costs associated with the letter agreement with NEGX, at
least through the second quarter of 1997. After that, the Company will need to
seek additional financing.
Anticipating the need for additional financing, in February 1997 the Company
signed a non-binding letter of intent with a brokerage firm setting forth the
terms and conditions under which the broker will attempt to assist the Company
with a future private placement. The letter agreement with the brokerage firm
contemplates a future placement of at least $6.0 million dollars in common stock
in the second or third quarter of 1997. The agreement is subject to several
contingencies including, but not limited to, due diligence and the execution of
formal agreement.
If the Company is unsuccessful in completing the private placement, or if
additional funds are necessary either before or after such a transaction, it is
uncertain at this time what actions the Company will take. Possibilities include
other debt or equity financings or the sale of existing assets.
In March 1996 the Company retained Beta Capital Group, Inc. ("Beta") as a
consultant to the Company. Beta is located in Newport Beach, California and
specializes in emerging oil and gas companies that have capital resources needs
and market support requirements. Beta has worked closely with the Company to
structure its financings and meet the Company's expected cash and capital
resources requirements. Mr. Antry was added to the Company's Board of Directors
on August 10, 1996. Beta's President, Steve Antry, was an officer of Benton Oil
and Gas Company between 1989 and 1992. During that time, Mr. Antry was
instrumental in obtaining various sources of capital that Benton Oil and Gas
required during a very significant growth period. Based on Mr. Antry's
background, the Company believes that Beta adds a tremendous value to the
Company because of their network of financial
18
<PAGE>
resources. Therefore, the Company will attempt to utilize Beta's syndication of
financial resources to fund future capital requirements. See "Consulting
Agreement--Related Party" on page 24 and "Item 9, Directors, Executive Officers,
Promoters and Control Persons; Compliance with Section 16(a) of the Exchange
Act."
In addition to the identified exploration program with NEGX, the Company has
pursued the acquisition of an oil and gas property in Southern Louisiana. On
January 10, 1996, the Company acquired a 7.8125% After Prospect Payout Working
Interest ("APPO WI") in the East Bayou Sorrel Prospect from third parties for a
total purchase price of $1.75 million. The purchase price consisted of the
issuance of 315,000 shares of the Company's common stock and $875,000 in cash.
On March 3, 1997 the Company acquired an additional 10% working interest in the
same prospect for $2.5 million cash from third parties. The prospect includes a
discovery well, the C.E. Schwing #1, which in February 1997 produced at a rate
in excess of 1,400 barrels of oil per day and 1,300 Mcf of natural gas per day
with a flowing tubing pressure of 6,300 PSI on a 12/64" choke from a perforated
interval of 13,208 feet to 13,226 feet. If that production rate is sustained,
this acquisition will increase the Company's net production (per BOE) by 25%
(based on 1996's average net daily production. An offset developmental well to
the C.E. Schwing #1 is expected to commence drilling operations in the second
quarter of 1997.
These acquisitions were funded with the Company's existing working capital and
the proceeds generated from a private placement of common stock during February
and March 1997. In that placement, the Company sold 1,500,000 shares of the
Company's restricted common stock to accredited investors for $2.50 per share.
The private placement was completed on March 10, 1997 generating net proceeds of
approximately $3.3 million. The Company has agreed to use its best efforts to
register the shares sold in this private placement for resale on or before July
10, 1997.
Capital Expenditures
During 1996, the Company capitalized or invested $1,403,413 in property and
equipment as follows:
Oil and Gas Properties:
Drilling Costs -
Exploratory Dry Holes $ 525,000
Developmental well 435,647
------------
Total Drilling Costs 960,647
Workovers or Recompletions of existing properties 206,627
Deposit on future exploratory well 181,312
------------
Total Oil and Gas properties 1,348,586
Service Equipment and Rolling Stock 27,777
Office Equipment 19,930
Gas Plant facility 7,120
-------------
$ 1,403,413
During 1996 the Company drilled two new wells. The first well was a
"double-stacked" horizontal - the first of its kind in Colorado. The well was
drilled in Loveland Field, located in Larimer County, Colorado. A
"double-stacked" horizontal well consists of drilling two separate horizontal
wells, or legs, in two different geologic formations from a single well bore.
This technology has been used extensively in the Austin Chalk Formation in Texas
and Pease Oil and Gas was the first company to attempt this technology in
Colorado. The geologic formations targeted during this well were the Niobrara, a
proved zone, and the Timpas, an unproved zone. Unfortunately, the Timpas zone
was found to be unproductive and the Company wrote-off $450,000 to dry hole
costs (this represents the estimated costs attributable to drilling the Timpas
leg). The remaining costs associated with this well for the Niobrara leg were
capitalized as developmental costs.
The second well was a deep wildcat prospect in Southern Louisiana that was
generated by NEGX. The well was drilled in excess of 14,000 feet and although
the logs indicated some excellent shows, it appears the targeted formation
either did not receive a hydrocarbon charge or it had passed through the
formation and the well was plugged and abandoned. The Company's cost for this
dry hole was $75,000.
19
<PAGE>
In 1996, the Company spent $206,627 for workovers, recompletions and equipment
acquisitions related to maintaining or enhancing the current production of its
producing oil and gas properties.
In November 1996, the Company also paid $181,312 for a deposit on an exploratory
well which commenced drilling operations on January 9, 1997. This well, the E.
Winn #1, is a 17,375 foot Miogyp Sand test, in the South Lake Arthur prospect,
located in Jefferson Davis Parish, Louisiana. Total depth is expected to be
reached sometime in April 1997. The deposit has been capitalized as of December
31, 1996 and will remain that way, along with the future drilling costs
incurred, until the outcome of the exploratory well is known.
RESULTS OF OPERATIONS
Overview
The Company's largest source of operating revenue is from the sale of produced
oil, natural gas, and natural gas liquids. Therefore, the level of the Company's
revenues and earnings are affected by prices at which natural gas, oil and
natural gas liquids are sold. As a result, the Company's operating results for
any prior period are not necessarily indicative of future operating results
because of the fluctuations in natural gas, oil and natural gas liquid prices
and the lack of predictability of those fluctuations as well as changes in
production levels.
Early in 1995, the Company initiated a corporate restructuring that focused on:
eliminating areas of its business that were losing money, reducing operating
costs, increasing efficiencies, and generating funds for working capital. These
initiatives included but were not limited to downsizing of the Company's oil
field service and supply operations and closing the administrative office in
Denver, Colorado. As is more fully discussed later in this section under their
respective captions, the Company's oil field service supply operating margins
have been historically low and even unprofitable. The burden of these low
margins or operating losses have been compounded with the risks inherent in
these operations and the capital investment required to maintain and operate.
Accordingly, the decision was made to downsize these operations in May 1995. The
administrative office was closed because the Company could not afford the luxury
and expense of two administrative offices.
In December 1994 the Company's Board of Directors did not declare the quarterly
cash dividend to holders of the Company's Series A Cumulative Convertible
Preferred Stock ("Preferred Stock") for the fourth quarter of 1994. In March
1995, the Board of Directors voted to suspend payment on any future Preferred
Stock dividends indefinitely. These decisions were based on the Company's
working capital position at that time, and the belief that the Company's primary
lender would not approve a dividend payment. However, pursuant to the terms
underlying the Preferred Stock, dividends continue to accrue on a quarterly
basis and will increase the number of common shares that will be issued upon
conversion of the preferred stock pursuant to the terms of the Company's
Articles of Incorporation. Whether dividends are paid in the future on the
Preferred stock will be contingent on many factors, including but not limited
to, whether or not a dividend can be justified through the cash flow and
earnings generated from future operations.
In January 1995, the Company extended a tender offer to the Preferred
stockholders. On February 28, 1995, the Company completed the tender offer to
its Preferred Stockholders whereby the holders of the Company's Preferred Stock
were given the opportunity to convert each share of Preferred Stock and all then
accrued and undeclared dividends (including the full dividend for the quarters
ended December 31, 1995 and March 31, 1995) into 4.5 shares of the Company's
Common Stock and warrants to purchase 2.625 shares of Common Stock at $5.00 per
share through December 31, 1996 and $6.00 per share through August 13, 1998 (the
date the warrants expire). As a result of the tender offer 933,492 shares of the
Preferred stock converted into 4,200,716 shares of the Company's Common Stock
and warrants to purchase 2,450,417 shares of Common stock. In addition, 21,600
shares of Preferred Stock converted into 56,739 shares of Common Stock prior to
the tender offer. In 1996, an additional 22,750 shares of the Preferred Stock
converted into 69,670 shares of common pursuant to terms of such conversion set
forth in the Company's Articles of Incorporation. Accordingly, as of December
31, 1996 there remained 179,938 shares of Preferred Stock outstanding. These
conversions substantially changed the capital structure of the Company.
Consideration of the restructuring initiatives is an important component when
comparing the results of operations between the two periods presented.
20
<PAGE>
Total Revenue
Total Revenue from all operations was as follows:
For the Year Ended December 31,
1996 1995
------------------ --------------------
Amount % Amount %
Oil and gas sales $2,546,676 41% $2,623,782 29%
Natural gas marketing
and trading 2,067,379 34% 3,872,565 43%
Gas plant processing 818,356 13% 1,135,050 13%
Oil field services
and supply 618,225 10% 1,302,741 14%
Well administration
and other income 115,028 2% 97,678 1%
-------- ----- ---------- -----
Total revenue $6,165,664 100% $9,031,816 100%
========= ==== ========= ====
The decrease in total revenue is a result of: a) the expiration of the Company's
natural gas marketing and trading contract with Public Service Company of
Colorado effective July 1, 1996; b) no third party gas was processed by the
Company's gas plant facility in 1996; c) a decrease in oil and gas production;
and d) downsizing of the Company's service and supply operations. These
circumstances, along with any known trends or changes that effect revenue on a
line-by-line basis, are discussed in the following paragraphs under their
respective captions.
Oil and Gas
Operating statistics for oil and gas production for the periods presented are as
follows:
For the Year Ended December 31,
1996 1995
----------- ---------
Production:
Oil (bbls) 100,000 121,500
Gas (Mcf) 412,000 496,500
BOE (6:1) 168,700 204,000
Average Collected Price:
Oil (per bbl) $ 20.35 $ 16.77
Gas (per Mcf) $ 1.26 $ 1.18
Per BOE (6:1) $ 15.10 $ 12.85
Gross Margin:
Revenue $ 2,546,676 $ 2,623,782
Operating costs (1,426,549) (1,617,318)
----------- -----------
Gross Margin $ 1,120,127 $ 1,006,464
========== =========
Gross Margin Percent 44% 38%
=========== ==========
Average Production Costs per
BOE before DD&A $ 8.46 $ 7.92
DD&A per BOE 3.50 3.63
----------- ----------
Total Costs of Production
per BOE $ 11.96 $ 11.55
========= ===========
Change in oil and gas revenue
attributed to:
Production $ (465,388)
Price 388,282
---------
Net change between 1995 and 1996 $ (77,106)
===========
Most of the decrease in oil and gas production can be attributed to the
following: 1) the sale of several marginal, uneconomic, or nonstrategic oil and
gas properties in 1996 (see divested production table below); and 2) to a much
lesser extent the natural decline in production that is inherent in oil and gas
wells. Both these circumstances were largely offset by an increase in price.
21
<PAGE>
The production included in the above tables and associated with the wells sold
during 1996 is as follows:
For the Year Ended December 31,
Divested Production 1996 1995
- ------------------- ------------ ----------
Oil (bbls) 3,900 16,700
Gas (Mcf) 4,500 23,000
BOE (6:1) 4,650 20,500
Natural Gas Marketing and Trading
The Company had a "take-or-pay" contract with Public Service Company of Colorado
("PSCo") which called for PSCo to purchase from the Company a minimum of 2.92
billion cubic feet ("BCF") of natural gas annually. The price paid the Company
by PSCo was based on the Colorado Interstate Gas Commission's "spot" price, plus
a fixed price bonus. The natural gas marketing and trading activities represent
natural gas that was purchased from third parties and sold to PSCo under the
terms of the contract.
Operating statistics for the Company's Marketing and Trading Activities for the
periods presented are as follows:
For the Year Ended December 31,
1996 1995
------------- ---------
Total Volume Sold (Mcf) 1,223,855 2,586,205
Average Price $ 1.69 $ 1.50
------------- ------------
Total Revenue 2,067,379 $3,872,565
Costs (1,745,446) (3,404,169)
------------ -----------
Gross Margin $ 321,933 $ 468,396
=========== ==========
The contract with PSCo expired on June 30, 1996. Historically, the price paid by
PSCo under that contract was at a premium above the market and therefore allowed
for the marketing and trading activities. Although the Company has been
negotiating with PSCo to renew the contract, no formal agreement has been
reached as of the date of this report. Consequently, no marketing and trading
revenues have been generated subsequent to June 30, 1996. With the increasing
competition fostering within all phases of the natural gas industry, it is
unlikely that the contract will be renewed at an above market premium, if at
all, and the Company is unlikely to resume marketing and trading activities.
Since the gross margin represents the net cash flow and income generated from
this activity, the loss of this premium contract price has and will have a
material and negative impact on the Company's current and future operations.
Gas Plant Processing Revenues
This category accounts for the natural gas processed and the natural gas liquids
extracted and sold by the Gas Plant facility.
Operating statistics for the periods presented are as follows:
For the Year Ended December 31,
1996 1995
---------- ---------
Production:
Natural Gas Processed (Mcf) -
From Company owned wells 363,000 424,600
Third party gas 228,000
---------- ----------
Total gas processed 363,000 653,400
Liquids Produced -
B-G Mix (gallons) 907,600 1,314,900
Propane (gallons) 694,000 1,053,900
Average Sales Price of Liquids (per gallon) $ 0.45 $ 0.34
=========== ============
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<PAGE>
Gross Margin: Amount Amount
---------- ----------
Revenue $ 818,356 $1,135,050
Costs (464,512) (942,867)
------------ ------------
Gross Margin $ 353,844 $ 192,183
=========== ===========
Gross Margin Percent 43% 17%
The decrease in processing volumes and revenue during 1996 as compared to the
same periods in 1995, can be substantially attributed to the Company purchased
and processed third party gas between February 1995 and September 1995. In
October 1995 the Company stopped processing third party gas to correct some
operational problems. The operational problems have been corrected and the plant
is now running more efficiently and effectively than it has in the past.
However, with the increased competition to process natural gas and the
historically low gas prices prevalent in the Rocky Mountain Region, the Company
has not been able to purchase third party gas at an economical rate. These
factors along with the increasing competitive environment in the natural gas
market, it is uncertain at this time if the Company will be able to compete with
other gas plants and purchasers of natural gas in its market area. Accordingly,
it cannot be determined at this time when, or if, the Company will process any
additional third party gas.
Costs associated with the Gas Plant operations consist of both semi-fixed and
variable costs. The semi-fixed costs consist of direct payroll, utilities,
operating supplies, general and administrative costs, and other items necessary
in the day-to-day operations. The semi-fixed costs average approximately
$435,000 annually and are not expected to change significantly regardless of the
volume processed by the Gas Plant. The variable costs consist primarily of
purchased gas, plant fuel and shrink, lubricants, repair and maintenance, and
costs of gas marketing and buying. These costs are generally a direct function
of the volume processed by the Gas Plant and are expected to either increase or
decrease proportionately with the corresponding plant production. When compared
to 1996, the costs in 1995 were higher in amount and as a percentage of revenue
as a result of the Company purchasing and processing third party gas between
February 1995 and September 1995. Currently, the gas processed by the Gas Plant
facility is from wells the Company owned. Accordingly, the costs, as a
percentage of revenue, have decreased in 1996.
As stated above, the Company currently processes natural gas exclusively from
wells owned or operated by the Company. Given the extremely competitive
environment in the DJ Basin where the gas plant facility is located, management
is exploring the possibility of increasing the Company's net cash flow by
entering into a gas processing agreement with a third party. Under this
scenario, the current operations at the gas plant facility would be shut down
and the gas currently processed by the plant would be sold to a third party.
Although no formal decision has been made, this possibility is being disclosed
since such a decision may ultimately impact the carrying value of the gas plant
facility under Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long- Lived Assets." As of December 31, 1996 the net
carrying value of the gas plant facility was approximately $3.34 million. It is
not certain at this time if a decision of this nature will ultimately be made,
and if so, if that decision would ultimate impact the carrying value of the gas
plant facility. However, should a determination be made in the future that the
carrying value of the gas plant facility will not be realized, a non-cash
impairment charge may need to be recognized as prescribed under SFAS No. 121,
which could have a material negative impact on the Company's future results of
operations and balance sheet.
Should operations at the Company's Gas Plant Facility be shut down and the
Company's gas processing activities discontinued, the Company would anticipate
incurring shut down costs, in addition to impairment charges as discussed above.
Although the amount of any such costs is unknown at this time, the Company does
not anticipate that any such costs or expenses would be material. The Company is
not aware of any environmental degradation which exists, or the obligation for
remediation of which would arise under applicable state or federal environmental
laws. The Company does not maintain a fund for environmental or other similar
costs. Any such costs or expenses would be paid by the Company out of operating
capital.
Oil Field Services and Oil Field Supply
Operating statistics for the Company's oil field service and supply operations
for the periods presented are as follows:
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<PAGE>
Service and Supply Operations
For the Year Ended December 31,
1996 1995
------------- -----------
Revenue $ 618,225 $ 1,302,741
Costs 553,343 (1,391,588)
------------- -----------
Net Operating Income (Loss) $ 64,882 $ (88,847)
=========== ============
The decrease in revenue from the service and supply operations is directly
related to the restructuring initiatives conducted in 1995. A summary of the
restructuring for both operations is discussed in the following paragraphs.
Service Operations
Historically, the Company's service business operated out of two locations -
Loveland and Sterling Colorado. The services provided included: servicing rigs,
vacuum trucks, roustabout services, and hot oiling services. The operations
serviced both the Company's needs and those of third parties. The restructuring
was focused on reducing the service rig, vacuum truck, and roustabout operations
to a point where the Company can service its own oil and natural gas operations
efficiently and at the lowest possible cost, while performing only limited
services for third parties. Any services of this type to third parties will be
limited to those circumstances when the equipment and man power is not needed in
the Company's operations. The Company did retain its hot oiler fleet (consisting
of three trucks) and intends to continue providing this service to third parties
on a full time basis.
Supply Operations
Historically, the Company's supply business has operated out of two locations -
Loveland and Sterling, Colorado. The restructuring was focused on consolidating
the operations to one location (Loveland, Colorado), eliminating duplicate costs
and ultimately reducing the amount of inventory.
Although total revenues from the service and supply operations decreased
approximately 53% from 1995 to 1996 as a result of the restructuring, the
margins improved since the operations ran more efficiently on the smaller scale.
Well Administration and Other Income
This revenue primarily represents the revenue generated by the Company for
operating oil and gas properties. There has been no significant change in the
average monthly revenue between 1996 and 1995 and Management does not expect any
significant change in the future.
Consulting Arrangement - Related Party
The Company entered into a consulting agreement with Beta in March 1996. Fees
and reimbursed expenses incurred by the Company in connection with Beta's
contract were $257,199 for the year ended December 31, 1996 with no similar
expenditures in 1995.
Depreciation, Depletion and Amortization
Depreciation, Depletion and Amortization ("DD&A") for the periods presented by
cost center consisted of the following:
For the Year Ended December 31
1996 1995
------------- ---------
Oil and Gas Properties $ 589,853 $ 741,924
Gas Plant Operations 234,534 245,953
Service and Supply Operations 140,132 166,173
Furniture and Fixtures 45,126 46,437
Non-Compete Agreements 45,994 91,827
----------- -----------
Total $1,055,639 $1,292,314
========== ===========
As discussed above under the caption Oil and Gas, DD&A per BOE for oil and gas
properties has remained relatively constant for the periods presented. The
decrease in DD&A for the Service and Supply Operations can be attributed to the
disposition of the corresponding assets during the restructuring initiatives
conducted in 1995. The decrease in the amortization of the Non-compete
Agreements can be attributed to one agreement which became fully
24
<PAGE>
amortized in 1995. That particular agreement had an original cost basis of
$100,000 and was amortized over a 24 month period.
Dry Hole, Plugging and Abandonment
As previously discussed under the caption Capital Expenditures, the Company
charged $450,000 to dry hole costs for the estimated costs attributable to
drilling the Timpas leg attempted on the horizontal well in Loveland Field,
Colorado and another $75,000 for a dry hole on a wildcat prospect in Southern
Louisiana that was generated by NEGX. The remaining costs in 1996 as well as all
the costs in 1995 relate to plugging and abandonment of a few depleted wells in
the Rocky Mountain Region.
Restructuring Charges
The restructuring charges incurred in 1995 were directly related to the
initiatives discussed above under the caption Overview and consisted primarily
of severance pay, relocation costs and a loss on the abandonment of the
administrative office lease in Denver, Colorado. The Company did not incur any
such costs in 1996.
Interest Expense
The higher interest expense incurred in 1996 is reflective of the increase in
the average long-term debt outstanding and amortization of the corresponding
debt, discount and issuance costs. Both of these circumstances are directly
related to the convertible debentures sold by the Company pursuant to the
private placement completed in November 1996 and previously discussed under the
caption Liquidity and Capital Resources.
(Loss) Gain on Sale of Assets
The gain on sale of assets in 1995 is primarily related to the sale of oil field
service equipment in connection with the Company's restructuring initiatives and
the sale of various oil and gas properties. The loss on sale of assets in 1996
is primarily related to the sale of certain oil and gas properties and the
abandonment of obsolete or unusable office equipment, furniture and fixtures.
Net Loss Per Common Share
Net loss per common share is computed by dividing the net loss applicable to
common stockholders (which includes accrued but unpaid preferred dividends) by
the weighted average number of common shares outstanding during the year. All
common stock equivalents have been excluded from the computations because their
effect would be anti-dilutive.
The Company completed a tender offer to the Company's preferred stockholders in
February 1995. In connection therewith, the Company offered the preferred
holders 4.5 common shares for each preferred share owned. The 4.5 shares
represented an increase from the original terms of the preferred stock which
provided for 2.625 common shares for each preferred share. In order to comply
with an accounting pronouncement, the Company was required to reduce earnings
available to common stockholders to convert their shares. Since the Company
issued an additional 1,750,000 common shares in the tender offer compared to the
shares that would have been issued under the original terms of the preferred
stock, the Company was required to deduct the fair value of these additional
shares of $1,523,906 from earnings available to common stockholders. This
non-cash charge resulted in the reduction of earnings per share by $.24 for the
year ended December 31, 1995.
While this charge is intended to show the cost of the inducement to the owners
of the Company's common shares immediately before the tender offer, management
does not believe that it accurately reflects the impact of the tender offer on
the Company's common stockholders. As disclosed to the preferred stockholders in
connection with the tender offer, the book value per share of common stock
increased from a negative amount to approximately $1.00 per share as a result of
the tender offer. Therefore, management believes that, even though the current
accounting rules require the $.24 charge per common share, there are other
significant offsetting factors by which the common shareholders benefited from
this conversion which are not reflected in the 1995 earnings per share
presentation.
25
<PAGE>
PART II - OTHER INFORMATION
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements that constitute Item 7 are included at the
end of this report beginning on Page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
This item is not applicable to the Registrant.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Directors and Executive Officers
The following table sets forth the names and ages of the current directors and
executive officers of the Company, the principal offices and positions with the
Company held by each person and the date such person became a director or
executive officer of the Company. The executive officers of the Company are
elected annually by the Board of Directors. The Board of Directors is divided
into three approximately equal classes. The directors serve three year terms and
until their successors are elected. Each year the stockholders elect one class
of directors. The executive officers serve terms of one year or until their
death, resignation or removal by the Board of Directors. There are no family
relationships between any of the directors and executive officers. In addition,
there was no arrangement or understanding between any executive officer and any
other person pursuant to which any person was selected as an executive officer.
The directors and executive officers of the Company are as follows:
Served as
Name Age Position With the Company Director Since
- -------------------- --- ------------------------- ---------------
Willard H. Pease, Jr. (1) 37 President, Chief Executive Officer 1983
and Director (Term Expires 1999)
James N. Burkhalter 61 Vice President of Engineering and 1993
Production and Director
(Term Expires 1997)
Patrick J. Duncan (1) 34 Chief Financial Officer, Treasurer, 1995
Corporate Secretary and Director
(Term Expires 1997)
Steve A. Antry 41 Director (Term Expires 1997) 1996
Richard A. Houlihan (1) 57 Director (Term Expires 1998) 1996
Homer C. Osborne (2) 68 Director (Term Expires 1998) 1994
James C. Ruane (2) 63 Director (Term Expires 1998) 1980
Leroy W. Smith 68 Director (Term Expires 1997) 1996
Robert V. Timlin 66 Director (Term Expires 1997) 1981
Clemons F. Walker (2) 58 Director (Term Expires 1999) 1996
William F. Warnick (2) 50 Director (Term Expires 1999) 1988
26
<PAGE>
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee.
Willard H. Pease, Jr. has been President and Chief Executive Officer of the
Company since 1990. Mr. Pease was Executive Vice President and Chief Operating
Officer of the Company from 1983 to 1990. Mr. Pease is responsible for the
Company's corporate finance, managing the day-to-day operations of the Company
and is principally responsible for the Company's oil and gas exploration and
production activities. Mr. Pease has worked in the oil field business for over
17 years. Mr. Pease received a B.A. degree in management with additional
educational focuses in geology in 1983.
James N. Burkhalter has been Vice President of Engineering and Production
of the Company since 1993, and is responsible for the Company's engineering,
production, regulatory compliance, and gas plant operations. Prior to joining
the Company Mr. Burkhalter was owner and president of Burkhalter Engineering, an
engineering firm which he formed in 1975. Mr. Burkhalter has been Chairman of
the Colorado Board of Registration for Professional Engineers and Surveyors,
serving eight years. From 1959 to 1975 Mr. Burkhalter worked for Amoco and Rocky
Mountain Natural Gas as a petroleum engineer. Mr. Burkhalter received a B.S.
degree in petroleum engineering in 1959 from the Colorado School of Mines.
Patrick J. Duncan has been the Chief Financial Officer of the Company since
September, 1994, the Company's Corporate Secretary since April 1995 and the
Company's Treasurer since March 1996. Mr. Duncan is responsible for all the
financial, accounting and administrative reporting and compliance required by
his individual job titles. Mr. Duncan was an Audit Manager with HEIN +
ASSOCIATES LLP, Certified Public Accountants, from 1991 until joining the
Company as the Company's Controller in April 1994. From 1988 until 1991, Mr.
Duncan was an Audit Supervisor with Coopers & Lybrand, Certified Public
Accountants. Mr. Duncan received a B.S. degree from the University of Wyoming in
1985.
Steve A. Antry is founder and president of Beta Capital Group, Inc., a
financial consulting firm located in Newport Beach, California. Beta specializes
in advising emerging oil and gas exploration companies that have both capital
needs and market support requirements. Prior to forming Beta in 1992, Mr. Antry
was an executive officer of Benton Oil & Gas Company from 1989 to 1992 and a
Marketing Director for Swift Energy's income funds from 1987 to 1989. Mr. Antry
is also a registered representative with Signal Securities, Inc., a registered
broker/dealer, and has B.B.A. and M.B.A. degrees from Texas Christian
University.
Richard A. Houlihan is a Certified Public Accountant, Senior Member of the
American Society of Appraisers and a Certified General Appraiser in Nevada and
Utah. He has been a principal of Houlihan Valuation Advisors since 1986, Mr.
Houlihan also was founder and president of Solitude Ski Resort, founder and
president of Houlihan, Lokey, Howard & Zukin, Inc., one of the largest business
valuation firms in the United States, was financial vice president of
Carr-Sigoloff Industries Corporation specializing in mergers and acquisitions,
and MAS Manager at Price Waterhouse & Company Management Advisory Services. Mr.
Houlihan has a B.S. degree from Brigham Young University and a M.V.S. degree
from Lindenwood College.
Homer C. Osborne was an officer and director of Garrett Computing System,
Inc., a petroleum engineering and computing firm, from 1967 until 1976, at which
time he organized Osborne Oil Company as a wholly-owned subsidiary of Garrett
Computing Systems, Inc. Mr. Osborne has operated Osborne Oil Company as a
separate entity since 1976.
James C. Ruane has owned and operated Goodall's Charter Bus Service, Inc.,
a bus chartering business representing Grey Line in the San Diego area, since
1958. Mr. Ruane has been an oil and gas investor for over 20 years.
Leroy W. Smith was president and owner of Doctors' Financial Management
Co., Inc. from 1956 through 1994 with offices in Burbank and Santa Ana,
California, which provided accounting and business management services for
professionals. Since retiring in 1994 Mr. Smith has served as trustee and
managed three retirement trusts with total market value of approximately $5.5
million. Mr. Smith is also an Enrolled Agent before the Internal Revenue
Service.
27
<PAGE>
Robert V. Timlin has been self-employed as a consulting petroleum engineer
since 1989. Mr. Timlin has been involved in the oil and gas industry for over 30
years and has served in a managerial capacity with several companies, including
HMT Management Inc., an oil and gas management firm, from 1983 to 1988; T&M
Casing Service, Inc., from 1975 to 1983; Dowell Studer, Inc., and Husky Oil
Company. Mr. Timlin received an Associates Degree in petroleum engineering in
1957.
Clemons F. Walker has been an independent financial consultant since August
of 1996. Prior to that he was employed as an investment banker and stockbroker.
Between 1978 and August 1995 Mr. Walker worked for Wilson Davis in Las Vegas,
Nevada when Presidential Brokerage purchased the Wilson Davis office in Las
Vegas and he continued to work for the surviving entity until August of 1996.
Since 1978 Mr. Walker has focused his efforts in investment banking by
supporting small-cap companies through assistance in private placements, public
offerings and other capital raising efforts. During his career, Mr. Walker has
organized, advised, facilitated, sold and participated in numerous debt and
equity transactions (both public and private) in a variety of industries,
including the oil and gas industry. Mr. Walker has a bachelor of arts degree in
Business Administration from Brigham Young University with a concentration in
Finance.
William F. Warnick has been a practicing attorney in Lubbock, Texas since
1971. Mr. Warnick serves as the Texas Attorney General's appointee to the Texas
School Board Land Commission and is a member of the American, Texas, and Lubbock
Bar Associations. He is an oil and gas investor and has served in various
management positions of private independent oil and gas companies. Mr. Warnick
received a B.A. degree in finance and a J.D. degree in 1971.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than ten percent of the
Company's Common Stock, to file reports of ownership and changes in ownership
with the Securities and Exchange Commission ("SEC"). Officers, directors and
greater than ten percent stockholders are required by SEC regulations to furnish
the Company with copies of all Section 16(a) forms they file.
The following disclosure is based solely upon a review of the Forms 3 and 4 and
any amendments thereto furnished to the Company during the Company's fiscal year
ended December 31, 1996, and Forms 5 and amendments thereto furnished to the
Company with respect to such fiscal year, or written representations that no
Forms 5 were required to be filed by such persons. Based on this review the
following persons who were directors, officers and beneficial owners of more
than 10% of the Company's outstanding Common Stock during such fiscal year filed
late reports on Forms 3 and 4.
James C. Ruane filed one late report on Form 4 reporting one transaction. LeRoy
W. Smith filed one late report on Form 4 reporting two transactions.
ITEM 10-EXECUTIVE COMPENSATION
Summary Compensation Table
The Summary Compensation Table shows certain compensation information for
services rendered in all capacities during each of the last three fiscal years
by the Chief Executive Officer. No executive officer received salary and bonus
in excess of $100,000 in 1996. The following information for the Chief Executive
Officer includes the dollar value of base salaries, bonus awards, the number of
stock options granted and certain other compensation, if any, whether paid or
deferred.
28
<PAGE>
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Compensation Awards
Restricted Securities
Name and Principal Other Annual Stock Underlying
Position Year Salary Bonus Compensation Awards Options/SARs(#)
- -------- ---- -------- ----- ------------ ------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Willard H. Pease, Jr .... 1996 $78,530(1) $5,000(3)$101,250 (2) None 110,400
President and Chief 1995 $75,240(1) None None None 139,600
Executive Officer . 1994 $75,240(1) None None None None
</TABLE>
(1) Includes $240 contributed by the Company to a qualified 401(k)
retirement plan.
(2) At December 31, 1995 the Company owed $60,000 to Mr. Pease. This loan
was unsecured, bore interest at 8% per annum and was originally due on January
31, 1996. On March 9, 1996 the Board of Directors agreed to change the terms of
the note to allow the note to be convertible into the Company's common stock at
$1.00 per share, the then current market rate, in exchange for a one-year
extension on the note. On December 16, 1996 Mr. Pease elected to convert the
note in its entirety, the note was canceled and Mr. Pease was issued 60,000
shares of the Company's restricted common stock. The $101,250 shown as other
annual compensation represents the difference between the closing sales price as
reported by NASDAQ on December 16, 1996 and the conversion price of $1.00 per
share. No additional amounts have been shown as Other Annual Compensation
because the aggregate incremental cost to the Company of personal benefits
provided to Mr. Pease did not exceed the lesser of $50,000 or 10% of his annual
salary in any given year.
(3) On March 9, 1996 the Board of Directors granted Mr. Pease 5,000 shares
of the Company's common stock for prior services. The shares were valued at
$5,000 or $1.00 per share which represented the market price of the Company's
common stock on the date of grant. The shares are fully vested.
Option Grants in the Last Fiscal Year
Set forth below is information relating to grants of stock options to the Chief
Executive Officer pursuant to the Company's Stock Option Plans during the fiscal
year ended December 31, 1996.
<TABLE>
<CAPTION>
Option/SAR Grants in Last Fiscal Year
Individual Grants
Number of
Securities % of Total
Underlying Options/SARs
Options/ Granted to Exercise or
SARs Employees in Base Price Expiration
Name Granted (#) Fiscal Year ($/Sh) Date
- --------------- ----------- ----------------- --------------- --------
<S> <C> <C> <C> <C>
Willard H. Pease, Jr. 110,400 (1) 33.9% $1.00(3) 03/08/01
President and Chief 60,000 (2) 18.4% $1.00(3) 01/31/97
Executive Officer
</TABLE>
(1) Consists of 8,900 shares underlying options issued under one of the
Company's qualified stock option plans and 101,500 shares underlying warrants to
purchase common stock. All these Options and Warrants became exercisable on
September 8, 1996.
(2) At December 31, 1995 the Company owed $60,000 to Mr. Pease. This loan
was unsecured, bore interest at 8% per annum and was originally due on January
31, 1996. On March 9, 1996 the Board of Directors agreed to change the terms of
the note to allow the note to be convertible into the Company's common stock at
$1.00 per share, the then current market price, in exchange for a one-year
extension on the note.
(3) The exercise price listed above was 100% of the market price of the
Common Stock on the date the options, warrants or convertible notes were granted
or approved by the Company's Board of Directors.
29
<PAGE>
Aggregated Option Exercises in the Last Fiscal Year and the Fiscal Year-End
Option Values
Set forth below is information with respect to the unexercised options to
purchase the Company's Common Stock held by Willard H. Pease, Jr. at December
31, 1996. No options were exercised during fiscal 1996.
<TABLE>
<CAPTION>
Aggregated Option/SAR Exercises in Last Fiscal Year
and FY-End Option/SAR Values
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
at FY-End (#) at FY-End ($)
Shares Acquired Value Realized Exercisable/ Exercisable/
Name on Exercise (#) ($) Unexercisable Unexercisable
- -------- ----------------- ------------------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Willard H. Pease, Jr. 60,000 (1) $101,250 (1) 250,000/-0- $544,557/-0- (2)
President and Chief
Executive Officer
</TABLE>
(1) On December 16, 1996, Mr. Pease converted a $60,000 promissory note into
60,000 shares of the Company's common stock pursuant to the terms of the
underlying promissory note. The $101,250 shown as other annual compensation
represents the difference between the closing sales price as reported by NASDAQ
on December 16, 1996 and the conversion price of $1.00 per share.
(2) The value of the unexercised In-the-Money Options 1996 was determined by
multiplying the number of unexercised options by the closing sales of the
Company's common stock on December 31,1996 as reported by NASDAQ and from that
total, subtracting the total exercise price.
Employment Contract
The Company has entered into an employment agreement with a Director, Willard
Pease, Jr., who is also the Company's President and Chief Executive Officer. The
employment agreement was entered into in 1993 and may be terminated by the
Company without cause on 30 days notice provided the Company continues to pay
the salary of Mr. Pease for 36 months. The salary must be paid in a lump sum if
the termination occurs after a change in control of the Company as defined in
the employment agreement. Mr. Pease may terminate the employment agreement on 90
days written notice. The base salary of Mr. Pease under the employment agreement
was increased to a base salary of $95,000 per year effective October 1, 1996.
Compensation of Directors
Directors who are employees do not receive additional compensation for service
as directors. Other directors each receive a $1,000 annual retainer fee, $750
per meeting attended and $100 per meeting conducted via telephone conference.
Directors may elect to receive the compensation either in cash or stock. All the
compensation paid to the outside directors in 1995 and 1996 was in the form of
stock.
ITEM 11- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock, its only class of outstanding voting
securities as of February 21, 1997, by (i) each person who is known to the
Company to own beneficially more than 5% of the outstanding Common Stock with
the address of each such person, (ii) each of the Company's directors and
officers, and (iii) all officers and directors as a group:
30
<PAGE>
Name and Address of
Beneficial Owner or Amount and Nature of
Name of Officer or Director Beneficial Ownership(1) Percent of Class
- --------------------------- ------------------------ ----------------
Steve Allen Antry
901 Dove Street, Suite 230
Newport Beach, CA 92660 671,832 Shares (2) 7.4%
James N. Burkhalter
P.O. Box 60219
Grand Junction, CO 81506 165,710 Shares (3) 2.0%
Patrick J. Duncan
P.O. Box 60219
Grand Junction, CO 81506 170,625 Shares (4) 2.0%
Richard A. Houlihan
650 Town Center Drive, Suite 550
Costa Mesa, CA 92625 288,983 Shares (5) 3.4%
Homer C. Osborne
1200 Preston Road #900
Dallas, TX 75230 49,407 Shares (6) 0.6%
Willard H. Pease, Jr.
P.O. Box 60219
Grand Junction, CO 81506 786,139 Shares (7) 9.2%
James C. Ruane
5010 Market St.
San Diego, CA 92102 281,838 Shares (8) 3.3%
Leroy W. Smith
P.O. Box 10040
Santa Ana, CA 92711-0040 181,280 Shares (9) 1.8%
Robert V. Timlin
1989 South Balsam
Lakewood, CO 80277 63,490 Shares (10) 0.8%
Clemons F. Walker
748 Rising Star Drive
Henderson, NV 89104 362,763 Shares (11) 4.2%
William F. Warnick
2022 Broadway
Lubbock, TX 79401 84,193 Shares (12) 1.0%
All Officers and Directors
as a group (eleven persons) 3,106,260 Shares (13) 29.8%
(1) Beneficial owners listed have sole voting and investment power with respect
to the shares unless otherwise indicated. On December 18, 1996, Mr. Pease
converted a $60,000 promissory note into 60,000 shares of the Company's common
stock pursuant to the terms of the underlying promissory note. The $101,250
shown as other annual compensation represents the difference between the closing
sales price as reported by NASDAQ on December 16, 1996 and the conversion price
of $1.00 per share.
(2) Includes 2,680 shares that are owned directly by Mr. Antry, 7,500 shares
underlying options that become exercisable on July 27, 1997, 61,137 shares
underlying presently exercisable warrants, 515 shares underlying convertible
preferred stock and 600,000 shares underlying presently exercisable warrants
that are held by Mr. Antry's wife.
(3) Includes 15,710 shares owned directly by Mr. Burkhalter, 115,000 shares
underlying presently exercisable options, and 35,000 shares underlying options
that become exercisable on July 27, 1997.
31
<PAGE>
(4) Includes 20,625 shares owned directly by Mr. Duncan, 105,000 shares
underlying presently exercisable options, and 45,000 shares underlying options
that become exercisable on July 27, 1997.
(5) Includes 151,150 shares owned directly by Mr. Houlihan, 7,500 shares
underlying options that become exercisable on July 27, 1997, 97,500 shares
underlying presently exercisable options, 8,333 shares underlying a convertible
debenture, and 24,500 shares owned by a trust that Mr. Houlihan has sole voting
and investment power.
(6) Includes 6,607 shares owned directly by Mr. Osborne, 35,300 shares
underlying presently exercisable options, and 7,500 shares underlying options
that become exercisable on July 27, 1997.
(7) Includes 121,173 shares that are owned directly by Mr. Pease, 364,966 shares
are owned by entities affiliated with Mr. Pease over which shares Mr. Pease has
sole voting and investment power, 148,500 shares underlying presently
exercisable options, 50,000 shares underlying options that become exercisable on
July 24, 1997, and 101,500 shares underlying presently exercisable warrants.
(8) Includes 107,528 shares owned directly by Mr. Ruane, 4,560 shares held by
Mr. Ruane as trustee for two trusts, over which shares Mr. Ruane may be deemed
to have shared voting and investment power, 12,500 shares underlying presently
exercisable warrants, 70,000 shares underlying presently exercisable options,
and 7,500 shares underlying options that become exercisable on July 27, 1997.
(9) Includes 1,280 shares owned directly by Mr. Smith, 10,000 shares owned by a
trust that Mr. Smith acts as the Trustee and is therefore deemed to have
beneficial ownership, 5,000 shares owned by his wife, 10,000 shares underlying
presently exercisable options, 7,500 shares underlying options that become
exercisable on July 27, 1997, 100,000 shares underlying presently exercisable
warrants that are owned by two separate trusts that Mr. Smith acts as the
Trustee and is therefore deemed to have beneficial ownership, 12,500 shares
underlying convertible preferred stock owned directly by Mr. Smith; 12,500
shares underlying convertible preferred stock held by his wife, and 22,500
shares underlying convertible preferred stock that are owned by two separate
trusts that Mr. Smith acts as the Trustee and is therefore deemed to have
beneficial ownership.
(10) Includes 5,990 shares owned directly by Mr. Timlin, 26,693 shares
underlying presently exercisable options, and 7,500 shares underlying options
that become exercisable on July 27, 1997.
(11) Includes 142,062 shares owned directly by Mr. Walker, 212,686 shares
underlying presently exercisable warrants, 7,500 shares underlying options that
become exercisable on July 27, 1997, and 515 shares underlying convertible
preferred stock.
(12) Includes 26,693 shares owned directly by Mr. Warnick, 50,000 shares
underlying presently exercisable options, and 7,500 shares underlying options
that become exercisable on July 27, 1997.
(13) Includes 583.800 shares underlying presently exercisable options, 190,000
shares underlying options that become exercisable on July 27, 1997, 1,185,073
shares underlying presently exercisable warrants, 48,530 shares underlying
convertible preferred stock, and 8,333 shares underlying a convertible note.
ITEM 12-CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
From time to time, various officers and directors of the Company and their
affiliates have participated in the drilling of oil and gas wells which were
drilled and operated by the Company. All such persons and entities have taken
working interests in the wells and have paid the drilling, completion and
related costs of the wells on the same basis as the Company and all other
working interest owners. On occasions of such participation the Company retained
the maximum interest in the well that it could justify, given its cash
availability and the risk involved.
32
<PAGE>
In August 1996, Richard A. Houlihan, a director of the Company purchased a
$25,000 10% collateralized debenture that included warrants to purchase 25,000
shares of Common Stock at $1.25 per share on the same terms as other
nonaffiliated purchasers.
At December 31, 1996 the Company owed certain affiliates of Willard H. Pease,
Jr. $116,719 principal, plus $31,398 in accrued interest, for oil and gas
revenue attributable to interests in wells operated by the Company that are
owned by the individuals and related entities. Of the principal amount, $2,877
was incurred in 1994, $4,603 was incurred in 1993, $20,992 was incurred in 1992,
$85,518 was incurred in 1991 and $2,729 was incurred in 1990.
At December 31, 1995 the Company owed $60,000 to Willard H. Pease, Jr., the
Company's President and CEO. This loan was unsecured, bears interest at 8% per
annum and was originally due in January 1996. In March 1996 the Board of
Directors agreed to change the terms of the note to allow the note to be
convertible into the Company's common stock at $1.00 per share, the then current
market price, in exchange for a one-year extension of the note. In December 1996
Mr. Pease elected to convert the note in its entirety, the note was canceled and
Mr. Pease was issued 60,000 shares of the Company's restricted common stock.
Until June 1993, Willard H. Pease, Jr. owned an oil well servicing business,
Grand Junction Well Services, Inc. ("GJWS"), which operated a workover and
completion rig. In June 1993, the Company acquired GJWS from Mr. Pease by
merging GJWS into a newly-formed subsidiary of the Company. In the merger, the
Company issued Mr. Pease 46,667 shares of Common Stock and the Company's 6%
secured convertible promissory note in the principal amount of $175,000, for a
total value of $350,000, which was the estimated fair market value of the GJWS
assets and business. The note was originally payable in three annual principal
installments of $45,000 on October 1, 1994, $65,000 on April 1, 1995 and $65,000
on April 1, 1996. The October 1, 1994 principal payment of $45,000 was paid and
the remaining installments were extended to October 1, 1997 and October 1, 1998,
respectively. The unpaid principal portion of $130,000 is convertible at the
election of Mr. Pease into Common Stock at $5.00 per share. The transaction was
approved unanimously by the disinterested directors of the Company.
In March 1996 the Company entered into a three-year consulting agreement with
Beta Capital Group, Inc. ("Beta"). Beta's president, Steve Antry, has been a
director of the Company since August 1996. The consulting agreement with Beta
provides for minimum monthly cash payments of $17,500 plus reimbursement for
out-of-pocket expenses. The Company also agreed to pay Beta additional fees, as
defined in the agreement, that are based on a percentage of the gross proceeds
generated from any public financing, private financing or from any warrants that
are exercised during the term of the agreement. During 1996 the Company paid
Beta, or its agents, a total of $424,706 under the terms of the agreement. The
total amount paid consisted of: a.) $162,500 for monthly consulting fees; b.)
$94,700 for the reimbursement of out-of-pocket expenses; c.) $163,000 for fees
related to funds generated from private placements; and d.) $4,506 for fees
related to funds generated from the exercise of warrants. In addition to the
cash compensation, the Company granted Beta warrants to purchase 1.0 million
shares of the Company's common stock for $.75 per share. As allowed under the
terms of the agreement, Beta subsequently assigned 400,000 of those warrants to
other parties, including 100,000 to a Mr. Richard Houlihan, a director of the
Company. All these warrants expire in April 2001.
All existing loans or similar advances to, and transactions with, officers and
their affiliates were approved or ratified by the independent and disinterested
directors. Any future material transactions with officers, directors and owners
of 5% or more of the Company's outstanding Common Stock or any affiliate of any
such person shall be on terms no less favorable to the Company than could be
obtained from independent unaffiliated third parties and must be approved by a
majority of the independent disinterested directors.
33
<PAGE>
PART IV
ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Description and Method of Filing
(3.1) Articles of Incorporation, as amended. (1)
(3.2) Plan of Recapitalization. (1)
(3.3) Certificate of Amendment to the Articles of Incorporation
filed on July 6, 1994. (2)
(3.4) Certificate of Amendment to the Articles of Incorporation
filed on December 19, 1994. (2)
(3.5) Bylaws, as amended and restated May 11, 1993. (1)
(4.1) Representative's Preferred Stock Purchase Warrant. (1)
(4.2) Warrant Agency Agreement between Willard Pease Oil and Gas
Company and American Securities Transfer, Inc. dated
August 23, 1993. (1)
(4.3) Amendment to Warrant Agency Agreement dated January 5,
1995. (2)
(4.4) Certificate of Designation of Series A Cumulative
Convertible Preferred Stock. (1)
(4.5) Certificate of Amendment of Certificate of Designation of
Series A Cumulative Convertible
Preferred Stock filed on August 16, 1993. (2)
(4.6) Second Certificate of Amendment of Certificate of
Designation of Series A Cumulative Convertible Preferred
Stock filed on November 1, 1994. (2)
(10.1) Residue Gas Sales and Purchase Agreement dated June 22,
1986, between Western Gas Supply Company and Loveland Gas
Processing, Ltd., and Amendments dated July 30, 1986,
August 12, 1986, September 11, 1986, April 16, 1987, April
1, 1988, January 2, 1992, March 26, 1992 and May 1, 1992.
(1)
(10.2) Amendment dated December 1, 1993, between Public Service
Company of Colorado and Loveland Gas Processing Co., Ltd.,
to Residue Gas Sales and Purchase Agreement dated June 22,
1986, between Western Gas Supply Company and Loveland Gas
Processing, Ltd.
(2)
(10.3) Gas Purchase and Sale Contract dated November 1, 1988,
between Fuel Resources Development Co. as seller and
Loveland Gas Processing Co., Ltd., as buyer, pertaining to
the purchase of gas, and Amendments dated November 1, 1990
January 24, 1991, May 1, 1991, July 5, 1991, August 1,
1991, April 1, 1992 and August 1, 1992. (1)
(10.4) Purchase Order No. 5 dated January 1, 1994 from Loveland
Gas Processing Co., Ltd. to Fuel Resources Development Co.
that amends the Gas Purchase and Sale Contract dated
November 1, 1988, between Fuel Resources Development Co.
and Loveland Gas Processing, Ltd. (2)
(10.5) Form of Warrants issued to Ronin Group Ltd., and Clemons
F. Walker for the purchase of an aggregate of 240,000
shares of Common Stock. (3)
(10.6) 1990 Stock Option Plan. (1)
(10.7) 1993 Stock Option Plan (1)
(10.8) 1994 Employee Stock Option Plan. (2)
(10.9) Form of 12% Convertible Unsecured Promissory Notes issued
by Pease Oil and Gas Company in 1994 Private Placement.(2)
(10.10) Form of Warrants issued to brokers Sales Agents in 1994
Private Placements. (2)
(10.11) Employment Agreement effective September 16, 1994 between
Pease Oil and Gas Company and Willard H. Pease, Jr. (2)
(10.12) Employment Agreement effective December 27, 1994 between
Pease Oil and Gas Company and Patrick J. Duncan. (2)
(10.13) Employment Agreement effective December 27, 1994 between
Pease Oil and Gas Company and James N. Burkhalter. (2)
(10.18) Interconnect Agreement dated January 1, 1995, between KN
Front Range Gathering Company and Loveland Gas Processing
Co., Ltd.(2)
(10.19) Gas Gathering Agreement dated February 1, 1995, between KN
Front Range Gathering Company and Loveland Gas Processing
Co., Ltd. (2)
34
<PAGE>
(10.20) Agreement dated August 15, 1994, between Hewlett-Packard
Company, Loveland Gas Processing Co., Ltd., Pease Oil and
Gas Company and Pease Operating Company. (2)
(10.21) Purchase and Sale Agreement dated April 24, 1995 among
Pease Oil and Gas Company, Thermo Cogeneration Partnership
L.P and Seahawk Energy, Inc. (3)
(10.22) Agreement between Beta Capital Group, Inc., and Pease Oil
and Gas Company dated March 9, 1996. (4)
(10.24) Form of Warrants issued to Beta Capital Group, Inc. (8)
(10.25) 1996 Stock Option Plan. (8)
(10.26) Mortgage, Assignment of Proceeds, Security Agreement and
Financing Statement from Pease Oil and Gas Company to
Holders of 1996 Collateralized Subordinated Convertible
Debentures dated as of November 15, 1996. (8)
(10.27) Purchase and Sale Agreement dated December 31, 1996 by and
between Atocha Exploration, Inc., Browning Oil Company,
Inc., Potosky Oil and Gas, Inc. and Pease Oil and
Gas Company. (5)
(10.28) Letter Agreement dated February 4, 1997 by and between
National Energy Group, Inc. and Pease Oil and Gas Company.
(6)
(10.29) Purchase and Sale Agreement dated February 26, 1997 by and
between Transworld Exploration & Production, Inc. (7)
(21) List of Subsidiaries. (3)
(23) Consents of Experts
(23.1) Consent of McCartney Engineering, LLC Consulting Petroleum
Engineers
(23.2) Consent of Hein + Associates LLP, Certified Public
Accountants
(27) Financial Data Schedule.
Footnotes:
(1) Incorporated by reference to Registration Statement No. 33-64448 on Form
SB-2.
(2) Incorporated by reference to the Registrant's 1994 Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1994.
(3) Incorporated by reference to Registration Statement No. 33-94536
on Form SB-2.
(4) Incorporated by reference to the Registrant's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1995.
(5) Incorporated by reference to Form 8-K filed January 10, 1997.
(6) Incorporated by reference to Form 8-K filed February 19, 1997.
(7) Incorporated by reference to Form 8-K filed March 17, 1997.
(8) Incorporated by reference to Form 10-KSB for the fiscal year ended
December 31, 1996 filed March 28, 1997.
35
<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.
PEASE OIL AND GAS COMPANY
Date: March 27, 1998 By:/s/ Willard H. Pease, Jr.
----------------------------
Willard H. Pease, Jr.
President and Chief Executive Officer
Date: March 27, 1998 By: /s/ Patrick J. Duncan
-------------------------
Patrick J. Duncan
Chief Financial Officer, Treasurer,
and Principal Accounting Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
Date: March 27, 1998 By:/s/ Willard H. Pease, Jr.
----------------------------
Willard H. Pease, Jr., President
and Chairman of the Board
Date: March 27, 1998 By: /s/ Patrick J. Duncan
-------------------------
Patrick J. Duncan
Chief Financial Officer,
Treasurer, and Director
Date: March 27, 1998 By:/s/ Steve A. Antry
---------------------
Steve A. Antry, Director
Date: March 27, 1998 By: /s/ R. Thomas Fetters, Jr.
------------------------------
R. Thomas Fetters, Jr., Director
Date: March 27, 1998 By:/s/ Stephen L. Fischer
--------------------------
Stephen L. Fischer, Director
Date: March 27, 1998 By:/s/ Homer C. Osborne
-----------------------
Homer C. Osborne, Director
Date: March 27, 1998 By:/s/ James C. Ruane
---------------------
James C. Ruane, Director
Date: March 27, 1998 By:/s/ Clemons F. Walker
------------------------
Clemons F. Walker, Director
Date: March 27, 1998 By:/s/ William F. Warnick
-------------------------
William F. Warnick, Director
36
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditor's Report..............................................F-2
Consolidated Balance Sheets - December 31, 1996 and 1995 .................F-3
Consolidated Statements of Operations -
For the Years Ended December 31, 1996 and 1995............................F-5
Consolidated Statements of Stockholders' Equity -
For the Years Ended December 31, 1996 and 1995............................F-6
Consolidated Statements of Cash Flows -
For the Years Ended December 31, 1996 and 1995............................F-7
Notes to Consolidated Financial Statements................................F-8
F-1
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Pease Oil and Gas Company
Grand Junction, Colorado
We have audited the accompanying consolidated balance sheets of Pease Oil and
Gas Company and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pease Oil and Gas
Company and subsidiaries as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
/s/ Hein + Associates LLP
HEIN + ASSOCIATES LLP
Denver, Colorado
February 21, 1997
F-2
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
1996 1995
ASSETS
CURRENT ASSETS:
Cash and equivalents ...................... $ 1,995,860 $ 677,275
Trade receivables, net of allowance
for bad debts of $25,000 and ...........
$51,000, respectively .................. 599,648 963,315
Inventory ................................. 408,787 532,289
Prepaid expenses and other ................ 56,327 77,844
Common stock subscription receivable,
91,667 shares .......................... -- 68,750
------------ ------------
Total current assets ............ 3,060,622 2,319,473
------------ ------------
OIL AND GAS PROPERTIES, at cost
(successful efforts method):
Undeveloped properties .................... 351,727 377,606
Wells in progress ......................... 181,312 --
Developed properties ...................... 9,505,408 9,149,516
------------ ------------
Total oil and gas properties .... 10,038,447 9,527,122
Less accumulated depreciation and depletion (3,946,974) (3,608,917)
------------ ------------
Net oil and gas properties ...... 6,091,473 5,918,205
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Gas plant ................................. 4,099,285 4,095,227
Service equipment and vehicles ............ 879,313 855,025
Buildings and office equipment ............ 459,228 529,703
------------ ------------
Total property, plant and equipment 5,437,826 5,479,955
Less accumulated depreciation ............. (1,376,154) (1,034,731)
------------ ------------
Net property, plant and equipment 4,061,672 4,445,224
------------ ------------
OTHER ASSETS:
Debt issuance costs, net of accumulated
amortization of $73,027 ..............
and $29,167, respectively ............ 1,093,479 20,833
Non-compete agreements, net of accumulated
amortization of $253,322 ............. 306,678 352,674
Other ..................................... 274,830 383,317
------------ ------------
Total other assets .............. 1,674,987 756,824
------------ ------------
TOTAL ASSETS ................................... $ 14,888,754 $ 13,439,726
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(continued)
DECEMBER 31,
1996 1995
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt:
Related parties ................... $ 285,895 $-
Other ............................. 45,944 1,100,474
Accounts payable, trade ................ 267,540 1,172,567
Accrued production taxes ............... 288,122 303,287
Other accrued expenses ................. 265,427 243,325
------------ ------------
Total current liabilities .... 1,152,928 2,819,653
------------ ------------
LONG-TERM LIABILITIES:
Long-term debt, less current maturities:
Convertible debentures, net of
discount of $1,732,170 . 3,267,830 --
Other ................................ 19,945 1,223,159
Accrued production taxes .................. 256,088 379,652
------------ ------------
Total long-term liabilities ..... 3,543,863 1,602,811
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 3, 5, 6, and 11)
STOCKHOLDERS' EQUITY:
Preferred Stock, par value $.01 per share,
2,000,000 shares authorized, 179,938
and 202,688 shares of Series A Cumulative
Convertible Preferred Stock issued and
outstanding (liquidation preference of
$2,204,000 and $2,280,000, respectively) 1,799 2,027
Common Stock, par value $.10 per share,
25,000,000 shares authorized, issued and
outstanding 7,526,817 shares and 7,180,804
shares, respectively .................. 752,682 718,081
Additional paid-in capital ............ 19,112,104 16,560,194
Accumulated deficit ................... (9,674,622) (8,263,040)
------------ ------------
Total stockholders' equity .. 10,191,963 9,017,262
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . $ 14,888,754 $ 13,439,726
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED
DECEMBER 31,
1996 1995
REVENUE:
Oil and gas sales $2,546,676 $2,623,782
Natural gas marketing and trading 2,067,379 3,872,565
Gas plant processing 818,356 1,135,050
Oil field services and supply 618,225 1,302,741
Well administration and other income 115,028 97,678
------- ------
Total revenue 6,165,664 9,031,816
--------- ---------
OPERATING COSTS AND EXPENSES:
Oil and gas production 1,426,549 1,617,318
Natural gas marketing and trading 1,745,446 3,404,169
Gas plant processing 464,512 942,867
Oil field services and supply 553,343 1,391,588
General and administrative 1,092,342 1,059,306
Consulting arrangement - related party 257,199 -
Depreciation, depletion and amortization 1,055,639 1,292,314
Dry holes, plugging, and abandonments 555,685 18,786
Restructuring costs - 226,986
------ -------
Total operating costs and expense 7,150,715 9,953,334
--------- ---------
LOSS FROM OPERATIONS (985,051) (921,518)
-------- --------
OTHER INCOME (EXPENSES):
Interest income 41,148 8,444
Interest expense:
Amortization of debt issuance and
discount costs (190,967) (17,554)
Other (311,461) (288,881)
Gain (loss) on sale of assets (6,660) 75,073
------ ------
Net (467,940) (222,918)
-------- --------
LOSS BEFORE INCOME TAXES (1,452,991) (1,144,436)
Income tax benefit 41,409 379,000
------ -------
NET LOSS (1,411,582) (765,436)
Preferred stock dividends:
Converted (22,750) (117,000)
In arrears (179,938) (202,688)
-------- --------
Total preferred stock dividends (202,688) (319,688)
-------- --------
Loss before non-cash inducement (1,614,270) (1,085,124)
Non-cash inducement in tender offer
(Note 1) - (1,523,906)
------ ----------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS $(1,614,270) $(2,609,030)
=========== ===========
NET LOSS PER COMMON SHARE:
Before non-cash inducement $ (.22) $ (.18)
Non-cash inducement (Note 1) - (.24)
------ ------
$ (.22) $ (.42)
====== ======
WEIGHTED AVERAGE NUMBER OF COMMON 7,278,000 6,190,000
========= =========
SHARES OUTSTANDING
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
Additional Total
Preferred Stock Common Stock Paid-in Stockholders
Shares Amount Shares Amount Capital Equity
---------- --------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES, 1/1/95 1,157,780 $ 11,578 2,286,028 $ 228,603 $16,744,348 $ 9,354,337
Conversion of preferred stock to
common stock:
In tender offer (933,492) (9,335) 4,200,716 420,072 (410,737) --
Other (21,600) (216) 56,739 5,673 (5,457) --
Acquisition of oil and gas properties for common
stock -- -- 65,000 6,500 53,422 59,922
Sale of common stock in private placement -- -- 500,000 50,000 325,000 375,000
Issuance of common stock to directors and
employees for services and other -- -- 21,036 2,104 11,327 13,431
Settlement of trade payable for common stock 63,206 6,321 57,961
Cancellation of treasury shares -- -- (11,921) (1,192) (48,808) --
Net loss -- -- -- -- -- (765,436)
-------- ------- ----------- ------- ---------- ---------
BALANCES, 12/31/95 202,688 2,027 7,180,804 718,081 16,560,194 9,017,262
Issuance of common stock to officers, directors,
and employees for compensation -- -- 51,490 5,149 57,162 62,311
Fair value of warrants granted for debt issuance
and discount costs -- -- -- -- 2,319,775 2,319,775
Conversion of debentures into common stock -- -- 82,353 8,235 61,765 70,000
Issuance of common stock for engineering
services -- -- 15,000 1,500 21,477 22,977
Exercise of options and warrants to purchase
common stock -- -- 67,500 6,750 57,625 64,375
Conversion of note payable to director into
common stock -- -- 60,000 6,000 54,000 60,000
Conversion of preferred stock to common stock (22,750) (228) 69,670 6,967 (6,739) --
Offering costs -- -- -- -- (13,155) (13,155)
Net loss -- -- -- -- -- (1,411,582)
-------- -------- -------- ------- ------------ -----------
BALANCES, 12/31/96 $ 179,938 $1,799 7,526,817 $752,682 $19,112,104 $10,191,963
============ ========= =========== ========= ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31,
1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,411,582) $ (765,436)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Provision for depreciation and depletion 1,009,645 1,200,487
Amortization of intangible assets and
discount on convertible debt 263,963 109,487
Deferred income taxes -- (400,000)
equipment 6,660 (75,073)
Provision for bad debts 21,497 35,176
Dry holes and abandonments 525,000 --
Issuance of common stock for services 85,288 71,392
Other (54,942) (41,770)
Changes in operating assets and liabilities:
(Increase) decrease in:
Trade receivables 342,170 625,286
Inventory 124,502 296,824
Prepaid expenses and other (14,316) 14,001
Increase (decrease) in:
Account payable (905,027) (529,581)
Accrued expenses (109,473) (160,512)
Net cash provided by (used in) operating --------- ---------
activities (143,615) 380,175
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property,
plant and equipment (1,403,413) (387,403)
Proceeds from redemption of certificate of deposit 53,500 43,000
Proceeds from sale of property and equipment 163,821 823,631
----------- ----------
Net cash provided by (used in) investing
activities (1,186,092) (479,228)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible debentures 5,000,000 -
Repayment of long-term debt 1,795,670) (943,341)
Proceeds from sale of common stock 133,125 281,250
Offering costs (13,155) (52,953)
Debt issuance costs (676,008) -
--------- -------------
Net cash provided by (used in) financing
activities 2,648,292 (715,044)
INCREASE (DECREASE) IN CASH AND EQUIVALENTS 1,318,585 144,359
CASH AND EQUIVALENTS, beginning of year 677,275 532,916
---------- -------------
CASH AND EQUIVALENTS, end of year $1,995,860 $677,275
========== =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest $192,502 $273,735
========== ============
Cash received (paid) for income taxes $41,409 $(21,000)
========== ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Fair value of warrants granted for debt
issuance costs $600,000 $ -
Fair value of warrants granted for discount
on convertible debentures 1,829,000 -
Conversion of long-term debt to common stock 130,000 -
Long-term debt incurred for purchase of vehicles - 24,992
Acquisition of oil and gas properties for
common stock - 59,922
Common stock subscription receivable - 68,750
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Nature of Operations - Pease Oil and Gas Company (the "Company") explores for,
develops, produces and sells oil and natural gas; transports, processes, sells,
markets and trades natural gas and natural gas liquids at a gas processing
plant; performs oil and gas well completion and operational services; and sells
new, used and reconditioned oil and gas production equipment and oil field
supplies. The Company conducts its business through the following wholly-owned
subsidiaries: Loveland Gas Processing Company, Ltd. ("LGPCo"); Pease Oil Field
Services, Inc.; Pease Oil Field Supply, Inc.; and Pease Operating Company, Inc.
Principles of Consolidation - The accompanying financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All material
intercompany transactions and accounts have been eliminated in consolidation.
Cash and Equivalents - For purposes of the statements of cash flows, the Company
considers all highly liquid investments purchased with an original maturity of
three months or less to be cash equivalents.
Oil and Gas Producing Activities - The Company follows the "successful efforts"
method of accounting for its oil and gas properties. Under this method of
accounting, all property acquisition costs and costs of exploratory and
development wells are capitalized when incurred, pending determination of
whether the well has found proved reserves. If an exploratory well has not found
proved reserves, the costs of drilling the well are charged to expense. The
costs of development wells are capitalized whether productive or nonproductive.
Geological and geophysical costs and the costs of carrying and retaining
undeveloped properties are expensed as incurred. Management estimates that the
salvage value of lease and well equipment will approximately offset the future
liability for plugging and abandonment of the related wells. Accordingly, no
accrual for such costs has been recorded.
Depletion and depreciation of capitalized costs for producing oil and gas
properties is provided using the units-of-production method based upon proved
reserves. Depletion and depreciation expense for the Company's oil and gas
properties amounted to $589,853 and $741,924 for the years ended December 31,
1996 and 1995, respectively.
Impairment of Long-Lived Assets - The Company performs an assessment for
impairment whenever events or changes in circumstances indicate that the
carrying amount of a long-lived asset may not be recoverable. When an assessment
for impairment of oil and gas properties is performed, the Company compares the
net carrying value of proved oil and gas properties on a lease-by-lease basis
(the lowest level at which cash flows can be determined on a consistent basis)
to the related estimates of undiscounted future net cash flows for such
properties. If the net carrying value exceeds the net cash flows, then
impairment is recognized to reduce the carrying value to the estimated fair
value. The allowance for impairment is included in accumulated depreciation and
depletion in the accompanying balance sheets.
F-7
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Property, Plant and Equipment - Property, plant, and equipment is stated at
cost. Depreciation of property, plant and equipment is calculated using the
straight-line method over the estimated useful lives of the assets, as follows:
YEARS
Gas plant 17
Service equipment and vehicles 4-7
Buildings and office equipment 7-15
Depreciation expense related to property, plant and equipment amounted to
$419,792 and $458,563 for the years ended December 31, 1996 and 1995,
respectively.
The cost of normal maintenance and repairs is charged to operating expenses as
incurred. Material expenditures which increase the life of an asset are
capitalized and depreciated over the estimated remaining useful life of the
asset. The cost of properties sold, or otherwise disposed of, and the related
accumulated depreciation or amortization are removed from the accounts, and any
gains or losses are reflected in current operations.
Non-compete Agreements - The costs of non-compete agreements were incurred in
connection with the 1993 acquisition of substantially all of the Company's
assets. These costs are being amortized over the terms of the two to ten-year
agreements on a straight-line basis. Amortization expense related to the
non-compete agreements was $45,994 and $91,827 for the years ended December 31,
1996 and 1995, respectively.
Debt Issuance Costs - Debt issuance costs relate to the $5 million private
placement of convertible debentures discussed in Note 3. These costs are being
amortized using the straight-line method (which approximates the interest
method) over the 5-year term of the debentures.
Inventory - Inventory consists primarily of oil and gas production equipment and
oil field supplies. These items are generally held for resale. At December 31,
1996 and 1995, inventory also includes approximately $72,000 and $100,000,
respectively, of crude oil, fuel, and propane. Inventory is carried at the lower
of cost or market, cost being determined generally under the first-in, first-out
(FIFO) method of accounting, or where possible, by specific identification. At
December 31, 1996 and 1995, the Company has classified $200,000 of used oil
field equipment inventory as long-term (included in other assets) because, based
on current inventory usage, it is not expected to be sold within the next year.
Accounting Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and the accompanying notes. The actual results could differ from
those estimates.
F-8
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's financial statements are based on a number of significant
estimates including the allowance for doubtful accounts, accrued production
taxes, realizability of intangible assets, assumptions affecting the fair value
of stock options and warrants, selection of the useful lives for property, plant
and equipment, and oil and gas reserve quantities which are the basis for the
calculation of depreciation, depletion, and impairment of oil and gas
properties. Management emphasizes that reserve estimates are inherently
imprecise and that estimates of more recent discoveries are more imprecise than
those for properties with long production histories. At December 31, 1996,
approximately 35% of the Company's oil and gas reserves are attributable to
non-producing properties. Accordingly, the Company's estimates are expected to
change as future information becomes available.
The Company is required under certain circumstances to evaluate the possible
impairment of the carrying value of its long-lived assets. For proved oil and
gas properties, this involves a comparison to the estimated future undiscounted
cash flows, which is the primary basis for determining the related fair values
for such properties. In addition to the uncertainties inherent in the reserve
estimation process, these amounts are affected by historical and projected
prices for oil and natural gas which have typically been volatile. It is
reasonably possible that the Company's oil and gas reserve estimates will
materially change in the forthcoming year.
At December 31, 1996, the Company's gas plant had a net carrying value of
approximately $3,340,000. The determination of impairment of the gas plant may
change in the future based on the Company's ability to continue to develop its
properties whereby sufficient quantities of natural gas and liquids are
available to operate the plant profitably.
Income Taxes - Income taxes are provided for in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." SFAS No.
109 requires an asset and liability approach in the recognition of deferred tax
liabilities and assets for the expected future tax consequences of temporary
differences between the carrying amounts and the tax bases of the Company's
assets and liabilities.
Revenue Recognition - The Company recognizes gas plant revenues and oil and gas
sales upon delivery to the purchaser. Revenues from oil field services are
recognized as the services are performed. Oil field supply and equipment sales
are recognized when the goods are shipped to the customer.
Net Loss Per Common Share - Net loss per common share is computed by dividing
the net loss applicable to common stockholders (which includes accrued but
unpaid preferred dividends) by the weighted average number of common shares
outstanding during the year. All common stock equivalents have been excluded
from the computations because their effect would be anti-dilutive.
In connection with the 1995 conversion of preferred stock to common stock
discussed in Note 6, the Company experienced a significant change in its capital
structure. The pro forma effect of these changes, as if the conversions occurred
on January 1, 1995, would have resulted in a reduction in the 1995 loss
applicable to common stockholders before non-cash inducement from $.18 per share
to $.14 per share. The pro forma loss per share calculations give effect to
4,257,455 common shares which
F-9
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
were issued in the conversion and the elimination of dividends related to the
converted preferred shares of approximately $117,000 for 1995. However, the pro
forma information does not give effect to the inducement discussed in the
following paragraph.
The Company completed a tender offer to the Company's preferred stockholders in
February 1995. In connection therewith, the Company offered the preferred
holders 4.5 common shares for each preferred share owned. The 4.5 shares
represented an increase from the original terms of the preferred stock which
provided for 2.625 common shares for each preferred share. Under a recently
issued accounting pronouncement, the Company was required to reduce earnings
available to common stockholders by the fair value of the additional shares
which were issued to induce the preferred stockholders to convert their shares.
Since the Company issued an additional 1,750,000 common shares in the tender
offer compared to the shares that would have been issued under the original
terms of the preferred stock, the Company was required to deduct the fair value
of these additional shares of $1,523,906 from earnings available to common
stockholders. This non-cash charge resulted in the reduction of earnings per
share by $.24 for the year ended December 31, 1995.
While this charge is intended to show the cost of the inducement to the owners
of the Company's common shares immediately before the tender offer, management
does not believe that it accurately reflects the impact of the tender offer on
the Company's common stockholders. As disclosed to the preferred stockholders in
connection with the tender offer, the book value per share of common stock
increased from a negative amount to approximately $1.00 per share as a result of
the tender offer. Therefore, management believes that, even though the current
accounting rules require the $.24 charge per common share, there are other
significant offsetting factors by which the common shareholders benefited from
this conversion which are not reflected in the 1995 earnings per share
presentation.
Stock-Based Compensation - The Company accounts for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Accordingly, compensation cost for stock options granted to
employees is measured as the excess, if any, of the quoted market price of the
Company's common stock at the measurement date (generally, the date of grant)
over the amount an employee must pay to acquire the stock. In October 1995, the
Financial Accounting Standards Board issued a new statement titled "Accounting
for Stock-Based Compensation" (FAS 123). FAS 123 requires that options,
warrants, and similar instruments which are granted to non-employees for goods
and services be recorded at fair value on the grant date. Fair value is
generally determined under an option pricing model using the criteria set forth
in FAS 123.
Reclassifications - Certain reclassifications have been made to the 1995
financial statements to conform to the presentation in 1996. The
reclassifications had no effect on the 1995 net loss.
2. RESTRUCTURING:
During 1995, in light of declining natural gas prices, declining rig counts,
lackluster margins and the competitive environment inherent in the oil and gas
industry, the Company undertook steps to reduce
F-10
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
operating costs, increase efficiencies, reduce operating risks and generate
additional working capital. During the second quarter of 1995, the Company
announced a restructuring program that included substantially downsizing its
service and supply businesses and closing its administrative office in Denver,
Colorado. As a result of this restructuring, 35 of the Company's 70 employees
were terminated, and service equipment, land and buildings were sold.
As of December 31, 1995, the Company recognized $226,986 of costs incurred in
connection with both the tender offer discussed in Note 6, and the restructuring
discussed above. The costs recognized in the restructuring consist primarily of
severance pay, a loss on the abandonment of the office lease, and a $90,000 loss
from the liquidation of inventory at an auction.
For the year ended December 31, 1995, the operating revenues and net operating
loss of the service and supply businesses, exclusive of restructuring charges
and gains on sales of assets, were as follows:
Revenues $1,302,741
Operating costs (1,391,588)
Depreciation (157,380)
---------------------
Net operating loss $(246,227)
Substantially, all of the 1995 net operating loss from these operations was
incurred prior to completion of the restructuring discussed above.
3. DEBT FINANCING ARRANGEMENTS:
Long-Term Debt - Long-term debt at December 31, 1996 and 1995, consists of the
following:
1996 1995
-------------- ------------
Unaffiliated Parties:
Collateralized convertible 10% debentures due
April 2001. See discussion below under the
caption "Convertible Debt and Consulting Agreement: $3,267,830 $ -
Other installment notes. Interest at 6.9% to 9.75%,
monthly principal and interest payments of
approximately $3,440 through 1998. All of the
notes are collateralized by vehicles. 52,555 85,423
Contract payable, $4,444 credited monthly against gas
purchases, due July 1997, collateralized by
certificate of deposit. 13,334 66,667
F-11
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1996 1995
--------------- ---------
Note payable to a bank, interest at prime plus 3%. - 1,762,802
Convertible 12% debentures, due May 1996, convertible
into 82,353 share of common stock. - 70,000
--------------- ---------
Total unaffiliated parties 5,065,889 1,984,892
--------------- ----------
Related Parties:
Note payable to the Company's president and CEO.
Interest at 6% annual principal payments of
$65,000 due January 1997 and 1998. The note is
convertible into common stock at $5.00 per share
and is collateralized by equipment. 130,000 130,000
Unsecured notes payable to the Company's president
and CEO and various entities controlled by him.
Interest at 8% to 10% with principal and interest
due January 1, 1997. 116,719 176,717
Accrued interest 39,177 32,024
---------- ---------
Total related parties 285,896 338,741
---------- ---------
Total long-term debt 5,351,785 2,323,633
Less current maturities:
Related parties (285,896) -
Other (45,944) (1,100,474)
---------- ----------
Total long-term debt, less current maturities $5,019,945 $1,223,159
========== ==========
In March 1996, the Company's president agreed to extend the due date of a
delinquent $60,000 note payable to him. As consideration for the extension, the
Company's Board of Directors approved amending the note to provide for
conversion to common stock at $1.00 per share. In December 1996, the president
exercised the conversion feature. The Company's Board of Directors has resolved
to repay all outstanding loans from related parties during 1997. Accordingly,
all such amounts are included in current liabilities in the 1996 balance sheet.
F-12
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Aggregate Debt Maturities - The aggregate maturities of long-term debt,
including the discount associated with the convertible debenture, are as
follows:
Year Ending Related
December 31, Parties Others Total
1997 $285,896 $45,944 $331,840
1998 - 19,945 19,945
2001 - 5,000,000 5,000,000
------------- ----------- -----------
$285,896 $5,065,889 $5,351,785
============= =========== ===========
Convertible Debt and Consulting Agreement - In March 1996, the Company entered
into a consulting agreement with a company (the "Consultant") that specializes
in developing and implementing capitalization plans, including the utilization
of debt capital in business operations. The initial term of the agreement is for
two years and provides for minimum monthly cash payments of $17,500. The
Consultant can elect to extend the agreement for an additional period of one
year. In addition to cash compensation, the Company agreed to grant warrants to
purchase 1,000,000 shares of the Company's common stock. The exercise price of
the warrants is $.75 per share and they expire in March 2001.
In April 1996, the Company, with the assistance of the Consultant, initiated a
private placement to sell up to $5,000,000 of collateralized convertible
debentures in the form of "Units". Each Unit consists of one $50,000 five-year
10% collateralized convertible debenture and detachable warrants to purchase
25,000 shares of the Company's common stock at $1.25 per share (see Note 7 for
additional information with respect to the warrants). Between May and November
1996, the offering was sold to various investors and the Company was successful
in selling the entire $5,000,000 generating net cash proceeds of $4,300,000. The
estimated fair value of the detachable warrants of $1,829,000 is treated as a
discount and is being amortized using the interest method, resulting in a
balance of $1,732,170 at December 31, 1996. Accordingly, the collateralized
convertible 10% debentures consisted of the following at December 31, 1996:
Convertible debentures, interest at 10%
collateralized by certain oil and gas properties,
due April 2001 $ 5,000,000
Less unamortized discount (1,732,170)
$ 3,267,830
The debentures are collateralized by a first priority interest in certain oil
and gas properties owned and operated by the Company.
F-13
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The debentures are convertible, at the holders option, into the Company's common
stock for $3.00 per share and may be redeemed by the Company, in whole or in
part, beginning at a premium of 110% of the original principal amount and are
subject to adjustment beginning on April 25, 1999. Interest on the debentures is
payable quarterly commencing on September 30, 1996 and the entire principal
balance is due on April 15, 2001.
The Company also agreed to pay the Consultant a fee equal to 2% of the net
proceeds from the private placement and up to 7% from the net proceeds from any
warrants which are exercised during the term of the agreement or up to six
months after termination in certain circumstances. All of the compensation paid
to the Consultant is limited to 15% of the gross proceeds generated from the
private placement, exercise of warrants, or other debt or equity financings that
may be consummated during the term of the agreement. In August 1996, a major
shareholder of the Consultant was elected to the Company's Board of Directors.
4. INCOME TAXES:
The Company's income tax benefit for the years ended December 31, 1996 and 1995
consists of the following:
1996 1995
------------ ----------
Current benefit (provision) $41,409 $(21,000)
Deferred benefit - 400,000
------------ -----------
Total $41,409 $379,000
============ ===========
A reconciliation of the income tax benefit at the statutory rate to the income
tax benefit reported in the accompanying financial statements is as follows:
1996 1995
------------ ----------
Computed tax benefit at the expected statutory rate $494,000 $389,100
State income taxes and other 39,000 10,900
Federal income taxes assessed in audit - (21,000)
Increase in valuation allowance (533,000) -
Federal income tax refund 41,409 -
------------- ----------
Total $41,409 $379,000
============= ==========
F-14
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred tax assets (liabilities) as of December 31, 1996 and 1995 are comprised
of the following:
1996 1995
--------------- ----------
Long-term Assets:
Net operating loss carryforwards $3,616,000 $3,050,000
Tax credit carryforwards 294,000 294,000
Percentage depletion carryforwards 58,000 58,000
Other 25,000 45,000
-------------- -----------
Total 3,993,000 3,447,000
Less valuation allowance (1,770,000) (1,237,000)
-------------- ------------
2,223,000 2,210,000
Long-term liability for property and equipment (2,223,000) (2,210,000)
-------------- ------------
Net long-term liability $ - $ -
============== ============
The Company has provided a valuation allowance for the net operating loss and
credit carryforwards based upon the various expiration dates and the limitations
which exist under IRS Sections 382 and 384.
During the year ended December 31, 1996, the Company increased the valuation
allowance by $533,000 primarily due to an increase in the net operating loss
carryforwards which are not considered to be realizable.
At December 31, 1996, the Company has net operating loss carryforwards for
income tax purposes of approximately $9,600,000, which expire primarily in 2008
through 2011. Approximately $2,880,000 of these net operating losses are subject
to limitations under IRS Sections 382 and 384. These losses may only offset
future taxable income to the extent of approximately $335,000 per year and
generally may not offset any gain on the sale of assets acquired in the
acquisition of Skaer Enterprises, Inc. Additionally, the Company has tax credit
carryforwards at December 31, 1996, of approximately $294,000 and percentage
depletion carryforwards of approximately $150,000.
5. COMMITMENTS AND CONTINGENCIES:
Gas Contracts - The Company operates a natural gas processing plant (the "Gas
Plant"). The Company had a contract with a major utility which called for the
major utility to purchase a minimum of 2.92 billion cubic feet ("BCF") and a
maximum of 3.65 BCF of natural gas annually. The price paid by the major utility
was on an MMBTU basis above the Colorado Interstate Gas Company's Northern
Pipeline "spot" price. The contract expired on June 30, 1996.
Historically, the price paid under this contract was at a premium above the
market which allowed the Company to conduct its marketing and trading
activities. The expiration of this contract and the corresponding loss of the
market premium resulted in the elimination of the Company's marketing and
F-15
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
trading activities beginning in July 1996. Management is continuing to explore
alternatives with the major utility and other purchasers of natural gas in order
to maximize the Company's natural gas revenue.
The Company also had a contract with an independent producer that required
purchases of gas quantities at a fixed margin per MMBTU for any difference
between plant sales and the contract volumes with the utility. This contract
also expired in June 1996. The revenue and corresponding costs incurred pursuant
to these contracts have been reflected as Gas Marketing and Trading in the
consolidated statements of operations.
Leases - The Company leases its office facilities under noncancellable operating
leases. The total minimum commitments under these leases amounted to
approximately $100,000 as of December 31, 1996. Total rent expense under all
operating leases for the years ended December 31, 1996 and 1995, was $26,807 and
$90,569, respectively.
Employment Agreements - During 1994, the Board of Directors approved employment
agreements with the Company's executive officers. The agreements may be
terminated by the officers upon 90 days notice or by the Company without cause
upon 30 days notice. In the event of a termination by the Company without cause,
the Company would be required to pay the officers their respective salaries for
one to three years. If the termination occurs following a change in control, the
Company would be required to make lump sum payments equivalent to two to three
years salary for each of the officers.
Profit Sharing Plan - The Company has established a 401(k) profit sharing plan
that covers all employees with one month of service who elect to participate in
the Plan. The Plan provides that the employees may elect to contribute up to 15%
of their salary to the Plan. All of the Company's contributions are
discretionary and amounted to $8,926 and $2,996 for the years ended December 31,
1996 and 1995, respectively.
Contingencies - The Company may from time to time be involved in various claims,
lawsuits, disputes with third parties, actions involving allegations of
discrimination, or breach of contract incidental to the operations of its
business. The Company is not currently involved in any such incidental
litigation which it believes could have a materially adverse effect on its
financial condition or results of operations.
6. PREFERRED STOCK:
The Company has the authority to issue up to 2,000,000 shares of Preferred
Stock, which may be issued in such series and with such preferences as
determined by the Board of Directors. During 1993, the Company issued 1,170,000
shares of Series A Cumulative Convertible Preferred Stock (the "Preferred
Stock").
At December 31, 1996, the Preferred Stock had a liquidation preference of $12.25
per share ($10 liquidation value plus $2.25 of dividends in arrears), and each
share of Preferred Stock was
F-16
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
convertible into 3.0625 shares of common stock and warrants to purchase 3.0625
common shares. Each warrant entitles the holder to purchase one share of common
stock at $6.00 per share through August 13, 1998, when the warrants expire. The
Preferred Stock will automatically convert into common stock if the reported
sale of Preferred Stock equals or exceeds $13.00 per share for ten consecutive
days. The Company may redeem the Preferred Stock at $10.00 per share plus any
dividends in arrears. Each share of Preferred Stock is entitled to receive
dividends at 10% per annum when, as and if declared by the Company's Board of
Directors. Unpaid dividends accrue and are cumulative.
In February 1995, the Company completed a tender offer to the preferred
stockholders whereby the holders of the Preferred Stock were given the
opportunity to convert each share of Preferred Stock and all accrued and
undeclared dividends (including the full dividend for the quarters ended
December 31, 1994 and March 31, 1995) into 4.5 shares of the Company's common
stock. As a result of this tender offer, 933,492 shares of the preferred stock
converted into 4,200,716 shares of the Company's common stock. In connection
with the tender offer and other conversions of preferred stock through December
31, 1996, warrants for an aggregate of 2,605,900 shares are outstanding.
Through December 31, 1996, the Board of Directors has elected to forego the
declaration of the regular quarterly dividend for five consecutive quarters
resulting in dividends in arrears of approximately $405,000 ($2.25 per share)
related to 179,938 outstanding shares of Preferred Stock. The Company is
precluded from paying dividends on its common stock so long as any dividends on
the Preferred Stock are in arrears. The terms of the Preferred Stock prohibited
the Company from entering into certain transactions without an affirmative vote
of the preferred stockholders. Otherwise, the preferred stockholders have no
voting rights.
In connection with the Company's 1993 preferred stock offering, the Company
issued warrants to the underwriter to purchase 90,000 shares of preferred stock
at $12.00 per share. If not previously exercised, these warrants will expire in
August 1998. In 1993, the Company also granted warrants to a consultant for the
purchase of 60,000 shares of common stock. The warrants are exercisable for
$6.00 per share and expired in November 1996.
7. STOCK BASED COMPENSATION:
Stock Option Plans - The Company's shareholders have approved four stock option
plans that authorize an aggregate of 900,000 shares for stock options that may
be granted to officers, directors, employees, and consultants. The dates the
plans, along with the corresponding number of options, that were adopted by the
Company's stockholders are as follows: June 14, 1991, 100,000 shares; June 25,
1993, 300,000 shares; June 3, 1994, 150,000 shares and August 10, 1996, 350,000
shares. The plans permit the issuance of incentive and non-statutory options and
provide for a minimum exercise price equal to 100% of the fair market value of
the Company's common stock on the date of grant. The maximum term of options
granted under the plans is 10 years and options granted to employees expire
three months after the termination of employment. None of the options may be
exercised during the first six months of the option term.
F-17
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
No options may be granted after 10 years from the adoption date of each plan.
The following is a summary of activity under these stock option plans for the
years ended December 31, 1996 and 1995:
1996 1995
------------ ----------------
Weighted Weighted
Average Average
Number Exercise Number Exercise
of Shares Price of Shares Price
Outstanding, beginning of year 459,600 $.94 347,000 $ 3.53
Canceled - - (224,000) 3.43
Expired (4,000) 7.19 (99,000) 3.70
Granted 165,700 1.39 435,600 .79
---------- ----- ------ ---------
Outstanding, end of year 621,300 1.02 459,600 .94
========== ===== ========= =========
For all options granted during 1996 and 1995, the weighted average market price
of the Company's common stock on the grant date was approximately equal to the
weighted average exercise price. At December 31, 1996, options for 542,000
shares were exercisable and options for the remaining 79,300 shares became
exercisable in February 1997. If not previously exercised, options outstanding
at December 31, 1996, will expire as follows:
Weighted
Average
Number Exercise
Year Ending December 31, of Shares Price
1997 5,000 $3.44
1998 15,000 2.94
2000 295,600 .83
2000 140,000 .70
2001 86,400 1.00
2001 79,300 1.81
------------
621,300
Warrants and Non-Qualified Stock Options - The Company has also granted warrants
and non-qualified options which are summarized as follows for the years ended
December 31, 1996 and 1995:
F-18
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1996 1995
------------------------ -------------------------
Weighted Weighted
Average Average
Number Exercise Number Exercise
of Shares Price of Shares Price
<S> <C> <C> <C> <C>
Outstanding, beginning of year .......... 3,359,418 $ 5.00 232,302 $ 4.05
Granted to:
Officer and director ............ 101,500 1.00 -- --
Consultants ..................... 1,090,000(a) .75 358,000 .97
Former officer and director ..... -- -- 77,000 3.61
Investors in private placements of:
Common stock ............... -- -- 1.25 250,000 1.25
Convertible debentures ..... 2,500,000 1.25 -- --
Brokers in private placement of
convertible debentures 223,500(b) 2.00 -- --
Issued to former holders of preferred
stock upon conversion 69,670 6.00 2,507,116 6.00
Repriced ............................. -- -- (15,000) 6.00
Expired .............................. (60,000) 6.00 (50,000) .85
Exercised ............................ (67,500) .95 -- --
---------- ---------- ----------- --------
Outstanding, end of year ................ 7,216,588 2.94 3,359,418 5.00
========== ========== =========== ========
</TABLE>
(a) Of such amount, warrants to purchase up to 1,000,000 shares were granted to
Beta Capital Group, Inc. in connection with a two-year consulting agreement. See
Note 3, "Convertible Debt and Consulting Agreement."
(b) Of such amount, warrants entitling the holder to purchase up to 11,137
shares were issued to Steve Antry, the President of Beta Capital Group, Inc. for
his services as a broker in connection with placement of the convertible
debentures.
F-19
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All outstanding warrants and non-qualified options were exercisable at December
31, 1996. If not previously exercised, warrants and non-qualified options
outstanding at December 31, 1996, will expire as follows:
Weighted
Average
Number Exercise
Year Ending December 31, of Shares Price
------------------------ --------------- -----------
1997 400,000 $1.25
1998 2,605,900 6.00
1998 118,188 1.51
1999 223,500 2.00
1999 50,000 3.34
2000 118,000 .76
2000 77,000 3.61
2001 1,040,000 .75
2001 101,500 1.00
2001 2,482,500 1.25
----------------
Total 7,216,588
Presented below is a comparison of the weighted average exercise price and
market price of the Company's common stock on the measurement date for all
warrants and stock options granted to non-employees during 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
-------------------------------- -------------------------------
Number of Exercise Market Number of Exercise Market
Shares Price Price Shares Price Price
Market price equal to
<S> <C> <C> <C> <C> <C> <C>
exercise price 101,500 $ 1.00 $ 1.00 118,000 $ .76 $ .76
Market price greater than
exercise price 50,000 .85 1.00 - - -
Exercise price greater than 3,763,500 1.16 .69 567,000 1.50 .79
market price
</TABLE>
Fair value of all warrants and stock options granted to non-employees during the
year ended December 31, 1996, was determined using the Black-Scholes option
pricing model. Significant assumptions included a risk-free interest rate of
6.5%, expected volatility of 63%, and that no dividends would be declared during
the expected term of the options. The weighted average contractual term of the
options was approximately 4.8 years compared to a weighted average expected term
of 1.9 years.
F-20
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair value of warrants granted to non-employees in 1996 amounted
to $600,000, which is recorded as a debt issuance cost in the 1996 balance
sheet.
In connection with private placements of debt and equity securities, the Company
granted common stock purchase warrants that are redeemable at the option of the
Company. Presented below is a summary of these warrants:
Redemption
Year Expiration Exercise Number of Price Per
Granted Date Price Shares Share
1994 August 1998 $1.92 83,188 $.25
1995 April 1997 1.25 250,000 .25
1996 July 2001 1.25 2,500,000 .10
In December 1996, the Company provided notice of redemption to the holders of
the warrants granted in 1995. Accordingly, the holders must exercise their
warrants by January 31, 1997 or accept the redemption price (see Note 11).
Pro Forma Stock-Based Compensation Disclosures - The Company applies APB Opinion
25 and related interpretations in accounting for stock options and warrants
which are granted to employees. Accordingly, no compensation cost has been
recognized for grants of options and warrants to employees since the exercise
prices were not less than the fair value of the Company's common stock on the
grant dates. Had compensation cost been determined based on the fair value at
the grant dates for awards under those plans consistent with the method of FAS
123, the Company's net loss and loss per share would have been changed to the
pro forma amounts indicated below.
Year Ended December 31,
1996 1995
Net loss applicable to common stockholders:
As reported $(1,614,270) $ (2,609,030)
Pro forma (1,764,270) (2,772,030)
Net loss per common share:
As reported $ (.22) $ (.42)
Pro forma (.24) (.45)
F-21
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each employee option and warrant granted in 1996 and 1995 was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions:
Year Ended December 31,
1996 1995
Expected volatility 64% 61%
Risk-free interest rate 6.5% 6.5%
Expected dividends - -
Expected terms (in years) 3.4 3.3
8. FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107 requires all entities to
disclose the fair value of certain financial instruments in their financial
statements. Accordingly, at December 31, 1996, management's best estimate is
that the carrying amount of cash, receivables, notes payable to unaffiliated
parties, accounts payable, and accrued expenses approximates fair value due to
the short maturity of these instruments. Management estimates that fair value is
approximately equal to carrying value of the convertible debentures since market
interest rates have not changed significantly since the offering commenced.
Management estimates that fair value differs from carrying value for the
following instruments as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
------------------------ -----------------------
Carrying Fair Carrying Fair
Value Value Value Value
<S> <C> <C> <C> <C>
Long-term portion of accrued $256,088 $225,000 $379,652 $335,000
production taxes
Notes payable to related parties 285,896 271,000 338,741 300,000
</TABLE>
Fair value of the above debt instruments was estimated using market interest
rates at December 31, 1996 for debt with comparable terms.
F-22
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. SIGNIFICANT CONCENTRATIONS:
Substantially all of the Company's accounts receivable at December 31, 1996 and
1995, result from crude oil, natural gas sales, and joint interest billings to
companies in the oil and gas industry. This concentration of customers and joint
interest owners may impact the Company's overall credit risk, either positively
or negatively, since these entities may be similarly affected by changes in
economic or other conditions. In determining whether or not to require
collateral from a customer or joint interest owner, the Company analyzes the
entity's net worth, cash flows, earnings, and/or credit ratings. Receivables are
generally not collateralized; however, receivables from joint interest owners
are subject to collection under operating agreements which generally provide
lien rights. Historical credit losses incurred on trade receivables by the
Company have been insignificant.
The Company's oil and gas properties are predominantly located in a single basin
in which the gas marketing arrangements are influenced by local supply and
demand. Accordingly, in comparison to the net price received by gas producers in
many other areas of the United States, the Company often realizes a lower net
sales price. Additionally, since the Company's gas plant is located in this
basin and its oil field service and supply operations are conducted in this
basin, the Company is vulnerable to a curtailment in drilling activity in order
to realize the value of oil field inventories and related operating assets.
At December 31, 1996, the Company had a receivable from a single customer for
$67,718, which was collected in January 1997. For the years ended December 31,
1996 and 1995, the Company had natural gas sales to the major utility discussed
in Note 5 which accounted for 34% and 46% of total revenues, respectively. For
the year ended December 31, 1996, the Company also had oil sales to a single
customer which accounted for 11% of total revenues.
At December 31, 1996, the Company has temporary cash investments of $1,941,550
with a single financial institution. The Company does not maintain insurance to
cover the risk that cash and temporary cash investments with a single financial
institution may be in excess of amounts insured by federal deposit insurance.
10. FOURTH QUARTER ADJUSTMENTS:
During the fourth quarter of 1996, the Company recognized a charge of $450,000
for drilling costs related to an unsuccessful well. This charge is included in
dry holes, plugging and abandonments in the 1996 statement of operations.
F-23
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. SUBSEQUENT EVENTS (UNAUDITED):
Property Acquisitions - In January 1997, the Company completed the acquisition
of a 7.8125% after prospect payout working interest in a producing oil and gas
prospect in Louisiana. The prospect is operated by Natural Energy Group, Inc.
(NEGX), an independent oil and gas producer. The purchase price was $1,750,000
which consisted of $875,000 in cash and the issuance of 315,000 shares of the
Company's common stock with a fair value of $875,000. In February 1997, the
Company entered into agreements with unaffiliated parties for the purchase of a
10% working interest in this prospect. The purchase price totals $2.5 million
and the agreements provide for an effective date of October 16, 1996. NEGX is
the operator of these properties.
In February 1997, the Company entered into an agreement with NEGX that provides
the Company with the right and the obligation to participate as a 12.5% working
interest owner in NEGX's defined drilling program. The agreement provides that
the Company will be required to pay 16.7% of the costs to earn its 12.5%
interest, under certain circumstances. The Company is also committed to
participate in other prospects operated by NEGX through February 1999 when the
initial term of the agreement expires. Management estimates that the Company's
capital requirements under this agreement will be between $5 million and $20
million for the year ending December 31, 1997.
Financing Arrangements - In January 1997, the Company commenced a private
placement of up to 1,500,000 shares of common stock for $2.50 per share. In
connection with the private placement, the Company agreed to use its best
efforts to register the shares for sale by including such securities in a
registration statement. As of March 10, 1997, the Company had received
subscriptions for the entire 1,500,000 shares resulting in total proceeds of
$3,750,000. Commissions and other costs of the offering are estimated to be
approximately 10% of the gross proceeds.
Through March 25, 1997, options and warrants were exercised for an aggregate of
1.65 million shares, resulting in net proceeds of $1.9 million.
In February 1997, the Company entered into a letter of intent with an
underwriter for a proposed private placement of the Company's common stock. The
aggregate gross proceeds of the offering will be at least $6 million unless
otherwise agreed by the parties. The underwriter would receive commissions equal
to 10% of the gross proceeds and warrants to purchase the Company's common
stock.
In January 1997, options for 190,000 shares of the Company's common stock were
granted to officers and directors. The options are exercisable at $2.97 per
share and expire in January 2002.
F-24
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SUPPLEMENTAL OIL AND GAS DISCLOSURES:
Costs Incurred in Oil and Gas Producing Activities - The following is a summary
of costs incurred in oil and gas producing activities for the years ended
December 31, 1996 and 1995:
1996 1995
----------- ----------
Property acquisition costs $16,022 $60,000
Development costs 806,564 161,000
Exploration costs 555,685 -
----------- ----------
Total $1,378,271 $221,000
========== ========
Results of Operations from Oil and Gas Producing Activities - Results of
operations from oil and gas producing activities (excluding natural gas
marketing and trading, well administration fees, general and administrative
expenses, and interest expense) for the years ended December 31, 1996 and 1995
are presented below.
1996 1995
------------- -------------
Oil and gas sales:
LGPCo $340,000 $373,000
Unaffiliated entities 2,207,000 2,251,000
-------------- -------------
Total oil and gas sales 2,547,000 2,624,000
Exploration and abandonment expenses (556,000) (19,000)
Production costs (1,427,000) (1,617,000)
Depletion, depreciation and impairment (590,000) (742,000)
Imputed income tax benefit (provision) 10,000 (91,000)
-------------- -------------
Results of operations from oil and gas
producing activities $(16,000) $155,000
======== ========
Oil and Gas Reserve Quantities (Unaudited) - Proved oil and gas reserves are the
estimated quantities of crude oil, natural gas, and natural gas liquids which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed oil and gas reserves are those reserves
expected to be recovered through existing wells with existing equipment and
operating methods. The reserve data is based on studies prepared by the
Company's consulting petroleum engineers. Reserve estimates require substantial
judgment on the part of petroleum engineers resulting in imprecise
determinations, particularly with respect to new discoveries. Accordingly, it is
expected that the estimates of reserves will change as future production and
development information becomes available. Approximately 25% of the Company's
proved developed reserves are currently non-producing as certain wells require
workovers, recompletions, or construction of a gathering system to an existing
gas pipeline at an
F-25
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
estimated total cost of $1.4 million. All proved oil and gas reserves are
located in the United States. The following table presents estimates of the
Company's net proved oil and gas reserves, and changes therein for the years
ended December 31, 1996 and 1995.
Changes in Net Quantities of Proved Reserves (Unaudited)
<TABLE>
<CAPTION>
1996 1995
----------------------- ---------------------
Oil . Gas Oil Gas
(Bbls) (Mcf) (Bbls) (Mcf)
<S> <C> <C> <C> <C>
Proved reserves, beginning of year ..... 1,294,000 5,851,000 1,352,000 5,724,000
Purchase of minerals in place .. 7,000 -- 38,000 447,000
Sale of minerals in place ...... (27,000) (26,000) (14,000) (107,000)
Extensions, discoveries, and....
other additions ........... 72,000 455,000 82,000 382,000
Revisions of previous estimates (71,000) (1,035,000) (43,000) (98,000)
Production ..................... (100,000) (412,000) (121,000) (497,000)
---------- ---------- ---------- ----------
Proved reserves, end of year 1,175,000 4,833,000 1,294,000 5,851,000
========== ========== ========== ==========
Proved developed reserves, beginning
of year 1,014,000 4,302,000 794,000 4,206,000
========== ========== ========== ==========
Proved developed reserves, end of year 1,034,000 4,078,000 1,014,000 4,302,000
=========== =========== =========== ===========
</TABLE>
The significant revision in the Company's estimated 1996 proved gas reserves was
related to a reduction in the proved undeveloped reserves in the Loveland Field.
The reduction was necessary due to the limited success of a well drilled during
1996.
Standardized Measure of Discounted Future Net Cash Flows (Unaudited) - Statement
of Financial Accounting Standards No. 69 prescribes guidelines for computing a
standardized measure of future net cash flows and changes therein relating to
estimated proved reserves. The Company has followed these guidelines which are
briefly discussed below.
Future cash inflows and future production and development costs are determined
by applying year-end prices and costs to the estimated quantities of oil and gas
to be produced. Estimated future income taxes are computed using current
statutory income tax rates including consideration for estimated future
statutory depletion and tax credits. The resulting future net cash flows are
reduced to present value amounts by applying a 10% annual discount factor.
F-26
<PAGE>
PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The assumptions used to compute the standardized measure are those prescribed by
the Financial Accounting Standards Board and, as such, do not necessarily
reflect the Company's expectations for actual revenues to be derived from those
reserves nor their present worth. The limitations inherent in the reserve
quantity estimation process, as discussed previously, are equally applicable to
the standardized measure computations since these estimates are the basis for
the valuation process.
The following summary sets forth the Company's future net cash flows relating to
proved oil and gas reserves as of December 31, 1996 and 1995 based on the
standardized measure prescribed in Statement of Financial Accounting Standards
No. 69.
1996 1995
Future cash inflows $46,727,000 $32,620,000
Future production costs (17,220,000) (13,871,000)
Future development costs (3,001,000) (3,269,000)
Future income tax expense (6,200,000) (1,800,000)
--------------- -----------------
Future net cash flows 20,306,000 13,680,000
10% annual discount for estimated (8,326,000) (5,200,000)
timing of cash flow --------------- -----------------
Standardized Measure of Discounted $11,980,000 $8,480,000
Future Net Cash Flows =============== =================
Changes in Standardized Measure (Unaudited) - The following are the principal
sources of change in the standardized measure of discounted future net cash
flows for the years ended December 31, 1996 and 1995:
1996 1995
------------- -----------
Standardized measure, beginning of year $8,480,000 $6,500,000
Sale of oil and gas produced, net of
production costs (1,120,000) (1,006,000)
Purchase of minerals in place 45,000 228,000
Sale of minerals in place (45,000) (80,000)
Net changes in prices and production costs 8,815,000 617,000
Net changes in estimated development costs 233,000 785,000
Revisions of previous quantity estimates (3,769,000) (803,000)
Discoveries, extensions, and other additions 1,089,000 620,000
Accretion of discount 848,000 650,000
Changes in income taxes, net (2,596,000) 969,000
-------------- -----------
Standardized Measure, end of year $11,980,000 $8,480,000
=========== ==========
Gas Plant (Unaudited) - The Company processes most of the natural gas from its
properties in a gas plant owned by the Company. Since the revenues from the
Company's properties are subject to agreements with royalty owners and, in some
cases, other working interest owners, gas processing agreements have been
entered into to set forth the contractual arrangements for processing charges.
Generally, the Company's processing fee consists of ownership of the natural gas
liquids and a portion of the residue gas that results from processing. The
Standardized Measure of Discounted Future Net Cash Flows shown above excludes
the Company's share of the natural gas liquids and residue gas related to the
Company's gas processing activities, as well as marketing and trading
activities.
The Company's reserve engineer has prepared the following estimates for the
reserves related to these activities as of December 31, 1996.
Future net revenues, discounted at 10% $537,000
========
Net quantities:
Natural gas (mcf) 1,514,000
Liquids (bbls) 237,000
13. PRIOR PERIOD ADJUSTMENT:
In March 1998, the Company determined that the value originally assigned to 2.5
million detachable warrants issued in connection with the 1996 private placement
of convertible debentures should be increased by $1,720,000. This amount, plus a
portion of the previously reported debt issuance costs, has been reclassified as
a discount to the convertible debentures. The impact of this adjustment did not
have a material impact on the previously reported results of operations.
However, the carrying amount of the convertible debentures, debt issuance costs
and additional paid-in capital has been restated to change the valuation
assigned to these warrants. The effect of the adjustment to the December 31,
1996 financial statements is summarized as follows:
<TABLE>
<CAPTION>
Convertible Additional
Debentures Debt Issuance Costs Paid-In Capital
<S> <C> <C> <C>
As previously reported $ 5,000,000 $ 1,105,874 $ 17,392,329
Prior period adjustments (1,732,170) (12,395) 1,719,775
------------- ------------------- ---------------
As restated $ 3,267,830 $ 1,093,479 $ 19,112,104
=========== ================ ==============
</TABLE>
See Note 4 for additional information regarding the convertible debt and
detachable warrants.
F-27
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,995,860
<SECURITIES> 0
<RECEIVABLES> 624,948
<ALLOWANCES> 25,000
<INVENTORY> 408,787
<CURRENT-ASSETS> 3,060,622
<PP&E> 15,476,273
<DEPRECIATION> 5,323,128
<TOTAL-ASSETS> 14,888,754
<CURRENT-LIABILITIES> 1,152,928
<BONDS> 3,267,830
0
1,799
<COMMON> 752,682
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 14,888,754
<SALES> 6,050,636
<TOTAL-REVENUES> 6,165,664
<CGS> 4,189,850
<TOTAL-COSTS> 7,150,715
<OTHER-EXPENSES> 2,960,865
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 502,428
<INCOME-PRETAX> (1,452,991)
<INCOME-TAX> (41,409)
<INCOME-CONTINUING> (1,411,582)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,614,270)
<EPS-PRIMARY> (0.22)
<EPS-DILUTED> (0.22)
</TABLE>
